SEC Filing | Shift Technologies, Inc.

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sft-20210930

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


			(Mark One)
☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
			For the quarterly period ended September 30, 2021
☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
			For the transition period from _______ to _______

Commission file number: 001-38839

Shift Technologies, Inc.

(Exact name of registrant as specified in its charter)


Delaware			82-5325852
(State or other jurisdiction of incorporation or organization)			(IRS Employer Identification No.)

290 Division Street, Suite 400, San Francisco, California 94103-4893 (Address of principal executive offices)

Registrant's telephone number, including area code: (855) 575-6739

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Class A common stock, par value $0.0001 per share

SFT

Nasdaq Capital Market

Securities registered pursuant to Section 12(g) of the Exchange Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☐

Accelerated filer

☐

Non-accelerated filer

☒

Smaller reporting company

☐

Emerging growth company

☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of November 11, 2021 the registrant had 81,291,036 shares of common stock outstanding.

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TABLE OF CONTENTS


		Page
Part I - Financial Information		1
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets	2
	Condensed Consolidated Statements of Operations and Comprehensive Loss	3
	Condensed Consolidated Statements of Stockholders' Equity	4
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	39
Part II - Other Information		40
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults Upon Senior Securities	41
Item 4.	Mine Safety Disclosures	41
Item 5.	Other Information	41
Item 6.	Exhibits	42
Signatures		43

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Statements contained in this Quarterly Report on Form 10-Q that reflect our current views with respect to future events and financial performance, business strategies, and expectations for our business constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Our forward-looking statements include, but are not limited to, statements regarding our or our management’s expectations, hopes, beliefs, intentions or strategies regarding the future. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “possible,” “potential,” “predict,” “project,” “should,” “would,” “will,” “approximately,” “shall”, the negative of any of these and any similar expressions may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.

The forward-looking statements contained in this Quarterly Report are based on our current expectations and beliefs concerning future developments and their potential effects on us. We cannot assure you that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements.

Some factors that could cause actual results to differ include, but are not limited to:

•general business and economic conditions and risks related to the larger automotive ecosystem;

•competition, and the ability of the Company to grow and manage growth profitably;

•our history of losses and ability to achieve or maintain profitability in the future;

•our ability to sustain our current rate of growth;

•our ability to establish our software as a platform to be used by automotive dealers;

•risks relating to our inspection and reconditioning hubs;

•impacts of COVID-19 and other pandemics;

•our reliance on third-party carriers for transportation:

•our current geographic concentration where we provide reconditioning services and store inventory;

•cyber-attacks or other privacy or data security incidents;

•the impact of copycat websites;

•failure to adequately protect our intellectual property, technology and confidential information;

•our reliance on third-party service providers to provide financing;

•the impact of federal and state laws related to financial services on our third-party service providers;

•the impact of federal, state and local laws on our ability to obtain and maintain necessary dealer and financing licenses in the states in which we do business;

•our ability to timely secure and maintain cost effective real estate locations in connection with the expansion of our business;

•risks that impact the quality of our customer experience, our reputation, or our brand;

•changes and ambiguity in the prices of new and used vehicles;

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•our ability to correctly appraise and price vehicles;

•access to desirable vehicle inventory;

•our ability to expeditiously sell inventory;

•our ability to expand product offerings;

•changes in applicable laws and regulations and our ability to comply with applicable laws and regulations;

•access to additional debt and equity capital;

•changes in technology and consumer acceptance of such changes;

•our reliance on internet search engines, vehicle listing sites and social networking sites to help drive traffic to our website;

•any restrictions on the sending of emails or messages or an inability to timely deliver such communications;

•seasonal and other fluctuations in our quarterly results of operations;

•competition in the markets in which we operate;

•changes in the auto industry and conditions affecting automotive manufacturers;

•natural disasters, adverse weather events and other catastrophic events;

•our dependence on key personnel;

•our ability to rapidly hire and retain qualified personnel necessary to grow our business as anticipated;

•increases in labor costs;

•our reliance on third-party technology and information systems;

•our use of open-source software;

•claims asserting that our employees, consultants or advisors have wrongfully used or disclosed alleged trade secrets of their current or former employers;

•significant disruptions in service on our platform;

•impairment charges;

•changes in LIBOR;

•volatility in the price of our common stock;

•issuances of our common stock and future sales of our common stock;

•our ability to establish and maintain effective internal control over financial reporting; and

•other economic, business and/or competitive factors, risks and uncertainties, including those described in “Item 1A. Risk Factors.”

