# Archer Aviation Inc. (ACHR) FY 2023 MD&A Verbatim Item 7 Management's Discussion and Analysis from Archer Aviation Inc.'s 10-K for fiscal year 2023. SEC filing source: https://www.sec.gov/Archives/edgar/data/1824502/000162828024007963/achr-20231231.htm Accession: 0001628280-24-007963 Filing date: 2024-02-29 Report date: 2023-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/ACHR/ All MD&A years: /company/ACHR/mda/ Previous year: /company/ACHR/mda/fy2022/ (FY 2022) Next year: /company/ACHR/mda/fy2024/ (FY 2024) 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 our consolidated financial statements and related accompanying notes included elsewhere in this Annual Report. Refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations located in our Annual Report on Form 10-K for the year ended December 31, 2022, filed on March 15, 2023, for a comparison of our results of operations for the years ended December 31, 2022 and 2021. In addition to historical consolidated financial information, the following discussion includes forward-looking statements. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated. See the section titled “Special Note Regarding Forward-Looking Statements” in this Annual Report. Our actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those set forth in Part I, Item 1A, “Risk Factors” in this Annual Report. Overview We are designing and developing eVTOL aircraft for use in UAM networks. Our mission is to unlock the skies, freeing everyone to reimagine how they move and spend time. Our eVTOL aircraft are designed to be safe, sustainable, and quiet. Our production aircraft, Midnight, which we unveiled in November of 2022, is designed around our proprietary 12-tilt-6 aircraft configuration. This means that it has 12 propellers attached to 6 booms on a fixed wing with all 12 propellers providing vertical lift during take-off and landing, and the forward 6 propellers tilting forward to cruise position to provide propulsion during forward flight with the wing providing aerodynamic lift like a conventional airplane. Midnight is designed to carry 4 passengers plus a pilot optimized for back-to-back short distance trips of around 20-miles, with minimal charging time between trips. We are working to certify Midnight with the FAA so that we can then enter into commercial service as soon as possible. In August 2023, we received the Special Airworthiness Certificate from the FAA for our first Midnight aircraft and began its flight testing program in October 2023. Midnight is the evolution of our demonstrator eVTOL aircraft, Maker, which through its flight test program has helped validate our proprietary 12-tilt-6 aircraft configuration and certain key enabling technologies. The design of Midnight marries what we believe to be cutting-edge electric propulsion technology with state-of-the-art aircraft systems to deliver the key attributes of our eVTOL aircraft: •Safety. High redundancy and simplified propulsion systems make for a significantly safer aircraft compared to a helicopter. Midnight has no single critical point of failure, meaning that should any single component fail, the aircraft can still safely complete its flight. •Low noise. With its intended cruising altitude at approximately 2,000 feet, the design of Midnight is such that the noise that reaches the ground is expected to measure around 45 A-weighted decibels, approximately 100 times quieter than that of a helicopter. During forward flight, the aircraft’s tilt propellers spin on axes that are aligned with the oncoming air flow, rather than edge-wise to the flow, as is the case with traditional helicopters - further decreasing noise levels. Since Archer’s aircraft is spinning 12 small propellers rather than one large rotor, it can also spin them at significantly lower tip speeds, resulting in much lower noise levels. •Sustainable. Midnight is all electric, resulting in zero operating emissions. Archer is committed to sourcing renewable energy wherever possible to power its aircraft. Archer’s design and engineering teams are working to integrate materials into this aircraft that have their own unique sustainability stories. We continue to work to optimize our eVTOL aircraft design for both manufacturing and certification. The development of an eVTOL aircraft that meets our business requirements demands significant design and development efforts on all facets of the aircraft. We believe that by bringing together a mix of talent with eVTOL, traditional commercial aerospace, as well as electric propulsion backgrounds, we have built a team that enables us to move through the design, development, and certification of our eVTOL aircraft with the FAA in an efficient manner, thus allowing us to achieve our end goal of bringing to market our eVTOL aircraft as efficiently as possible. Our Planned Lines of Business Upon receipt of all necessary FAA certifications and any other government approvals necessary for us to manufacture and operate our aircraft, we intend to operate two complementary lines of business: Archer UAM and Archer Direct. 