Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the related notes of Latch, Inc. and its subsidiaries included elsewhere in this Report. Some of the information contained in this discussion and analysis contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth in Part I, Item 1A. “Risk Factors,” actual results may differ materially from those anticipated in these forward-looking statements. Unless the context otherwise requires, references in this subsection to “we,” “our,” “Latch” and the “Company” refer to the business and operations of Latch Systems, Inc. (formerly known as Latch, Inc.) and its consolidated subsidiaries prior to the Business Combination and to Latch, Inc. (formerly known as TS Innovation Acquisitions Corp.) and its consolidated subsidiaries following the consummation of the Business Combination.
For a comparison of our results of operations for the years ended December 31, 2020 and December 31, 2019, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Registration Statement on Form S-1 filed with the SEC on June 25, 2021.
Overview
Latch is an enterprise technology company focused on revolutionizing the way people experience spaces by making spaces better places to live, work and visit. Latch has created a full-building operating system, LatchOS, that addresses the essential needs of modern buildings by streamlining building operations, enhancing the resident experience and enabling more efficient interactions with service providers.
The Business Combination
On June 4, 2021, we consummated the previously announced Merger, pursuant to which Merger Sub merged with and into Legacy Latch, with Legacy Latch becoming our wholly owned subsidiary. On the Closing Date, and in connection with the Closing of the Transactions, we changed our name to Latch, Inc. On June 7, 2021, Latch’s common stock and warrants began trading on Nasdaq under the ticker symbols “LTCH” and “LTCHW,” respectively.
See Part I, Item 1. “Business” and Note 1, Description of Business, in Part II, Item 8. “Financial Statements” for additional detail about the Business Combination.
Key Factors Affecting Our Performance
We believe that our future success will be dependent on many factors, including those further discussed below. While these areas represent opportunities for Latch, they also represent challenges and risks that we must successfully address in order to operate and grow our business.
Investing in Research and Development (“R&D”) and enhancing our customer experience. Our performance is significantly dependent on the investments we make in research and development, including our ability to attract and retain highly skilled research and development personnel. We must continually develop and introduce innovative new hardware products, mobile
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applications and other new offerings. If we fail to innovate and enhance our brand and our products, our market position and revenue will likely be adversely affected.
Product introductions and expansion of our platform. We will need to expend additional resources to continue introducing new products, features and functionality to enhance the value of our platform. To date, product introductions have often had a positive impact on our operating results due primarily to increases in revenue associated with sales of new products in the quarters following their introduction. In the future, we intend to continue to release new products and enhance our existing products, and we expect that our operating results will be impacted by these releases.
Category adoption, expansion of our total addressable market and market growth. Our future growth depends in part on the continued consumer adoption of hardware and software products that improve resident experience and the growth of this market. In addition, our long-term growth depends in part on our ability to expand into adjacent markets and international territories in the future.
Key Business Metrics
We review the following key business metrics to measure our performance, identify trends affecting our business, formulate business plans and make strategic decisions that will impact our future operational results. Increases or decreases in our key business metrics may not correspond with increases or decreases in our revenue.
The limitations our key business metrics have as an analytical tool include: (1) they might not accurately predict our future GAAP financial results; (2) we might not realize all or any part of the anticipated contract value reflected in our Total Bookings; and (3) other companies, including companies in our industry, may calculate our key business metrics or similarly titled measures differently, which reduces their usefulness as comparative measures.
The key business metrics presented below represent our key business metrics for the year ended December 31, 2021. We have undertaken a strategic review of these metrics and, beginning with the three months ending March 31, 2022, we anticipate no longer reporting the following metrics as key business metrics: Hardware Bookings, Software Bookings, Total Bookings, Total Booked ARR and Booked Home Units—Cumulative. This change is intended to better align our key business metrics with our internal priorities and business plans for 2022 and beyond. Rather than focusing on bookings-related metrics that represent future target deliveries, we plan to focus on the near-term delivery of software revenue. We intend to continue reporting revenue (GAAP) and net loss (GAAP) as key business metrics during the year ending December 31, 2022, and we also intend to begin reporting software revenue (GAAP) as an additional key business metric.
We anticipate reviewing and reporting new key business metrics beginning with the three months ended March 31, 2022, including “ARR” and “Spaces.” Brief descriptions of these new key business metrics are provided below. We will provide additional detail regarding these key business metrics when we begin reporting them in subsequent periods.
ARR is the value of annual recurring revenue from software or services subscriptions at the end of the period, net of promotional and term discounts.
Spaces is the count of units that actively generate software or services revenue, in alignment with our revenue recognition policy.
Year ended December 31,
(In thousands) 2021 2020 $ Change % Change
GAAP Measures:
Key Performance Indicators:
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Year ended December 31,
(In thousands) 2020 2019 $ Change % Change
GAAP Measures:
Key Performance Indicators:
Bookings
We use Bookings to measure sales volume and velocity of our hardware and software products. Bookings represent written but non-binding LOIs from our customers to purchase Latch hardware products and software services, not reflecting discounts. We sell software services with all our access hardware products. Based on historical experience, we believe there is sufficient or reasonable certainty about the customers’ ability and intent to fulfill these commitments with a target delivery date no longer than 24 months following LOI signature. Bookings (including Hardware and Software Bookings) are adjusted to account for any adjustments made to Booked Home Units—Cumulative, including adjustments for those Bookings that do not ship within a 36-month construction timeframe.
Hardware Bookings
Hardware Bookings represent the total revenue commitment to be recognized at time of shipment of the product. We calculate Hardware Bookings by multiplying the total booked units by the sales price (excluding discounts) for each respective unit. There is typically a lag between Hardware Bookings and recognition of GAAP revenue due to installation timelines with a target delivery date no longer than 24 months following LOI signature.
Software Bookings
Software Bookings represent the total revenue commitment over the life of the software agreement. We calculate Software Bookings by multiplying the total booked units by the subscription price (excluding discounts) and the contract term as outlined in the LOI. There is typically a lag between Software Bookings and recognition of GAAP revenue due to installation timelines and the recognition of Software Revenue over the course of the contract with a target delivery date no longer than 24 months following LOI signature. Our long-term software contracts typically average between five and six years in length.
Booked ARR
We use Booked Annual Recurring Revenue (“ARR”) to assess the general health and trajectory of our recurring software. Booked ARR is defined as the cumulative value of annual recurring revenue from Latch software subscriptions that are under a signed LOI. We calculate Booked ARR by multiplying the total number of units that have been booked by the annual listed subscription pricing (excluding discounts) at the time of booking. LOIs typically deliver within six to 18 months of signing, depending on construction timelines. Booked ARR is adjusted for Bookings that do not ship within a 36-month construction timeframe. It should be viewed differently from Software Bookings as it represents only the average annual software revenue, not the lifetime contract value.
Booked Home Units—Cumulative
We use Booked Home Units—Cumulative to measure the number of homes signed to operate on our platform, market penetration in the rental homes market and the size of the opportunity to grow revenue by increasing sales of additional hardware, software and service revenue into already-signed homes. Booked Home Units represent the total number of apartment units or similar dwellings installed cumulatively, as well as committed to be installed, with Latch products. Booked
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Home Units are adjusted for Bookings that do not ship within a 36-month construction timeframe. LOIs typically deliver within six to 18 months of signing, depending on construction timelines.
Adjusted EBITDA
We define Adjusted EBITDA as our net loss, excluding the impact of stock-based compensation expense, depreciation and amortization expense, interest income, interest expense, provision for income taxes, restructuring, one-time litigation expenses, loss on extinguishment of debt, change in fair value of derivative instruments, warrant liabilities and trading securities, and transaction related expenses. We believe excluding the impact of these items in calculating Adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core operating performance. We monitor, and have presented in this Report, Adjusted EBITDA because it is a key measure used by our management and board of directors to understand and evaluate our operating performance, to establish budgets and to develop operational goals for managing our business. See “Non-GAAP Financial Measures” for additional information and a reconciliation of this measure to net loss, the most directly comparable financial measure calculated and presented in accordance with GAAP.
Components of Results of Operations
Revenue
We currently generate revenue from three sources: (1) hardware devices that are both Latch-built (“first-party”) and partner-built (“third-party”), (2) professional services related to the hardware devices and (3) software products used by property managers via Web or mobile and by residents via mobile.
Hardware and Other Related Revenue
We generate hardware revenue primarily from the sale of our portfolio of both first-party and third-party devices for our smart access and smart building solutions. We sell hardware to building developers directly or through our channel partners who act as an intermediary and installer. We recognize hardware revenue when the hardware is shipped directly to building developers or to our channel partners, which is when control is transferred to the building developer. We provide warranties that our hardware will be substantially free from defects in materials and workmanship for a period of one year for electronic components and five years for mechanical components. We replace, repair or refund warrantable devices at our sole discretion. We also generate revenues related to hardware, which includes professional services related to installation and activation of hardware devices sold to building developers. These services are recognized over time on a percentage of completion basis.
We continue to see the impact of labor and building material shortages and construction delays. We continue to confront production issues due to industry-wide supply chain disruptions that created shortages of certain construction materials and other products, and our customers also experienced trade labor availability constraints and delays. These factors continue to create construction delays for our customers, which have and may continue to delay the timing of our hardware revenue. In addition, we are experiencing higher inventory costs as a result of the global supply chain shortages, which we will continue to incur where economically reasonable in order to prioritize and meet customer demand.
Software Revenue
We generate software revenue primarily through the sale of our SaaS over our cloud-based platform on a subscription-based arrangement. Subscription fees vary depending on the optional features selected by customers as well as the term length. SaaS arrangements generally have term lengths of month-to-month, two-year, five-year and ten-year and include a fixed fee paid upfront except for the month-to-month arrangements. As a result of significant discounts provided to our customers on the longer-term software contracts paid up front, we have determined that there is a significant financing component related to the time value of money and have therefore broken out the interest component. Revenue is primarily recognized on a ratable basis over the subscription period of the contractual arrangement beginning when or as control of the promised services is available or transferred to the customer. We expect software revenue to increase as a percentage of total revenue over time.
Cost of Revenue
Cost of hardware and other related revenue consists primarily of product costs, including manufacturing costs, duties and other applicable importing costs, shipping and handling costs, packaging, warranty costs, assembly costs and warehousing costs, as well as other non-inventoriable costs including personnel-related expenses associated with supply chain logistics and
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direct deployment, outsourced labor costs and channel partner fees. Cost of software revenue consists primarily of outsourced hosting costs and personnel-related expenses associated with monitoring and managing the outsourced hosting service provider. Our cost of revenue excludes depreciation and amortization shown in operating expenses.
We expect some volatility in cost of hardware and other related revenue primarily due to: (i) a new generation of hardware products being released with varying production costs; (ii) recent widespread challenges within the global electronics supply chain leading to a much more tactical sourcing environment and higher production and shipping costs; and (iii) changes to import tariff amounts as a result of changes to U.S. trade policy with China.
Operating Expenses
Operating expenses consist of research and development, sales and marketing, general and administrative and depreciation and amortization expenses.
Research and Development Expenses
Research and development expenses consist primarily of personnel and related expenses for our employees working on our product, design and engineering teams, including salaries, bonuses, benefits, payroll taxes, travel and stock-based compensation. Also included are non-personnel costs such as amounts paid to our third-party contract manufacturers for tooling, engineering and prototype costs of our hardware products, fees paid to third-party consultants, R&D supplies and rent. We expect our research and development expenses to increase in absolute dollars as we continue to make significant investments in developing new products and enhancing existing products.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of personnel and related expenses for our employees working on our sales, customer success, deployment and marketing teams, including salaries, bonuses, benefits, payroll taxes, travel, commissions and stock-based compensation. Also included are non-personnel costs such as marketing activities (trade shows and events, conferences and digital advertising), professional fees, rent and customer support. We expect our sales and marketing expense to increase in absolute dollars as we continue to invest in our sales force and marketing efforts to drive increased market share through new customer acquisition and provide best in class support to our existing customer base.
General and Administrative Expenses
General and administrative expenses consist primarily of personnel and related expenses for our executive, legal, human resources, finance and IT functions, including salaries, bonuses, benefits, payroll taxes, travel and stock-based compensation. Additional expenses included in this category are non-personnel costs such as legal fees, rent, professional fees, audit fees, bad debt expense and insurance costs. During the first quarter of 2021, we incurred stock-based compensation expense from a non-recurring secondary purchase as described in Note 14, Stock-Based Compensation, in Part II, Item 8. “Financial Statements.” Excluding this impact, we expect our general and administrative expenses to increase in absolute dollars primarily due to: (i) the continued growth of our business and related infrastructure; and (ii) legal, accounting, director and officer insurance, investor relations and other costs associated with operating as a public company.
Depreciation and Amortization Expenses
Depreciation and amortization expenses consist primarily of depreciation expense related to investments in property and equipment and internally developed capitalized software.
Other Income (Expense), Net
Other income (expense), net consists of interest expense associated with the significant financing component of our longer-term software contracts, interest expense associated with our debt financing arrangements, interest income on highly liquid short-term investments, gain or loss on extinguishment of debt and gain or loss on change in fair value of derivatives and warrant liabilities.
Income Taxes
The provision for income taxes consists primarily of income taxes related to state jurisdictions in which we conduct business. We maintain a full valuation allowance on our deferred tax assets as we have concluded that it is more likely than not that the deferred assets will not be utilized.
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Results of Operations
The following table summarizes our historical Consolidated Statements of Operations and Comprehensive Loss data. The period to period comparison of operating results is not necessarily indicative of results for future periods:
Year ended December 31,
(In thousands, other than share and per share data)
Revenue:
Cost of revenue(1)
Operating expenses:
Other income (expense)
Change in fair value of derivative liabilities (12,588) (863) (11,725) N.M.
Change in fair value of warrant liability 4,085 — 4,085 N.M.
Change in fair value of trading security 50 — 50 N.M.
Other income (expense) 1 45 (44) (98)
Other comprehensive income (loss)
Unrealized loss on available-for-sale securities (676) — (676) N.M.
Foreign currency translation adjustment (8) 9 (17) (189)
Earnings (loss) per common share:
Basic and diluted net loss per share $ (1.92) $ (9.12)
Weighted average shares outstanding:
(1)Exclusive of depreciation and amortization shown in operating expenses below.
N.M.: Not meaningful
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Comparison of years ended December 31, 2021 and December 31, 2020
Revenue
Revenue increased $23.3 million driven by an $18.9 million increase in hardware and other related revenue and a $4.4 million increase in software revenue. We experienced delays in unit deliveries in the first half of 2020 as a result of the impact of COVID-19 on the residential multi-family construction market, but as the construction market and economy began to improve, hardware unit deliveries started increasing during the third quarter of 2020. The 132% hardware and other related revenue growth is also attributable to accelerated demand, including for new 2021 product releases such as C2, Latch Intercom and third-party smart home devices as well as our new professional services offerings. The software revenue growth of 117% reflects the continued growth in the home units install base as a result of the hardware units delivered in 2020 and 2021.
Cost of Revenue
Cost of revenue increased $23.8 million primarily as a result of the increase in cost of hardware and other related revenue of $23.4 million, which was mainly driven by the costs associated with the increased hardware unit deliveries and increased hardware inventory costs due to the global supply chain challenges.
Research and Development Expenses
Research and development expenses increased $20.5 million primarily due to: (i) $9.9 million of higher stock-based compensation due to the RSUs granted in 2021 and a stock-based compensation charge incurred in the first quarter of 2021 in connection with the sale of shares to investors by certain Company employees and non-employee service providers; and (ii) $9.6 million of higher personnel-related expenses due to increased headcount to invest in new hardware devices as well as our expanded functionality of our LatchOS platform.
Sales and Marketing Expenses
Sales and marketing expenses increased $21.9 million primarily due to: (i) $12.5 million in higher personnel-related expenses due to increased headcount as we invest in our sales force and demand generation team; (ii) $3.5 million of higher stock-based compensation due to the RSUs granted during 2021; (iii) $2.3 million of higher advertising expense; (iv) $1.4 million of higher software license expense due to increased investments made in technology; and (v) $1.2 million in higher travel expenses.
General and Administrative Expenses
General and administrative expenses increased $42.0 million primarily due to: (i) $14.2 million of higher stock-based compensation due to the RSUs granted during 2021 and a stock-based compensation charge incurred in the first quarter of 2021 in connection with the sale of shares to investors by certain Company employees and non-employee service providers; (ii) $6.9 million in higher professional fees, including audit fees, and $6.2 million in higher personnel-related expenses as a result of building out our corporate infrastructure to operate as a public company; (iii) $5.9 million in higher litigation costs as a result of an estimated liability recorded in connection with a dispute with a service provider; (iv) $4.6 million in higher transaction costs and professional advisory fees in connection with the Business Combination; (v) $2.3 million in public company insurance expense; and (vi) $1.8 million of higher bad debt expense.
Depreciation and Amortization Expenses
The increase in depreciation and amortization expenses of $1.9 million was primarily due to the increase in amortization of internally developed software released in 2021.
Total Other Income (Expense), Net
Other expense increased $13.5 million primarily due to: (i) an $11.7 million unfavorable change in the fair value of the derivative liabilities related to our Convertible Notes (as defined below under “—Liquidity and Capital Resources—Indebtedness”) and warrants related to our term loan; (ii) $1.3 million increased loss on extinguishment of debt related to our Convertible Notes; and (iii) $4.6 million higher interest expense primarily related to our Convertible Notes, partially offset by a $4.1 million favorable change in the fair value of the private placement warrants.
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Liquidity and Capital Resources
We have incurred losses since our inception. Prior to the Closing of the Business Combination, our operations were financed primarily through net proceeds from the issuance of our redeemable convertible preferred stock and Convertible Notes, as well as borrowings under our term loan. We received approximately $448.0 million in cash proceeds, net of fees and expenses funded in connection with the Closing, which included approximately $192.6 million from the sale of approximately 19.3 million newly-issued shares of common stock in connection with the Business Combination. See Note 1, Description of Business, in Part II, Item 8. “Financial Statements.” At Closing, we also repaid the $5.0 million term loan and cancelled the associated $5.0 million revolving line of credit described below. Also in connection with the Closing of the Business Combination, $50.0 million outstanding principal amount of Convertible Notes and unpaid accrued interest converted into 6.9 million shares of our common stock. As of December 31, 2021, we had an accumulated deficit of $328.5 million, working capital of $291.8 million, $3.4 million outstanding under our $6.0 million revolving facility with a freight forwarding and customs brokerage company and $124.8 million in cash and cash equivalents. During 2021, we invested in available-for-sale securities, including commercial paper, corporate bonds, U.S. government agency debt securities and asset backed securities. As of December 31, 2021, available-for-sale securities totaled approximately $261.9 million. See Note 3, Investments, in Part II, Item 8. “Financial Statements.” The Company’s available-for-sale securities investment portfolio is primarily invested in highly rated securities, with the primary objective of minimizing the potential risk of principal loss. The Company’s investment policy generally requires securities to be investment grade and limits the amount of credit exposure to any one issuer.