34 Table of Contents Archer UAM We plan to operate our own UAM ecosystem initially in select major cities. Our UAM ecosystem will operate using our eVTOL aircraft, which is currently in development. Consumers will be able to book rides directly through our service through an app-based platform. We project that the cost to manufacture and operate our eVTOL aircraft will be such that it will be able to enter the UAM ride-sharing market at a price point that is competitive with ground-based ride sharing services today. We will continue to evaluate our go-to-market strategy based on, among other things, estimated demand, readiness of the required infrastructure, and our ability to scale of our aircraft fleet. Archer Direct We also plan to selectively sell our aircraft to third parties. We have entered into the United Purchase Agreement for the conditional purchase of up to $1.0 billion worth of aircraft, with an option for another $500.0 million worth of aircraft. In August 2023, we entered into two new contracts with the U.S. Air Force, worth up to $142.0 million, which includes the purchase of aircraft, as well as the sharing of additional flight test data certification related reports, pilot training, and the development of maintenance and repair operations. As we get closer to commercialization, we will look to determine the right mix of selling our aircraft versus using them as part of our UAM ecosystem based on, among other factors, our capital needs, our manufacturing volumes, our ability to ramp Archer UAM operations, and the purchase demand from our Archer Direct customers. To date, we have not generated revenue from either of these planned categories, as we continue to design, develop, and seek the governmental approvals necessary for our eVTOL aircraft to enter into service. We will use our cash and cash equivalents for the foreseeable future to continue to fund our efforts to bring our eVTOL aircraft to market. The amount and timing of any future capital requirements will depend on many factors, including the pace and results of the design and development of our aircraft and manufacturing operations, as well as our progress in obtaining necessary FAA certifications and other government approvals. For example, any significant delays in obtaining such FAA certifications and other government approvals will likely require us to raise additional capital above our existing cash on hand and delay our generation of revenues. Components of Results of Operations Revenue We are still working to design, develop, certify, and bring up manufacturing of our eVTOL aircraft and thus have not generated any revenues from either of our planned lines of business. We do not expect to begin generating significant revenues until we are able to complete the design, development, certification, and manufacturing bring up of our eVTOL aircraft. Operating Expenses Research and Development Research and development activities represent a significant part of our business. Our research and development efforts focus on the design and development of our eVTOL aircraft, including certain of the systems that are used in it. As part of those activities, we continue to work closely with the FAA towards our goal of achieving certification of our eVTOL aircraft on an efficient timeline. Research and development expenses consist primarily of personnel-related costs (including salaries, bonuses, benefits, and stock-based compensation) for employees focused on research and development activities, costs associated with developing and building prototype aircraft, associated facilities costs, and depreciation. We expect research and development expenses to increase significantly as we progress towards the certification and manufacturing of our eVTOL aircraft. We cannot determine with certainty the timing, duration or the costs necessary to complete the design, development, certification, and manufacturing bring up of our eVTOL aircraft due to the inherently unpredictable nature of our research and development activities. Development timelines, the probability of success, and development costs may differ materially from expectations. 35 Table of Contents General and Administrative General and administrative expenses consist primarily of personnel-related costs (including salaries, bonuses, benefits, and stock-based compensation) for employees associated with administrative services such as finance, legal, human resources, information technology, associated facilities costs, depreciation, and non-cash technology and dispute resolution agreements expense. We expect our general and administrative expenses to increase as we hire additional personnel and consultants to support our operations and comply with applicable regulations, including the Sarbanes-Oxley Act and other SEC rules and regulations. Other Warrant Expense Other warrant expense consists entirely of non-cash expense related to the vesting of warrants issued in conjunction with the execution of the United Purchase Agreement and the Warrant to Purchase Shares Agreement (the “United Warrant Agreement”) with United. Other (Expense) Income, Net Other (expense) income, net consists of miscellaneous income and expense items, including the change in fair value of our warrant liabilities. Interest Income (Expense), Net Interest income (expense), net primarily consists of interest income from our cash and cash equivalents and short-term investments in marketable securities, net of interest on notes payable. 