We subcontract with other companies to manufacture our products. During the normal course of business, we and our manufacturers procure components based upon a forecasted production plan. If we cancel all or part of the orders, we may be liable to our suppliers and manufacturers for the cost of the unutilized component orders or components purchased by our manufacturers. Historically, we do not believe there have been any material liabilities that have resulted from cancellation of purchase orders.
Our short-term liquidity needs primarily include working capital for sales and marketing, research and development and continued innovation. Our future capital requirements will depend on many factors, including our levels of revenue, the expansion of sales and marketing activities, market acceptance of our products, the results of business initiatives, the timing of new product introductions and overall economic conditions.
We believe our existing cash and cash equivalents, marketable securities and revolving facility will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months.
Indebtedness
2020 Convertible Notes
Between August 11, 2020 and October 23, 2020, Legacy Latch issued a series of Convertible Notes with a maturity date of April 23, 2022 (subject to the holder’s option to extend the maturity date for a period of one year), for an aggregate principal amount of $50 million (the “Convertible Notes”). The Convertible Notes accrued interest at a rate of 5% per annum for the first six months, 7% per annum for the following six months and 9% per annum from month 13 until maturity, that was due and payable upon the earlier to occur of the maturity date or an event of default, unless otherwise converted prior to maturity or an event of default.
The terms of the Convertible Notes provided for the principal and accrued interest to automatically convert into the type of preferred stock issued in a sale of preferred stock at a specified conversion price. Upon certain corporate transactions or liquidity events, outstanding principal at 1.25 times par value and interest on each Convertible Note would, at the holder’s option, be due and payable in full or be converted into common stock of Legacy Latch at a specified conversion price.
As noted above, in connection with the Closing, $50.0 million outstanding principal amount of Convertible Notes and unpaid accrued interest converted into 6.9 million shares of our common stock.
Revolving Line of Credit and Term Loan
In September 2020, Legacy Latch obtained a revolving line of credit and a term loan, both of which were secured by a first-perfected security interest in substantially all of the assets of Legacy Latch.
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The revolving line of credit provided a credit extension of up to $5.0 million and bore interest at the greater of the prime rate plus 2% or 5.25% per annum, as long as Legacy Latch maintained an Adjusted Quick Ratio (as defined in the credit agreement) of 1.25. If the Adjusted Quick Ratio fell below 1.25, then the revolving line of credit would bear interest at the greater of the prime rate plus 3% or 6.25% per annum. Legacy Latch could only borrow up to 80% of eligible accounts receivable. Legacy Latch did not draw any amounts on the line of credit, which was cancelled upon the repayment in full of the term loan in connection with the Closing.
The available amount under the term loan was an initial $5.0 million, with two additional tranches of $2.5 million each, which Legacy Latch could draw down on in annual increments from closing. The term loan bore interest at the greater of the prime rate plus 3% or 6.25% per annum. The term loan was set to mature on December 1, 2024. On June 4, 2021, the Company paid in full the outstanding principal and accrued interest on the term loan.
Revolving Credit Facility
On July 1, 2021, the Company executed a new revolving credit facility replacing the matured facility described in Note 9, Debt, in Part II, Item 8. “Financial Statements.” The revolving facility has a credit limit of $6.0 million with no stated maturity date. An installment plan agreement is executed for each financing request, which includes the interest rate. The revolving facility has no financial or other covenants. As of December 31, 2021, $3.4 million was outstanding under the revolving credit facility.
Cash Flows
The following table sets forth a summary of our cash flows for the years ended December 31, 2021, 2020 and 2019:
Year Ended December 31,
Effect of exchange rates on cash (6) 13 —
Cash flows for the year ended December 31, 2021 compared to December 31, 2020
Operating Activities
The increase of $52.2 million in net cash used in operating activities reflects the $56.6 million increase in the net loss, after adjusting for non-cash items, and a higher increase in accounts receivable of $18.0 million driven by the higher 2021 revenue, partially offset by:
•a $17.6 million increase in accounts payable and accrued expenses primarily associated with higher expenses to support general business growth and the related timing of payments, in addition to an increase in accrued litigation costs; and
•a $6.2 million increase in deferred revenue primarily due to the growth in long-term software contracts.
Investing Activities
Net cash used in investing activities increased $272.2 million to $277.7 million for the year ended December 31, 2021 from $5.5 million for the year ended December 31, 2020, primarily due to purchases of available-for-sale and trading securities of $268.8 million, net of sales and maturities, and higher spend on internally developed software costs that are capitalized of $1.6 million reflecting increased headcount as well as incremental new functionality being added to our LatchOS platform for future product releases.
Financing Activities
In the year ended December 31, 2021, net cash provided by financing activities consisted of: (i) $448.0 million of net proceeds from the Business Combination; (ii) $3.3 million from the issuance of common stock in connection with exercises
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of stock options; and (iii) $3.4 million of net borrowings under our revolving facility, partially offset by the $5.0 million repayment of the term loan and a $1.8 million payment for tax withholdings on net settlement of RSUs.
In the year ended December 31, 2020, net cash provided by financing activities consisted of: (i) $50.0 million of net proceeds from the issuance of the Convertible Notes; (ii) $10.3 million of net proceeds from the issuance of Series B-1 preferred stock; and (iii) $4.9 million of net proceeds from the issuance of the term loan.
Cash flows for the year ended December 31, 2020 compared to December 31, 2019
Operating Activities
The increase of $6.0 million in net cash used in operating activities reflects the $15.7 million increase in the net loss, after adjusting for non-cash items, partially offset by:
•a higher increase in accounts receivable of $5.2 million in 2019 associated with increased adoption of products;
•a higher investment of $1.1 million in inventories in 2019, primarily associated with the launch of the next generation of the M series product in 2019;
•a $2.3 million increase in deferred revenue in 2020 reflecting the growth in long-term software contracts; and
•a $1.4 million net increase in accounts payable and accrued expenses reflecting the accrual of expenditures incurred related to the Business Combination and to support general business growth, and the related timing of payments.
Investing Activities
In 2020, net cash used in investing activities consisted principally of capitalized internally developed software costs of $5.0 million, primarily reflecting the continued new functionality being added to our LatchOS platform for future product releases.
In 2019, net cash used in investing activities consisted of capitalized software development costs of $2.9 million as a result of new functionality and products being built for our LatchOS platform and the purchase of property and equipment of $0.9 million.
Financing Activities
In 2020, net cash provided by financing activities consisted principally of the net proceeds from the issuance of the Convertible Notes of $50.0 million, Series B-1 preferred stock of $10.3 million and the term loan of $4.9 million, as well as proceeds and subsequent repayment of funds pursuant to the Paycheck Protection Program under the CARES Act.
In 2019, net cash provided by financing activities consisted principally of the net proceeds from the issuance of Series B-1 preferred stock of $56.5 million and convertible promissory notes of $9.0 million.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements as of December 31, 2021 or 2020.
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities in the consolidated financial statements. We base these estimates and judgments on historical experience, projected future cash flows and various other factors that we believe are reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions, and to the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected.
We believe that of our significant accounting policies, which are described in the notes to our consolidated financial statements (see Note 2, Summary of Significant Accounting Policies, in Part II, Item 8. “Financial Statements”), the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe that the following
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accounting policies are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue Recognition
We currently generate revenue primarily from three sources: hardware devices, professional services and software products. Revenue is recognized upon transfer of control of promised goods or services to customers at the transaction price. The Company estimates the transaction price, including variable consideration, at the commencement of the contract and recognizes revenue over the contract term.
To determine the transaction price, we analyze all of the performance obligations included in the contract. We consider the terms of the contract and our customary business practices, which typically include financing components or non-cash consideration. At times, our contracts include consideration payable to a customer in the form of fixed discounts or rebates. We record the consideration payable to a customer as a reduction to the transaction price resulting in a reduction to revenue over the service period.
If we enter into contracts that contain multiple promised services, we evaluate which of the promised services represent separate performance obligations based on whether or not the promised services are distinct and whether or not the services are separable from other promises in the contract. If these criteria are met, then we allocate the transaction price to the performance obligations using the relative stand-alone selling price method at contract inception.
Hardware and Other Related Revenue
We generate hardware revenue primarily from the sale of our portfolio of devices for our smart access and smart apartment solutions. We sell hardware to building developers directly or through our channel partners who act as the intermediary and installer. We recognize hardware revenue when the hardware is shipped directly to building developers or to our channel partners, which is when control is transferred to the building developer.
We provide warranties that our hardware will be substantially free from defects in materials and workmanship for a period of one year for electronic components and five years for mechanical components. We replace, repair or refund warrantable devices at our sole discretion.
We determined these warranties are not separate performance obligations as they cannot be purchased separately and do not provide a service in addition to an assurance the hardware will function as expected. We record a reserve as a component of cost of hardware revenue based on historical costs of replacement units for returns of defective products. Due to our limited operating history, our ability to forecast future operating results, including the estimation of product returns, may differ materially from actual results. We also provide certain customers a wholesale arrangement with a right of return for non-defective products, which is treated as a reduction of hardware revenue based on our expectations and historical experience.
We also generate revenues related to hardware, which includes professional services related to installation and activation of hardware devices sold to building developers. These services are recognized over time on a percentage of completion basis.
Software Revenue
We generate software revenue primarily through the sale of our SaaS to building developers over our cloud-based platform on a subscription-based arrangement. Subscription fees vary depending on the optional features selected by customers as well as the term length. SaaS arrangements generally have term lengths of month-to-month, two-year, five-year and ten-year and include a fixed-fee paid upfront except for the month-to-month arrangements. As a result of significant discounts provided to our customers on the longer-term software contracts paid upfront, we have determined that there is a significant financing component related to the time value of money and have therefore broken out the interest component and recorded as a component of interest income (expense), net on the consolidated statements of operations and comprehensive loss. The interest expense related to the significant financing component is recorded using the effective interest method, which has higher interest expense at inception and declines over time to match the underlying economics of the transaction where the outstanding principal balance decreases over time.
The services provided by us for the subscription-based arrangements are considered stand-ready performance obligations where customers benefit from the services evenly throughout the service period. Revenue is primarily recognized on a ratable basis over the subscription period of the contractual arrangement beginning when or as control of the promised services is available or transferred to the customer.
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Stock-Based Compensation
We compensate our executive officers, board of directors, employees and consultants with stock-based compensation under our stock incentive plans as described in Note 14, Stock-Based Compensation, in Part II, Item 8. “Financial Statements.” We record stock-based compensation expense based upon the award’s grant date fair value. We estimate the fair value of stock options granted on the date of grant using the Black-Scholes-Merton option-pricing model, which requires us to estimate the risk-free interest rate, expected term, expected stock price volatility and dividend yield.
The risk-free interest rate assumption is based upon observed interest rates for constant maturity U.S. Treasury securities consistent with the expected term of our stock options.
The expected term represents the period of time the stock options are expected to be outstanding and is based on the “simplified method.” Under the “simplified method,” the expected term of an option is presumed to be the mid-point between the vesting date and the end of the contractual term. We use the “simplified method” due to the lack of sufficient historical exercise data to provide a reasonable basis upon which to otherwise estimate the expected term of the stock options.
Since we have minimal trading history of our common stock, the expected volatility was derived from the average historical stock volatility of several unrelated public companies within our industry that we consider to be comparable to our business over a period equivalent to the expected term of the awards.
We do not expect any material changes in the near term to the underlying assumptions used to calculate stock-based compensation expense. However, if changes in these assumptions occur, and, should those changes be significant, they could have a material impact on our stock-based compensation expense.
Common Stock Valuations
In the absence of a public trading market at the time of granting stock options prior to the Closing, the fair value of Legacy Latch common stock was determined by the Legacy Latch board of directors, with input from management, taking into account Legacy Latch’s most recent valuations from an independent third-party valuation specialist. Legacy Latch’s board of directors intended all stock options granted to have an exercise price per share not less than the per share fair value of our common stock on the date of grant. The valuations of Legacy Latch common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. The assumptions used in the valuation models were based on future expectations combined with management judgment and considered numerous objective and subjective factors to determine the fair value of Legacy Latch common stock as of the date of each option grant, including the following factors:
•relevant precedent transactions involving Legacy Latch capital stock;
•contemporaneous valuations performed at periodic intervals by unrelated third-party specialists;
•the liquidation preferences, rights, preferences and privileges of Legacy Latch redeemable convertible preferred stock relative to its common stock;
•Legacy Latch’s actual operating and financial performance;
•current business conditions and projections;
•Legacy Latch’s stage of development;
•the likelihood and timing of achieving a liquidity event for the shares of common stock underlying the stock options, such as an initial public offering, given prevailing market conditions;
•any adjustment necessary to recognize a lack of marketability of the common stock underlying the granted options;
•recent secondary stock sales and tender offers;
•the market performance of comparable publicly traded companies; and
•U.S. and global capital market conditions.
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In valuing Legacy Latch common stock at various dates, the Legacy Latch board of directors determined the equity value of the business using various valuation methods, including combinations of income and market approaches, with input from management.
Application of these approaches involved the use of estimates, judgment and assumptions that are highly complex and subjective, such as those regarding Legacy Latch’s expected future revenue, expenses and future cash flows, discount rates, market multiples, the selection of comparable companies and the probability of possible future events. Changes in any or all of these estimates and assumptions or the relationships between those assumptions impact our valuations as of each valuation date and may have a material impact on the valuation of our common stock.
Impairment of Internally Developed Software
Our fixed assets are primarily comprised of capitalized software development. We evaluate the recoverability of our long-lived assets, including capitalized software, for impairment whenever events or circumstances indicate that the carrying amount of the assets may not be recoverable. Recoverability of long-lived assets are measured by comparison of the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Capitalized software is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The amount of impairment loss, if any, is measured as the difference between the carrying value of the asset and its estimated fair value. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded for deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized.
The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
Recent Accounting Pronouncements
See Note 2, Summary of Significant Accounting Policies, in Part II, Item 8. “Financial Statements” for more information.
Non-GAAP Financial Measures
To supplement our financial statements presented in accordance with GAAP and to provide investors with additional information regarding our financial results, we have presented in this Report Adjusted EBITDA, a non-GAAP financial measure. Adjusted EBITDA is not based on any standardized methodology prescribed by GAAP and is not necessarily comparable to similarly titled measures presented by other companies.
We define Adjusted EBITDA as our net loss, excluding the impact of stock-based compensation expense, depreciation and amortization expense, interest income, interest expense, provision for income taxes, restructuring, one-time litigation expenses, loss on extinguishment of debt, gain or loss on change in fair value of derivative instruments, warrant liabilities and trading securities, and transaction related expenses. The most directly comparable GAAP measure is net loss. We believe excluding the impact of these items in calculating Adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core operating performance. We monitor, and have presented in this Report, Adjusted EBITDA because it is a key measure used by our management and board of directors to understand and evaluate our operating performance, to establish budgets and to develop operational goals for managing our business. We believe Adjusted EBITDA helps identify underlying trends in our business that could otherwise be masked by the effect of the expenses that we include in net loss. Accordingly, we believe Adjusted EBITDA provides useful information to investors, analysts and others in understanding and evaluating our operating results, enhancing the overall understanding of our past performance.
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Adjusted EBITDA is not prepared in accordance with GAAP and should not be considered in isolation of, or as an alternative to, measures prepared in accordance with GAAP. There are a number of limitations related to the use of Adjusted EBITDA rather than net loss, which is the most directly comparable financial measure calculated and presented in accordance with GAAP. In addition, the expenses and other items that we exclude in our calculations of Adjusted EBITDA may differ from the expenses and other items, if any, that other companies may exclude from Adjusted EBITDA when they report their operating results.
In addition, other companies may use other measures to evaluate their performance, all of which could reduce the usefulness of Adjusted EBITDA as a tool for comparison.
The following table reconciles Adjusted EBITDA to net loss, the most directly comparable financial measure calculated and presented in accordance with GAAP.
Reconciliation of Net Loss to Adjusted EBITDA
Year Ended December 31,
Provision for income taxes 53 8 50
Change in fair value of derivative liabilities 12,588 863 —
Change in fair value of warrant liability (4,085) — —
Change in fair value of trading security (50) — —
Restructuring costs(2) — 1,065 —
(1)As a result of significant discounts provided to our customers on our longer-term software contracts paid upfront, the Company has determined that there is a significant financing component related to the time value of money and has therefore broken out the interest component and recorded it as a component of interest income (expense), net on the consolidated statements of operations and comprehensive loss. The interest expense is recorded using the effective interest method, which has higher interest expense at inception and declines over time to match the underlying economics of the transaction where the outstanding principal balance decreases over time. Interest expense associated with the significant financing component included in interest (income) expense, net was $3.1 million, $1.5 million and $0.4 million for the years ended December 31, 2021, 2020 and 2019, respectively.
(2)The Company initiated a restructuring plan in the first quarter of 2020 as part of its efforts to reduce operating expenses and preserve liquidity due to the uncertainty and challenges stemming from the COVID-19 pandemic. The restructuring included a RIF involving an approximate 25% reduction in headcount, which resulted in severance and benefit costs for affected employees and other miscellaneous direct costs. These costs are included principally within research and development, sales and marketing, and general and administrative within the consolidated statements of operations and comprehensive loss, based on the department to which the expense relates.
(3)Transaction costs related to the Business Combination. These costs are included within sales and marketing and general and administrative within the consolidated statements of operations and comprehensive loss.
(4)Legal and settlement fees incurred in connection with non-ordinary course litigation and other disputes, including $6.8 million related to an estimated liability recorded in connection with a dispute with a service provider during the year ended December 31, 2021. See Note 11, Commitments and Contingencies,in Part II, Item 8. “Financial Statements.” These costs are included within general and administrative within the consolidated statements of operations and comprehensive loss.
(5)Stock-based compensation and warrant expense associated with equity compensation plans, including $14.6 million related to RSUs granted during the year ended December 31, 2021 and $13.8 million related to the secondary purchase
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transaction during the year ended December 31, 2021. See Note 14, Stock-Based Compensation,in Part II, Item 8. “Financial Statements.”
Emerging Growth Company Status
Following the consummation of the Business Combination, the Post-Combination Company was an emerging growth company (“EGC”), as defined in the 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 elected to use this extended transition period 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) were no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our 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 relied 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 were not required to, among other things: (i) provide an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002; (ii) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act; (iii) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the 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 were eligible to remain an EGC under the JOBS Act until the earliest of (i) the last day of our first fiscal year following the fifth anniversary of the TSIA IPO, (ii) the last date of our fiscal year in which we had total annual gross revenue of at least $1.07 billion, (iii) the date on which it we were deemed to be a “large accelerated filer” under the rules of the SEC with at least $700.0 million of outstanding securities held by non-affiliates, or (iv) the date on which we had issued more than $1.0 billion in non-convertible debt securities during the previous three years.