36 Table of Contents Results of Operations The following table sets forth our consolidated statements of operations for the periods indicated: [[GREPCENT_TABLE]] [["","Year Ended December 31,"],["","2023","","2022","","Change $","","Change %"],["","(In millions)"],["Operating expenses:"],["Research and development (1)","$","276.4","","","$","171.5","","","$","104.9","","","61","%"],["General and administrative (1)","168.4","","","165.1","","","3.3","","","2","%"],["Other warrant expense","2.1","","","10.8","","","(8.7)","","","(81)","%"],["Total operating expenses","446.9","","","347.4","","","99.5","","","29","%"],["Loss from operations","(446.9)","","","(347.4)","","","(99.5)","","","29","%"],["Other (expense) income, net","(26.9)","","","27.8","","","(54.7)","","","NM"],["Interest income (expense), net","16.4","","","2.3","","","14.1","","","NM"],["Loss before income taxes","(457.4)","","","(317.3)","","","(140.1)","","","44","%"],["Income tax expense","(0.5)","","","\u2014","","","(0.5)","","","100","%"],["Net loss","$","(457.9)","","","$","(317.3)","","","$","(140.6)","","","44","%"]] [[/GREPCENT_TABLE]] NM=Not Meaningful. (1) Includes stock-based compensation expense as follows: [[GREPCENT_TABLE]] [["","Year Ended December 31,"],["","2023","","2022"],["Research and development","$","28.9","","","$","26.1"],["General and administrative","16.3","","","76.7"],["Total stock-based compensation expense","$","45.2","","","$","102.8"]] [[/GREPCENT_TABLE]] Comparison of the Year Ended December 31, 2023 and 2022 Research and Development Research and development expenses increased by $104.9 million, or 61%, for the year ended December 31, 2023, compared to the year ended December 31, 2022, as we invested in people and materials to advance our technology development. The increase was primarily due to an increase of $40.9 million in costs related to professional services and tools and materials to support our increased research and development activities, an increase of $38.1 million in personnel-related expenses due to a significant increase in our workforce from the prior year, and an increase of $14.7 million in warrant expenses related to the warrants issued to Stellantis in connection with the manufacturing and collaboration agreement between us and Stellantis. See Note 10 - Stock-Based Compensation to our consolidated financial statements for further details on our warrants. The remainder of the increase was made up of other incidental items. General and Administrative General and administrative expenses increased by $3.3 million, or 2%, for the year ended December 31, 2023, compared to the year ended December 31, 2022. The increase was primarily due to a $70.3 million non-cash charge comprised of a $26.3 million non-cash charge associated with the Initial Vested Share Tranche and a $44.0 million non-cash charge for the unvested portion of the Warrant that is contingent and may never be realized, relating to a series of agreements between us, Boeing and Wisk on August 10, 2023, providing for, among other things, certain investments and warrant issuances, as well as an autonomous flight technology agreement and the resolution of certain federal and state court litigation between the parties (the “Technology and Dispute Resolution Agreements”). The increase was partially offset by a reversal of previously recognized stock-based compensation expense of $59.1 million associated with the forfeiture of the unvested portion of the restricted stock units (“RSUs”) granted to our founders pursuant to the terms and conditions of the Business Combination Agreement immediately prior to closing (the “Founder Grant”) issued to the Company’s co-founder and former co-CEO. See Note 8 - Commitments and Contingencies and Note 10 - Stock-Based Compensation to our consolidated financial statements 37 Table of Contents for further details on our commitments and contingencies and stock-based compensation, respectively. The remainder of the offset was made up of other incidental items. Other Warrant Expense Other warrant expense decreased by $8.7 million, or 81%, for the year ended December 31, 2023, compared to the year ended December 31, 2022. The decrease was primarily due to the vesting of United warrants associated with specific milestones during the year ended