The Company’s aggregate market value of the voting and non-voting common equity held by non-affiliates, based on the closing price of our common stock of $12.27 on June 30, 2021, was approximately $1.4 billion. As a result, we were deemed to be a large accelerated filer, and ceased to be an EGC, as of December 31, 2021.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We had cash and cash equivalents and available-for-sale securities of approximately $386.6 million as of December 31, 2021. Our cash equivalents and available-for-sale securities are held in money market funds, U.S. government agency debt securities, commercial paper, corporate bonds and asset-backed securities. The primary objective of our investment activities is the preservation of capital, and we do not enter into investments for trading or speculative purposes. We have not been exposed, nor do we anticipate being exposed, to material risks due to changes in interest rates. On June 4, 2021, the Company paid in full the outstanding principal and accrued interest on the term loan and converted the Convertible Notes to common stock. We have a revolving credit facility that includes a fixed interest rate and requires repayment of each financing request within 90 days. A hypothetical 10% increase in interest rates during any of the periods presented would not have had a material impact on our consolidated financial statements.
Foreign Currency Exchange Risk
Substantially all of our revenue and operating expenses are denominated in U.S. dollars and we do not believe that our exposure to foreign currency exchange risk is material to our business, financial condition or results of operations. If a significant portion of our revenue and operating expenses becomes denominated in currencies other than U.S. dollars, we may not be able to effectively manage this risk, and our business, financial condition and results of operations could be adversely affected by translation and by transactional foreign currency conversions.
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Commodity Risk
We are exposed to market risk with respect to commodity price fluctuations for components used in the manufacture of our products. These components are impacted by global pricing pressures, general economic conditions and changes in tariff rates. We strive to offset increases in the cost of these materials through supplier negotiations and global sourcing initiatives. We are also exposed to fluctuations in transportation costs, which may continue to remain at elevated levels depending on freight carrier capacity and fuel prices. Transportation costs are managed by optimizing logistics and supply chain planning. We continue to invest in supply chain initiatives to address industry-wide capacity challenges.
Inflation Risk
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and operating results.
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Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Audit Committee of Latch, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Latch, Inc. and subsidiaries (the “Company”) as of December 31, 2021 and 2020, the related consolidated statements of operations and comprehensive loss, redeemable convertible preferred stock and shareholders’ equity (deficit), and cash flows, for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Deloitte & Touche LLP
(PCAOB ID No. 34)
New York, New York
March 1, 2022
We have served as the Company’s auditor since 2020.
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Latch, Inc. and Subsidiaries
Consolidated Balance Sheets
As of December 31, 2021 and 2020
(in thousands)
Assets
Current assets
Available-for-sale securities - current 158,973 —
Prepaid expenses and other current assets 11,606 3,309
Property and equipment, net 2,039 753
Available-for-sale securities - non-current 102,878 —
Internally developed software, net 12,475 7,416
Current liabilities
Other current liabilities 4,342 —
Term loan, net — 5,481
Convertible notes, net — 51,714
Warrant liability 9,787 —
Other non-current liabilities — 1,051
Commitments and contingencies (see Note 11)
Stockholders’ equity (deficit)
Accumulated other comprehensive income (loss) (676) 9
(1)Shares outstanding for all periods reflect the adjustment for the Exchange Ratio as a result of the Business Combination. Shares issued and outstanding as of December 31, 2021 excludes 738,000 shares subject to vesting requirements. See Note 1, Description of Business.
See accompanying notes to the consolidated financial statements.
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Consolidated Statements of Operations and Comprehensive Loss
Years ended December 31, 2021, 2020 and 2019
(in thousands, except share and per share amounts)
Year Ended December 31,
Revenue:
Cost of revenue(1)(2):
Operating expenses:
Other income (expense)
Change in fair value of derivative liabilities (12,588) (863) —
Change in fair value of warrant liability 4,085 — —
Change in fair value of trading security 50 — —
Other income (expense) 1 45 —
Provision for income taxes 53 8 50
Other comprehensive income (loss)
Unrealized loss on available-for-sale securities (677) — —
Foreign currency translation adjustment (8) 9 —
Net loss per common share:
Basic and diluted net loss per common share $ (1.92) $ (9.12) $ (7.65)
Weighted average shares outstanding:
(1)Exclusive of depreciation and amortization shown in operating expenses below.
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Consolidated Statements of Operations and Comprehensive Loss
Years ended December 31, 2021, 2020 and 2019
(in thousands, except share and per share amounts)
(2)Stock-based compensation expense included in cost of revenue and operating expenses is as follows:
Cost of hardware and other related revenue $ 192 $ 15 $ 50
Cost of software revenue 18 — 1
See accompanying notes to the consolidated financial statements.
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Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)
Years Ended December 31, 2021, 2020 and 2019 (in thousands)
Shares Amount Shares Amount
Retroactive application of Exchange Ratio (5,178) — (564) — — — — —
Exercises of common stock options — — 2,117 — 304 — — 304
Common stock warrants issued — — — — 38 — — 38
Stock-based compensation — — — — 3,667 — — 3,667
Exercises of common stock options — — 1,137 — 226 — — 226
Common stock warrants issued — — — — 391 — — 391
Foreign currency translation adjustment — — — — — 9 — 9
Stock-based compensation — — — — 1,560 — — 1,560
Conversion of Legacy Latch warrants — — 233 — 2,143 — — 2,143
Foreign translation adjustment — — — — — (8) — (8)
Unrealized loss on available-for-sale securities — — — — — (677) — (677)
(1) Excludes 738,000 shares subject to vesting requirements. See Note 1, Description of Business.
See accompanying notes to the consolidated financial statements.
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Consolidated Statements of Cash Flows
Years Ended December 31, 2021, 2020 and 2019 (in thousands)
Year ended December 31,
Operating activities
Adjustments to reconcile net loss to net cash used by operating activities
Change in fair value of derivatives 12,588 863 —
Change in fair value of warrant liability (4,085) — —
Change in fair value of trading security (50) — —
Loss on disposal of property and equipment — 36 —
Provision for excess and obsolete inventory 186 145 150
Changes in assets and liabilities
Prepaid expenses and other current assets (2,450) (1,753) (733)
Other current liabilities 974 — —
Other non-current liabilities 626 1,051 —
Investing activities
Purchase of available-for-sale securities (269,237) — —
Proceeds from sales and maturities of available-for-sale securities 4,644 — —
Purchase of trading security (4,250) — —
Purchase of property and equipment (1,541) (269) (908)
Purchase of intangible assets (700) (199) (4)
Financing activities
Proceeds from issuance of term loan, net of issuance costs — 4,927 —
Repayment of term loan (5,000) — —
Proceeds from unsecured loan — 3,441 —
Repayment of unsecured loan — (3,441) —
Proceeds from issuance of common stock 3,258 226 304
Payments for tax withholding on net settlement of equity awards (1,799) — —
Proceeds from revolving credit facility 7,934 — —
Repayment of revolving credit facility (4,566) — —
Effect of exchange rates on cash (6) 13 —
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Consolidated Statements of Cash Flows
Years Ended December 31, 2021, 2020 and 2019 (in thousands)
Cash and cash equivalents
Supplemental disclosure of cash flow information
Cash paid during the year for:
Income taxes $ 70 $ 8 $ 58
Supplemental disclosure of non-cash investing and financing activities
Capitalization of transaction costs $ — $ 653 $ —
Accrued issuance costs $ — $ 42 $ —
Accrued fixed assets $ 480 $ — $ —
Prepaid expense received as part of business combination $ 510 $ — $ —
See accompanying notes to the consolidated financial statements.
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Latch, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
1.DESCRIPTION OF BUSINESS
Latch, Inc. (referred to herein, collectively with its subsidiaries, as “Latch” or the “Company”) is an enterprise technology company focused on revolutionizing the way people experience spaces by making spaces better places to live, work and visit. Latch has created a full-building operating system, LatchOS, that addresses the essential needs of modern buildings by streamlining building operations, enhancing the resident experience and enabling more efficient interactions with service providers.
On June 4, 2021 (the “Closing Date”), the Company consummated the previously announced merger pursuant to that certain Agreement and Plan of Merger, dated as of January 24, 2021 (the “Merger Agreement”), by and among the Company (formerly known as TS Innovation Acquisitions Corp. (“TSIA”)), Latch Systems, Inc. (formerly known as Latch, Inc. (“Legacy Latch”)) and Lionet Merger Sub Inc., a wholly owned subsidiary of TSIA (“Merger Sub”), pursuant to which Merger Sub merged with and into Legacy Latch, with Legacy Latch becoming a wholly owned subsidiary of the Company (the “Business Combination” and, collectively with the other transactions described in the Merger Agreement, the “Transactions”). In connection with the consummation of the Transactions (the “Closing”), the Company changed its name from TS Innovation Acquisitions Corp. to Latch, Inc. The “Post-Combination Company” following the Business Combination is Latch, Inc.
The Company is located and headquartered in New York, NY. Other offices operated by the Company are in: San Francisco, CA; Denver, CO; and Taipei, Taiwan. In May 2019, the Company incorporated Latch Taiwan, Inc., a wholly-owned subsidiary, in the state of Delaware. In October 2020, the Company incorporated Latch Insurance Solutions, LLC, a wholly owned subsidiary, in the state of Delaware. In September 2021, the Company incorporated Latch Systems Ltd, a wholly owned subsidiary, in England and Wales.The Company’s revenues are derived primarily from operations in North America.
The Business Combination
On January 24, 2021, TSIA entered into the Merger Agreement with Merger Sub and Legacy Latch. Legacy Latch’s board of directors unanimously approved Legacy Latch’s entry into the Merger Agreement.
On June 3, 2021, TSIA held a special meeting of its stockholders (the “Special Meeting”), at which the TSIA stockholders considered and adopted, among other matters, a proposal to approve the Business Combination, including (a) adopting the Merger Agreement and (b) approving the other Transactions contemplated by the Merger Agreement.
On June 4, 2021, the Company consummated the Business Combination and the other Transactions (the “Closing”). The following occurred upon the Closing:
•The mandatory conversion feature upon a business combination was triggered for the Convertible Notes described in Note 9, Debt, causing a conversion of the $50.0 million outstanding principal amount of these Convertible Notes and any unpaid accrued interest into equity securities at a specified price. The noteholders received approximately 6.9 million shares of common stock in the Post-Combination Company. Also, the embedded derivative related to the Convertible Notes was extinguished as part of the Closing.
•The 71.1 million outstanding shares of redeemable convertible preferred stock described in Note 12, Convertible Preferred Stock and Equity, were exchanged for 63.8 million shares of common stock in the Post-Combination Company.
•Legacy Latch repaid in full the outstanding principal and accrued interest on the term loan, described in Note 9, Debt, in the total amount of $5.0 million. The embedded derivative in the warrants issued in connection with the term loan was extinguished as part of the Closing.
•Holders of 5,916 shares of TSIA’s Class A common stock sold in its initial public offering (the “Initial Shares”) properly exercised their right to have such shares redeemed for a full pro rata portion of the trust account holding the proceeds from TSIA’s initial public offering (the “TSIA IPO”), calculated as of two business days prior to the consummation of the Business Combination, which was approximately $10.00 per share, or approximately $0.06 million in the aggregate.
•The shares of TSIA Class B common stock held by TS Innovation Acquisitions Sponsor, L.L.C. (“Sponsor”) automatically converted to 7.4 million shares of common stock in the Post-Combination Company. Of the 7.4 million
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
shares of common stock held by the Sponsor, 0.7 million are subject to vesting under certain conditions (the “Sponsor Earnout Shares”), including that the volume-weighted average price of the Post-Combination Company equals or exceeds $14.00 for any 20 trading days within a 30 trading day period on or prior to the five year anniversary of the Closing.
•Pursuant to subscription agreements entered into in connection with the Merger Agreement, certain investors agreed to subscribe for an aggregate of approximately 19.3 million newly-issued shares of common stock at a purchase price of $10.00 per share for an aggregate purchase price of approximately $192.6 million (the “PIPE Investment”). The PIPE Investment included approximately 0.3 million newly issued shares of common stock at a purchase price of $10.00 per share for an aggregate purchase price of $2.6 million that was used to fund a cash election (see Note 14, Stock-Based Compensation). At the Closing, the Company consummated the PIPE Investment.
•After giving effect to the Transactions, the redemption of Initial Shares as described above and the consummation of the PIPE Investment, there were approximately 140.5 million shares of common stock issued and outstanding (excluding the Sponsor Earnout Shares).
As noted above, an aggregate of $0.06 million was paid from TSIA’s trust account to holders that properly exercised their right to have Initial Shares redeemed, and the remaining balance immediately prior to the Closing of approximately $300.0 million remained in the trust account. The remaining amount in the trust account was used to fund the Business Combination. Latch received approximately $450.0 million in cash proceeds, net of fees and expenses funded in connection with the Closing of the Business Combination, which included approximately $192.6 million from the PIPE Investment mentioned above.
The following table reconciles the elements of the Business Combination to the Consolidated Statement of Cash Flows and the Consolidated Statement of Redeemable Convertible Preferred Stock and Stockholders’ Equity for the year ended December 31, 2021.
Cash - TSIA trust and cash, net of redemptions $ 300,122
Cash - PIPE Investment including cash election 192,550
Less: transaction costs and advisory fees paid (36,783)
Less: Cash election payment (2,313)
Less: issuance and other costs paid (5,621)
Net proceeds from Business Combination 447,955
Less: Accrued issuance costs —
Plus: Prepaid expenses received as part of Business Combination 510
Reverse recapitalization, net of transaction costs $ 434,593
As a result of the Business Combination, each share of Legacy Latch redeemable convertible preferred stock and common stock was converted into the right to receive approximately 0.8971 shares of the common stock of the Post-Combination Company (the “Exchange Ratio”).
Based on the following factors, the Company determined under the Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations, that the Business Combination was a reverse recapitalization.
•Legacy Latch stockholders owned approximately 60.0% of the shares in the Post-Combination Company, and thus had sufficient voting rights to exert influence over the Post-Combination Company.
•Legacy Latch appointed a majority of the Post-Combination Company’s board of directors and maintained a majority of the composition of management.
•Legacy Latch was the larger entity based on historical revenues and business operations and comprised the ongoing operations of the Post-Combination Company.
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
•The Post-Combination Company assumed the name “Latch, Inc.”
The accounting for the transaction was similar to that resulting from a reverse acquisition, except that goodwill or other intangibles were not recognized, and the transaction was followed by a recapitalization.
In accordance with guidance applicable to these circumstances, the equity structure has been recast in all comparative periods up to the Closing Date to reflect the number of shares of the Company’s common stock, par value $0.0001 per share, issued to Legacy Latch’s stockholders in connection with the Business Combination. As such, the shares and corresponding capital amounts and earnings per share related to Legacy Latch redeemable convertible preferred stock and Legacy Latch common stock prior to the Business Combination have been retroactively recast as shares reflecting the Exchange Ratio of 0.8971 established in the Business Combination.
Post-Combination Company common stock and warrants commenced trading on the Nasdaq Stock Market LLC under the symbols “LTCH” and “LTCHW,” respectively, on June 7, 2021.
COVID-19
In March 2020, the outbreak of COVID-19 was declared a pandemic. The COVID-19 pandemic disrupted and may continue to disrupt the Company’s hardware deliveries due to delays in construction timelines at customers’ building sites. In addition, the COVID-19 pandemic resulted in a global slowdown of economic activity and a recession in the United States, and the economic situation remains fluid as parts of the economy appear to be recovering while others continue to struggle. COVID-19 has also affected our supply chain consistent with its effect across many industries, including creating shipping and logistics challenges. We expect these impacts, including potential delayed product availability and higher component and shipping costs, to continue for as long as the global supply chain is experiencing these challenges. We continue to invest in supply chain initiatives to address industry-wide capacity challenges. While the nature of the situation is dynamic, the Company has considered the impact when developing its estimates and assumptions. Actual results and outcomes may differ from management’s estimates and assumptions.
In the first quarter of 2020, the Company initiated a restructuring plan as part of its efforts to reduce operating expenses and preserve liquidity due to the uncertainty and challenges stemming from the COVID-19 pandemic. The Company incurred costs in connection with involuntary termination benefits associated with a reduction in force (the “RIF”), which involved an approximate 25% reduction in headcount, including severance and benefits costs for affected employees and other miscellaneous direct costs. As a result of its strong performance in 2020 and 2021, the Company rehired some of the staff that was terminated at the outset of the pandemic. Restructuring cost of $1.1 million was recorded for the year ended December 31, 2020, principally in research and development, sales and marketing, and general and administrative within the Consolidated Statements of Operations and Comprehensive Loss based on the department to which the expense relates. All amounts have been paid as of December 31, 2021.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted to provide certain relief in response to the COVID-19 pandemic. The CARES Act includes numerous tax provisions and other stimulus measures (see Note 15, Income Taxes). Among the various provisions in the CARES Act, the Company is utilizing the payroll tax deferrals. In the second quarter of 2020, the Company received and repaid $3.4 million in loans under the CARES Act.
2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”).
Principles of Consolidation
The consolidated financial statements include the accounts of Latch, Inc. and its wholly-owned subsidiaries, Latch Systems, Inc., Latch Taiwan, Inc., Latch Insurance Solutions, LLC and Latch Systems Ltd. All intercompany transactions have been eliminated in consolidation.
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
Use of Estimates
The preparation of consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expense during the reporting period. Estimates are used when accounting for revenue recognition, allowance for doubtful accounts, allowance for hardware returns, estimates of excess and obsolete inventory, stock-based compensation, warrants, impairment of fixed assets, investment in trading securities and capitalized internally developed software. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, and makes adjustments when facts and circumstances dictate. These estimates are based on information available as of the date of the consolidated financial statements. Due to the use of estimates inherent in the financial reporting process and given the unknowable duration and effects of the COVID-19 pandemic, among other factors, actual results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash and cash equivalents. Cash and cash equivalents are recorded at cost, which approximates fair value. As of December 31, 2021 and 2020, cash consists primarily of funds held in the Company’s checking accounts, money market funds and commercial paper. The Company considers these money market funds and commercial paper to be Level 1 financial instruments.
The Company’s cash balances exceed the limits that are federally insured. To date, the Company has not recognized any losses caused by uninsured balances.
Marketable Securities
The Company classifies its fixed income marketable securities as available-for-sale based on its intentions with regard to these instruments. Accordingly, marketable securities are reported at fair value, with all unrealized holding gains and losses reflected in stockholders’ equity. If it is determined that an investment has an other-than-temporary decline in fair value, the Company recognizes the investment loss in other income (expense) in the consolidated statements of operations and comprehensive loss. The Company periodically evaluates its investments to determine if impairment charges are required.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are stated at net realizable value, net of allowance for doubtful accounts and reserve for wholesale returns (see “—Revenue Recognition—Hardware and other related” below for further information). On a periodic basis, management evaluates its accounts receivable and determines whether to provide an allowance or if any accounts should be written off based on a past history of write-offs, collections and current credit conditions. A receivable is considered past due if the Company has not received payments based on agreed-upon terms.