December 31, 2022. The warrants associated with the specific milestones fully vested in the first quarter of 2023. See Note 10 - Stock-Based Compensation to our consolidated financial statements for further details on our warrants. Other (Expense) Income, Net Other (expense) income, net decreased by $54.7 million for the year ended December 31, 2023, compared to the year ended December 31, 2022. The decrease was primarily due to changes in fair value of our warrant liabilities. See Note 3 - Summary of Significant Accounting Policies to our consolidated financial statements for further details. Interest Income (Expense), Net Interest income (expense), net increased by $14.1 million for the year ended December 31, 2023, compared to the year ended December 31, 2022. The increase was primarily due to interest income from our cash and cash equivalents and short-term investments in marketable securities. Liquidity and Capital Resources As of December 31, 2023, our principal sources of liquidity were cash and cash equivalents of $464.6 million. We have incurred net losses since our inception and to date have not generated any revenues. We expect to incur additional losses and higher operating expenses for the foreseeable future. We believe that our existing cash and cash equivalents will be sufficient for at least the next 12 months to meet our requirements and plans for cash, including meeting our working capital requirements and capital expenditure requirements. On August 10, 2023, we entered into subscription agreements with certain investors providing for the private placement of 26,173,286 shares of our Class A common stock for net proceeds of approximately $139.0 million, after deducting offering costs. On June 23, 2023, we issued 6,337,039 shares of Class A common stock to Stellantis at a price of $3.94506 per share in connection with the first milestone under the Stellantis Forward Purchase Agreement and received approximately $25.0 million in gross proceeds. On August 10, 2023, Stellantis waived certain conditions provided for in the Stellantis Forward Purchase Agreement relating to our actual achievement pursuant to Milestone 2 (as defined in the Stellantis Forward Purchase Agreement). In connection with this, we submitted an election notice to draw down upon the $70.0 million applicable to Milestone 2, which equals 12,313,234 shares of our Class A common stock. On October 16, 2023, we issued 12,313,234 shares of our Class A common stock to Stellantis, at a price per share of $5.68, for gross proceeds of approximately $70.0 million. On October 5, 2023, we entered into the Credit Agreement with Synovus Bank, as administrative agent and lender, and the additional lenders (the “Lenders”) from time to time. We may request the Lenders to provide multiple delayed term loan advances (together, the “Loan”) in an aggregate principal amount of up to $65.0 million for the construction and development of our manufacturing facility in Covington, Georgia. The Loan under the Credit Agreement shall accrue interest from and including the date the applicable advance is made but excluding the repayment date at a rate of the secured overnight financing rate (“SOFR”), plus 2.00% subject to a SOFR floor of 0.00%. We are required to make interest-only payments for 36 months on the Loan starting on November 14, 2023, followed by monthly interest and principal payments for the remaining maturity, with any outstanding principal, interest and other then outstanding indebtedness due at maturity. The Credit Agreement matures on the earlier of October 5, 2033 or the date on which the outstanding Loan has been declared or automatically becomes due and payable pursuant to the terms of the Credit Agreement. Our obligations under the Credit Agreement are jointly and severally guaranteed by our current and future wholly-owned domestic subsidiaries, and are secured by cash, general intangibles, instruments, securities, financial assets, security entitlements and other property maintained in a money market account at Synovus Bank. 38 Table of Contents In November 2023, we filed a shelf registration statement on Form S-3 (the “Shelf Registration Statement”), which became effective in November 2023. The Shelf Registration Statement permits the offering of up to $70.0 million aggregate dollar amount of shares of our Class A common stock or preferred stock, debt securities, warrants to purchase our Class A common stock, preferred stock or debt securities, subscription rights to purchase our Class A common stock, preferred stock or debt securities and/or units consisting of some or all of these securities, in one or more offerings and in any combination. In connection with the Shelf Registration Statement, we entered into an Open Market Sales AgreementSM (the “Sales Agreement”), with Cantor Fitzgerald & Co., as the sales agent, pursuant to which we may offer and sell shares of our Class A common stock having an aggregate offering