The Company generally does not require any security or collateral to support its receivables. The allowance for doubtful accounts was $2.0 million and $0.1 million as of December 31, 2021 and 2020, respectively.
Inventories, Net
Inventories consist of finished goods and component parts, which are purchased from contract manufacturers and component suppliers. Inventories are stated at the lower of cost or net realizable value with cost being determined using the average cost method. The Company periodically assesses the valuation of inventory and writes down the value for estimated excess and obsolete inventory based upon estimates of future demand and market conditions, when necessary.
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
Property and Equipment, Net
Property and equipment are stated at cost less accumulated depreciation and amortization.Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the assets as follows:
Useful lifein years
Office furniture 5
Computers and equipment 3 - 5
Software Development Costs
The Company capitalizes certain development costs incurred in connection with its internally developed software. These capitalized costs are primarily related to its software that is hosted by the Company and accessed by its customers via a mobile or web application on a subscription basis. Costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental, are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. The Company also capitalizes costs related to specific software upgrades and enhancements when it is probable the expenditures will result in additional features and functionality. Maintenance costs are expensed as incurred. Internally developed software is amortized on a straight-line basis over its estimated useful life, generally three to five years. The Company capitalized $7.4 million, $5.0 million and $3.0 million in internally developed software during the years ended December 31, 2021, 2020 and 2019, respectively. Amortization expense related to internally developed software for the years ended December 31, 2021, 2020 and 2019 was $2.4 million, $0.8 million and $0.3 million, respectively. The net book value of capitalized internally developed software at December 31, 2021 and 2020 was $12.5 million and $7.4 million, respectively.
Intangible Assets
The Company’s finite-lived intangible assets consist primarily of acquisitions of an assembled workforce, patents and other intangibles. Intangible assets with finite lives are recorded at their estimated fair value at the date of acquisition and are amortized over their estimated useful lives using the straight-line method. Additionally, the Company has indefinite-lived intangible assets that were acquired, primarily including domain names. Intangible assets consisted of the following as of December 31, 2021 and 2020, included within other non-current assets on the consolidated balance sheets.
Assembled workforce $ 700 $ —
Other intangibles 4 4
Less: Accumulated amortization $ (213) $ (64)
Total intangible assets, net $ 846 $ 295
Total amortization expense for the year ended December 31, 2021 was $0.1 million and less than $0.1 million for both years ended December 31, 2020 and 2019.
The estimated useful life of the intangible assets is as follows:
Useful life in years
Assembled workforce 3
Other intangibles 3 - 13
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
The Company entered into an asset purchase agreement, which was effective in October 2021. The Company evaluated the acquisition under ASC 805, Business Combinations. The acquisition included the purchase of an assembled workforce to support certain of the Company’s business development efforts. The Company performed the screen test and determined that the acquired set did not include any substantive assets outside of the assembled workforce. The assembled workforce represents professional services that the Company was previously obtaining externally prior to the acquisition. The Company determined the acquisition did not qualify as a business as it did not contain any substantive inputs that would be necessary to create any outputs, as a condition of the asset purchase agreement was to wind-down the existing business. Therefore, the Company accounted for the acquisition as an asset acquisition.
Equity Issuance Costs
Costs incurred in connection with the issuance of the Company’s series preferred stock have been recorded as a direct reduction against redeemable convertible preferred stock within the Consolidated Balance Sheets.
Additionally, certain transaction costs incurred in connection with the Merger Agreement that are direct and incremental to the Business Combination (see Note 1, Description of Business) have been recorded as a component of additional paid in capital within the Consolidated Balance Sheets.
Revenue Recognition
The Company adopted Accounting Standards Update (“ASU”) No. 2014-09 and its related amendments (collectively known as ASC 606, Revenue from Contracts with Customers) effective January 1, 2018, using the full retrospective approach to all contracts. Incremental costs to obtaining customer contracts, primarily sales commissions, were capitalized in accordance with the adoption of ASC 606.
In determining the appropriate amount of revenue to be recognized as it fulfills its obligations under its agreements, the Company performs the following steps: (i) identify contracts with customers; (ii) identify performance obligations; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations; and (v) recognize revenue when (or as) the Company satisfies each performance obligation.
A performance obligation is a promise in a contract to transfer a distinct good or service to a customer and is the unit of account in ASC 606. Revenues are recognized when control of the promised goods or services are transferred to a customer in an amount that reflects the consideration that the Company expects to receive in exchange for those services. The Company currently generates its revenues from three primary sources: (1) hardware devices, (2) professional services and (3) software products.
Hardware and other related
The Company generates hardware revenue primarily from the sale of its portfolio of devices for its smart access and smart apartment solutions. The Company sells hardware to building developers directly or through its channel partners who act as the intermediary and installer. The Company recognizes hardware revenue when the hardware is shipped directly to building developers or to its channel partners, which is when control is transferred to the building developer. The Company provides warranties that its hardware will be substantially free from defects in materials and workmanship for a period ofone year for electronic components and five years for mechanical components. The Company replaces, repairs or refunds warrantable devices at its sole discretion. The Company determined these warranties are not separate performance obligations as they cannot be purchased separately and do not provide a service in addition to an assurance the hardware will function as expected. The Company records a reserve as a component of cost of hardware revenue based on historical costs of replacement units for returns of defective products. For the years ended December 31, 2021, 2020 and 2019, the reserve for hardware warranties was approximately 1%, 2% and 2% of cost of hardware revenue, respectively. The Company also provides certain customers a wholesale arrangement with a right of return for non-defective product, which is treated as a reduction of hardware revenue based on the Company’s expectations and historical experience. For the years ended December 31, 2021, 2020 and 2019, the reserve for wholesale returns against revenue was $(0.1) million, $0.1 million and $0.6 million, and the reserve against accounts receivable was $0.6 million, $1.8 million and $1.5 million, respectively.
The Company also generates revenues related to hardware, which includes professional services related to installation and activation of hardware devices sold to building developers. These services are recognized over time on a percentage of completion basis. The Company recognized professional services revenue of $1.9 million for the year ended December 31, 2021. The Company recognized no professional services revenue for the years ended December 31, 2020 and 2019.
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
Software
The Company generates software revenue primarily through the sale of its software-as-a-service (“SaaS”) to building developers over its cloud-based platform on a subscription-based arrangement. Subscription fees vary depending on the optional features selected by customers as well as the term length. SaaS arrangements generally have term lengths of month-to-month, two-year, five-year and ten-year and include a fixed fee paid upfront except for the month-to-month arrangements. As a result of significant discounts provided to our customers on the longer-term software contracts paid upfront, the Company has determined that there is a significant financing component related to the time value of money and has therefore broken out the interest component and recorded it as a component of interest income (expense), net on the consolidated statements of operations and comprehensive loss. The interest expense related to the significant financing component is recorded using the effective interest method, which has higher interest expense at inception and declines over time to match the underlying economics of the transaction where the outstanding principal balance decreases over time. The amount of interest expense related to this component was $3.1 million, $1.5 million and $0.4 million for the years ended December 31, 2021, 2020 and 2019, respectively.
The services provided by the Company for the subscription-based arrangements are considered stand-ready performance obligations where customers benefit from the services evenly throughout the service period. Revenue is primarily recognized on a ratable basis over the subscription period of the contractual arrangement beginning when or as control of the promised services is available or transferred to the customer.
Performance Obligations
The Company enters into contracts that contain multiple distinct performance obligations: hardware, professional services and software. The hardware performance obligation includes the delivery of hardware, the professional services performance obligation includes the delivery of activation and installation of the hardware and the software performance obligation allows the customer access to the software during the contracted-use term when the promised service is transferred to the customer. The Company has determined that the hardware, professional services and software are individual distinct performance obligations because they can be sold by the Company on a standalone basis, and because other vendors sell similar technologies and services on a standalone basis.
For each performance obligation identified, the Company estimates the standalone selling price, which represents the price at which the Company would sell the good or service separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price, taking into account available information such as market conditions, historical pricing data and internal pricing guidelines related to the performance obligations. The Company then allocates the transaction price among those obligations based on the estimation of standalone selling price. For software revenue, the Company estimates the transaction price, including variable consideration, at the commencement of the contract and recognizes revenue over the contract term. The aggregate amount of the transaction price allocated to performance obligations that were unsatisfied was $30.2 million as of December 31, 2021. The Company expects to recognize the short-term amount of $6.0 million over the next 12 months, of which $9.4 million will be recognized as revenue and $3.4 million will be recognized as interest expense related to the significant financing component, and the long-term portion of $24.2 million over the contracted-use term of each agreement, of which $32.8 million will be recognized as revenue and $8.6 million will be recognized as interest expense related to the significant financing component.
Revenue Disaggregation
The Company had total revenue of $41.4 million, $18.1 million and $14.9 million for the years ended December 31, 2021, 2020 and 2019, respectively, all generated within North America.
Deferred Contract Costs
The Company capitalizes commission expenses paid that are incremental to obtaining customer software contracts. Costs related to the initial signing of software contracts are amortized over the average customer life, which has been estimated to be ten years. The Company determined the period of benefit by taking into consideration the length of terms in its customer contracts, including renewals and extensions. Amounts expected to be recognized within one year of the balance sheet date are recorded as deferred contract costs, current and are included in prepaid expenses and other current assets on the consolidated balance sheets; the remaining portion is recorded as deferred contract costs non-current and is included in other
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
non-current assets on the consolidated balance sheets. Amortization expense is included in sales and marketing expense in the consolidated statements of operations and comprehensive loss.
The following table represents a roll-forward of the Company’s deferred contract costs:
Additions to deferred contract costs 454
Amortization of deferred contract costs (65)
Additions to deferred contract costs 827
Amortization of deferred contract costs (101)
Contract Assets and Contract Liabilities (Unbilled Receivables and Deferred Revenue)
Contract assets (unbilled receivables) $ 633 $ —
Contract liabilities (deferred revenue) $ 30,206 $ 15,522
The Company enters into contracts with its customers, which may give rise to contract assets (unbilled receivables) and contract liabilities (deferred revenue) due to revenue recognition differing from the timing of billing to customers. The Company recognizes unbilled receivables when the performance obligation precedes the invoice date. The Company records unbilled receivables within prepaid and other current assets on the consolidated balance sheets.
The Company records contract liabilities to deferred revenue when the Company bills customers in advance of the performance obligations being satisfied on the Company’s contracts, which is generally the case for the Company’s software revenue. The Company generally invoices its customers monthly, or up to two years, five years or ten years in advance of services being provided. The Company recognized $4.2 million, $1.8 million and $0.3 million of prior year deferred software revenue during the years ended December 31, 2021, 2020 and 2019, respectively.
Increase in contract liabilities for the years ended December 31, 2021, 2020 and 2019 primarily resulted from growth of contracts with new and existing customers. Deferred revenue that will be recognized during the succeeding 12-month period is recorded within current liabilities on the accompanying consolidated balance sheets.
Cost of Revenue
Cost of hardware and other related revenue consists primarily of product costs, including manufacturing costs, duties and other applicable importing costs, shipping and handling costs, packaging, warranty costs, assembly costs and warehousing costs, as well as other non-inventoriable costs including personnel-related expenses associated with supply chain logistics and direct deployment, outsourced labor costs and channel partner fees.
Cost of software revenue consists primarily of outsourced hosting costs and personnel-related expenses associated with monitoring and managing outsourced hosting service providers.
Cost of revenue excludes depreciation and amortization shown in operating expenses.
General and Administrative
General and administrative expense consists primarily of personnel and related expenses for our executive, legal, human resources, finance and IT functions, including salaries, bonuses, benefits, payroll taxes, travel and stock-based compensation. Additional expenses included in this category are non-personnel costs such as legal fees, rent, professional fees, audit fees, bad debt expense and insurance costs.
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
Research and Development
Research and development (“R&D”) expense consists primarily of personnel and related expenses for our employees working on our product design and engineering teams, including salaries, bonuses, benefits, payroll taxes, travel and stock-based compensation. Also included are non-personnel costs such as amounts paid to our third-party contract manufacturers for tooling, engineering and prototype costs of our hardware products, fees paid to third party consultants, R&D supplies and rent. R&D costs that do not meet the criteria for capitalization are expensed as incurred.
Sales and Marketing
Sales and marketing expense consists primarily of personnel and related expenses for our employees working on our sales, customer success, deployment and marketing teams, including salaries, bonuses, benefits, payroll taxes, travel, commissions and stock-based compensation. Also included are non-personnel costs such as marketing activities (trade shows and events, conferences and digital advertising), professional fees, rent and customer support.
Costs associated with the Company’s advertising are expensed as incurred and are included in sales and marketing expenses. Advertising expense was $2.5 million, $0.4 million and $0.8 million for the years ended December 31, 2021, 2020 and 2019, respectively.
Depreciation and Amortization
Depreciation and amortization expense consists primarily of depreciation expense related to investments in property and equipment, internally developed capitalized software and intangible assets.
Impairment of Long-Lived Assets
The Company assesses long-lived assets for impairment in accordance with the provisions of ASC 360, Property, Plant and Equipment. Long-lived assets (asset group), such as property and equipment and internally developed capitalized software costs subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted future cash flows expected to result from the use and eventual disposition of the asset. The amount of impairment loss, if any, is measured as the difference between the carrying value of the asset and its estimated fair value. Fair value is determined through various valuation techniques, including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. As of December 31, 2021 and 2020, no impairment charge has been recorded.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded for deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2021 and 2020, the Company recorded a full valuation allowance against its deferred tax assets.
The Company recognizes the effect of income tax positions only if those positions are more likely than not to be sustained. Recognized income tax positions are measured at the largest amount that has a greater than 50% likelihood of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
Stock-Based Compensation
The Company measures and records the expense related to stock-based payment awards based on the fair value of those awards as determined on the date of grant. The Company recognizes stock-based compensation expense over the requisite service period of the individual grant, generally equal to the vesting period, and uses the straight-line method to recognize stock-based compensation. The fair value of restricted stock units (“RSUs”) is determined using the closing trading price on the grant date. The Company uses the Black-Scholes-Merton (“Black-Scholes”) option-pricing model to determine the fair
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
value of stock options. The Black-Scholes option-pricing model requires the use of highly subjective and complex assumptions to determine the fair value of stock options, including the option’s expected term and the price volatility of the underlying stock. The Company calculates the fair value of options granted by using the Black-Scholes option-pricing model with the following assumptions:
•Expected Volatility—The Company estimates volatility for option grants by evaluating the average historical volatility of a peer group of companies for the period immediately preceding the option grant for a term that is approximately equal to the option’s expected term.
•Expected Term—The expected term of the Company’s options represents the period that the stock-based awards are expected to be outstanding. The Company has elected to use the midpoint between the stock option’s vesting term and contractual expiration period to compute the expected term, as the Company does not have sufficient historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior.
•Risk-Free Interest Rate—The risk-free interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with a term that is equal to the option’s expected term at the grant date.
•Dividend Yield—The Company has not declared or paid dividends to date and does not anticipate declaring dividends. As such, the dividend yield has been estimated to be zero.
Cash Settled RSUs
The Company grants cash settled RSUs that are classified as liability awards as defined in ASC 718, Compensation - Stock Compensation. Cash settlement is required (no election for share settlement) and the cash settlement is not contingent on the occurrence of an event. These awards are recorded as a share-based liability, and fair value is remeasured quarterly. Each vested award is released for cash equal to the Company’s common stock value.
Fair Value Measurement
Fair value accounting is applied for all financial assets and liabilities and nonfinancial assets and liabilities that are recognized or disclosed at fair value in the consolidated financial statements on a recurring basis (at least annually). Fair value is defined as the exchange price that would be received for an asset or an exit price that would be paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
The authoritative guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are as follows:
•Level 1—Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
•Level 2—Inputs are observable, either directly or indirectly, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities.
•Level 3—Inputs are generally unobservable and typically reflect management’s best estimate of assumptions that market participants would use in pricing the asset or liability.
The level in the fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest-level input that is significant to the fair value measurement in its entirety.
Convertible Notes and Derivatives
The Company accounts for convertible notes, net using an amortized cost model pursuant to ASC 835, Interest. Convertible notes are classified as liabilities measured at amortized cost, net of debt discounts from debt issuance costs, lender fees and
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Notes to Consolidated Financial Statements
(in thousands, except share and per share data)
the initial fair value of bifurcated derivatives, which reduce the initial carrying amount of the notes. The carrying value is accreted to the stated principal amount at contractual maturity using the effective-interest method with a corresponding charge to interest expense pursuant to ASC 835. Debt discounts are presented on the balance sheet as a direct deduction from the carrying amount of the related debt.
The Company accounts for its derivatives in accordance with ASC 815-10, Derivatives and Hedging, or ASC 815-15, Embedded Derivatives, depending on the nature of the derivative instrument. ASC 815 requires each contract that is not a derivative in its entirety to be assessed to determine whether it contains embedded derivatives that are required to be bifurcated and accounted for as a derivative financial instrument. The embedded derivative is bifurcated from the host contract and accounted for as a freestanding derivative if (i) the combined instrument is not accounted for in its entirety at fair value with changes in fair value recorded in earnings, (ii) the terms of the embedded derivative are not clearly and closely related to the economic characteristics of the host contract and (iii) a separate instrument with the same terms as the embedded derivative would qualify as a derivative instrument. Embedded derivatives are measured at fair value and re-measured at each subsequent reporting period and recorded within convertible notes, net on the consolidated balance sheets and changes in fair value recorded in other income (expense) within the statements of operations and comprehensive loss.
Earnings per Share
The calculation of earnings per share is based on the weighted average number of common stock or common stock equivalents outstanding during the applicable period. The dilutive effect of common stock equivalents is excluded from basic earnings per share and is included in the calculation of diluted earnings per share. Potentially dilutive securities include outstanding convertible preferred stock, common stock options and common stock warrants.
The Company follows the two-class method when computing net loss per common share when shares are issued that meet the definition of participating securities. The two-class method determines net loss per common share for each class of common stock and participating securities according to dividends declared or accumulated and participation rights in undistributed earnings. The two-class method requires income available to common stockholders for the period to be allocated between common stock and participating securities based upon their respective rights to receive dividends as if all income for the period had been distributed. The Company’s redeemable convertible preferred stock contractually entitles the holders of such shares to participate in dividends but does not contractually require the holders of such shares to participate in the Company’s losses. For periods in which the Company reports net losses, diluted net loss per share is the same as basic net loss per share because potentially dilutive common shares are not assumed to have been issued if their effect is anti-dilutive.