amount of up to $70.0 million. The $70.0 million of Class A common stock that may be issued and sold pursuant to the Sales Agreement is included in the $70.0 million of securities that may be issued and sold pursuant to the Shelf Registration Statement. We will pay Cantor Fitzgerald & Co. a commission rate of up to 3.0% of the gross proceeds from the sale of any shares of Class A common stock pursuant to the Sales Agreement. As of December 31, 2023, we had $49.3 million remaining under the Sales Agreement. In the long term, our ability to support our working capital and capital expenditure requirements will depend on many factors, including: •the level of research and development expenses we incur as we continue to develop our eVTOL aircraft; •capital expenditures needed to bring up our aircraft manufacturing capabilities, including for both the build out of our manufacturing facilities and component purchases necessary to build our aircraft; •general and administrative expenses as we scale our operations; and •sales, marketing and distribution expenses as we build, brand and market our eVTOL aircraft and UAM network. Until such time as we can generate significant revenue from our business operations, we expect to finance our cash needs primarily through existing cash on hand, pre-delivery payments, equity financing and debt financing. The following includes our short-term and long-term material cash requirements from known contractual obligations as of December 31, 2023: Notes Payable See Note 7 - Notes Payable to our consolidated financial statements for further details on our debt. Leases We lease office, lab, hangar, and storage facilities in the normal course of business. Under our operating leases as noted in Note 8 - Commitments and Contingencies to our consolidated financial statements, we have current obligations of $5.5 million and long-term obligations of $18.5 million. Cash Flows The following table summarizes our cash flows for the periods indicated: [[GREPCENT_TABLE]] [["","Year Ended December 31,"],["","2023","","2022"],["","(In millions)"],["Net cash provided by (used in):"],["Operating activities","$","(271.6)","","","$","(200.4)"],["Investing activities","420.7","","","(464.3)"],["Financing activities","250.1","","","(9.9)"]] [[/GREPCENT_TABLE]] Cash Flows Used in Operating Activities We continue to experience negative cash flows from operations as we are still working to design, develop, certify, and bring up manufacturing of our eVTOL aircraft and thus have not generated any revenues from either of our planned lines of business. Our cash flows from operating activities are significantly affected by our cash investments to support the growth of our research and development activities related to our eVTOL aircraft, as well as the general and administrative functions 39 Table of Contents necessary to support those activities and operations as a publicly traded company. Our operating cash flows are also impacted by the working capital requirements to support growth and fluctuations in personnel-related expenditures, accounts payable, accrued interest and other current liabilities, and other current assets. Net cash used in operating activities during the year ended December 31, 2023 was $271.6 million, resulting from a net loss of $457.9 million, adjusted for non-cash items consisting primarily of a $70.3 million non-cash charge comprised of a $26.3 million non-cash charge associated with the Initial Vested Share Tranche and a $44.0 million non-cash charge for the unvested portion of the Warrant that is contingent and may never be realized, relating to the Technology and Dispute Resolution Agreements, $45.2 million in stock-based compensation which includes the reversal of $59.1 million of stock-based compensation expense related to the forfeiture of one of the Founder Grants, a loss of $32.9 million due to a change in fair value of our warrant liabilities, and $17.5 million of research and development warrant expense related to the warrants issued to Stellantis (see Note 10 - Stock-Based Compensation to our consolidated financial statements). The net cash provided by changes in our net operating assets and liabilities of $13.2 million was primarily related to a $9.2 million increase in accounts payable due to timing of payments. Net cash used in operating activities during the year ended December 31, 2022 was $200.4 million, resulting from a net loss of $317.3 million, adjusted for non-cash items consisting primarily of $102.8 million in stock-based compensation primarily related to the Founder Grants and $10.8 million in other warrant expense related to the United warrants (see Note 10 - Stock-Based Compensation), partially offset by a gain of $22.9 million primarily due to the change in fair value of our warrant liabilities. The net cash related to changes in our net operating assets and liabilities of $19.2 million was primarily related to a $15.6 million increase in accrued expenses and other current liabilities mainly due to legal fees and expenses and a $10.1 million increase in other long-term liabilities mainly due to the $10.0 million pre-delivery payment from United (see Note 10 - Stock-Based Compensation), partially offset by a $3.4 million increase in operating lease right-of-use assets and lease liabilities, net driven by lease payments and a $2.2 million increase in prepaid expenses primarily due to prepaid research and development-related expenses. Cash Flows Provided by (Used in) Investing Activities Net cash provided by investing activities during the year ended December 31, 2023 was $420.7 million, driven by proceeds from maturities of short-term investments of $465.0 million, offset by purchases of property and equipment of $44.3 million within the period. Net cash used in investing activities during the year ended December 31, 2022 was $464.3 million, driven by purchases of short-term investments of $487.4 million and purchases of property and equipment of $6.9 million, offset by proceeds from maturities of short-term investments of $30.0 million. Cash Flows Provided by (Used in) Financing Activities Net cash provided by financing activities during the year ended December 31, 2023 was $250.1 million, driven by gross proceeds from the PIPE financing of $145.0 million, proceeds from the issuance of common stock to Stellantis of $95.0 million, and proceeds from shares issued under an at-the-market offering of $20.7 million, partially offset by the repayment of term loans to Silicon Valley Bank, a division of First-Citizens Bank, for $10.0 million. Net cash used in financing activities during the year ended December 31, 2022 was $9.9 million, consisting primarily of the repayment of debt for $10.0 million. Critical Accounting Policies and Estimates Our consolidated financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgements, often as a result of the need to make estimates of matters that are inherently uncertain. 40 Table of Contents We believe that the following critical accounting policies involve a greater degree of judgment or complexity than our other accounting policies. Accordingly, these are the policies we believe are the most critical to a full understanding and evaluation of our consolidated financial statements. For additional information, refer to Note 3 - Summary of Significant Accounting Policies to our consolidated financial statements. Common Stock Valuation Prior to the Business Combination, there was no public market for our common stock, and our board of directors determined the fair value of our common stock by taking into account input from management and independent third-party valuation analyses. The determinations of the fair value of our common stock were made using methodologies, approaches, and assumptions consistent with the American Institute of Certified Public Accountants Accounting and Valuation Guide: Valuation of Privately-Held-Company Equity Securities Issued as Compensation. In valuing our common stock, we determined the equity value of our business using a combination of the market and income approach valuation methods. The total enterprise value was then allocated to our various share classes using a hybrid approach consisting of the option pricing model (“OPM”) and probability-weighted expected return method (“PWERM”). The OPM considers preferred stockholders’ liquidation preferences, participation rights, dividend policy, and conversion rights to determine how proceeds from a liquidity event shall be distributed among the various ownership classes at a future date, whereas the PWERM estimates the fair market value of the common stock based on an analysis of future values for various potential liquidity outcomes. Since there was no active market for our common stock, we also applied a discount for lack of marketability for both OPM and PWERM scenarios. Application of these approaches and methods involves the use of estimates, judgments, and assumptions, such as future revenue, expenses and cash flows, selections of comparable companies, probabilities and timing of exit events, and other factors. The fair value of our common stock, utilizing the above methodology prior to the closing of the Business Combination, was used to determine the fair value of the United warrants, and was a key input in the estimation of the fair value of our stock options (as discussed below). Since the closing of the Business Combination in September 2021, the fair value of our common stock is based on the closing price of our Class A common stock, as quoted on the NYSE, on the date of grant. Stock-Based Compensation We account for stock-based compensation awards granted to employees and non-employees by recording compensation expense based on each award’s grant date estimated fair value over the vesting period, in accordance with ASC 718, Compensation — Stock Compensation. We estimate the fair value of RSUs based on the fair value of our common stock on the date of grant. We estimate the fair value of stock options using the Black-Scholes option-pricing model. Determining the fair value of stock options under this model requires highly subjective assumptions, including the fair value of the underlying common stock, risk-free interest rate, expected term of the award, expected volatility of the price of our common stock, and expected dividend yield of our common stock. These estimates involve inherent uncertainties and the application of management’s judgment. If we had made different assumptions, our stock-based compensation expense could have been materially different. We have not issued any stock options since the closing of the Business Combination. The fair value of RSUs that vest based on service conditions is determined based on the value of the underlying common stock at the date of grant. The Founder Grants vest when either a market condition or performance condition is satisfied. We determined the fair value of the performance award by utilizing the trading price on the Closing Date. When the applicable performance milestone is deemed probable of being achieved, we will recognize compensation expense for the portion earned to date over the requisite period. For the market condition award, we estimated the fair value using a Monte Carlo simulation model. We recognize compensation expense for the market award on a straight-line basis over the derived service period. Determining the fair value for the market condition award under this model requires subjective assumptions, including the expected volatility of the price of our common stock. If the applicable performance condition is not probable of being achieved, compensation cost for the value of the award incorporating the market condition is recognized, so long as the requisite service is provided. If the performance milestone becomes probable of being achieved, the full fair value of the award will be recognized, and any remaining expense for the market award will be cancelled. Income Taxes We are subject to income taxes in the United States and other jurisdictions. Our income tax provision consists of an estimate of federal, state and foreign income taxes based on enacted federal, state and foreign tax rates, as adjusted for allowable credits, deductions, uncertain tax positions, changes in the valuation of our deferred tax assets and liabilities, and changes in tax laws. 41 Table of Contents We recognize tax benefits from uncertain tax positions only if we believe that it is more-likely-than-not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. Although we believe that we have adequately reserved for our uncertain tax positions, we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves when facts and circumstances change, such as the closing of issues under audit or expiration of statute of limitation, changes in or interpretations of tax law. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences may affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and results of operations. Significant judgment is applied when assessing the need for valuation allowances and includes the evaluation of historical income (loss) adjusted for the effects of non-recurring items. Areas of estimation include consideration of future taxable income. We have placed a full valuation allowance against our federal and state deferred tax assets since the recovery of the assets is uncertain. Should a change in circumstances lead to a change in judgment about the utilization of deferred tax assets in future years, the adjustment related to valuation allowances would be reported as an increase to income. Recent Accounting Pronouncements See Note 3 - Summary of Significant Accounting Policies to our consolidated financial statements for a discussion about accounting pronouncements recently adopted and recently issued and not yet adopted. Credit Risk Financial instruments, which subject us to concentrations of credit risk, consist primarily of cash, cash equivalents, and short-term investments. Our cash and cash equivalents are held at several long-standing financial institutions located in the United States. At times, cash account balances with any one financial institution may exceed Federal Deposit Insurance Corporation insurance limits ($250 thousand per depositor per institution). We have not experienced any losses due to these excess deposits and believe this risk is not significant. Our short-term investments consisted of high quality, investment grade marketable securities and were held at a major financial institution located in the United States. We have established guidelines regarding diversification of our investments and their maturities that are designed to preserve principal and achieve liquidity requirements. We review these guidelines and modify them as necessary based on updated liquidity needs and changes in our operations and financial position.