We do not undertake, and expressly disclaim, any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws. We caution you not to place undue reliance on the forward-looking statements, which speak only as of the date of this filing.

iii

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Part I - Financial Information

ITEM 1. FINANCIAL STATEMENTS

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(in thousands, except share and per share amounts)

(unaudited)


	As of September 30, 2021		As of December 31, 2020
ASSETS
Current assets:
Cash and cash equivalents	$	247,532	$	233,936
Accounts receivable, net of allowance for doubtful accounts of $298 and $46	12,789		8,426
Inventory	88,885		49,086
Prepaid expenses and other current assets	5,258		5,478
Total current assets	354,464		296,926
Property and equipment, net	5,972		2,123
Capitalized website and internal use software costs, net	8,495		6,542
Restricted cash, non-current	1,625		1,605
Deferred borrowing costs	—		2,149
Other non-current assets	2,307		2,748
Total assets	$	372,863	$	312,093

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	11,696	$	10,675
Accrued expenses and other current liabilities	39,250		22,286
Flooring line of credit	50,250		13,870
Total current liabilities	101,196		46,831
Convertible notes	144,048		—
Financial instruments liability	7,639		25,230
Other non-current liabilities	3,150		2,850
Total liabilities	256,033		74,911

Commitment and contingencies (Note 10)

Stockholders’ equity:
Preferred stock – par value $0.0001 per share; 1,000,000 shares authorized at September 30, 2021 and December 31, 2020, respectively	—		—
Common stock – par value $0.0001 per share; 500,000,000 shares authorized at September 30, 2021 and December 31, 2020, respectively; 84,281,072 and 83,904,182 shares issued and outstanding at September 30, 2021 and December 31, 2020, respectively	8		8
Additional paid-in capital	503,070		511,617
Accumulated deficit	(386,248)		(274,443)
Total stockholders’ equity	116,830		237,182
Total liabilities and stockholders’ equity	$	372,863	$	312,093

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

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive Loss

(in thousands, except share and per share amounts)

(unaudited)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2021		2020		2021		2020
Revenue
Ecommerce revenue, net	$	156,248	$	48,486	$	374,889	$	97,870
Other revenue, net	6,215		2,036		15,309		3,933
Wholesale vehicle revenue	17,337		9,392		50,455		20,504
Total revenue	179,800		59,914		440,653		122,307
Cost of sales	166,848		56,188		404,006		111,666
Gross profit	12,952		3,726		36,647		10,641
Operating expenses:
Selling, general and administrative expenses	57,886		24,030		156,264		52,109
Depreciation and amortization	1,375		1,181		4,037		3,258
Total operating expenses	59,261		25,211		160,301		55,367
Loss from operations	(46,309)		(21,485)		(123,654)		(44,726)
Change in fair value of financial instruments	11,967		(579)		17,591		(6,211)
Interest and other expense, net	(3,047)		(1,256)		(5,742)		(3,707)
Net loss and comprehensive loss attributable to common stockholders	$	(37,389)	$	(23,320)	$	(111,805)	$	(54,644)
Net loss and comprehensive loss per share attributable to common stockholders, basic and diluted	$	(0.48)	$	(6.96)	$	(1.43)	$	(17.05)
Weighted-average number of shares outstanding used to compute net loss per share attributable to common stockholders, basic and diluted	78,096,901		3,352,870		78,052,624		3,205,180

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

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders' Equity

(in thousands, except share and per share amounts)

(unaudited)


	Convertible Preferred Stock			Common Stock			Additional Paid-in Capital		Accumulated Deficit		Total Stockholders’ Equity
	Shares	Amount		Shares	Amount
Balance at December 31, 2020	—	$	—	83,904,182	$	8	$	511,617	$	(274,443)	$	237,182
Warrant exchange	—	—		125,160	—		(497)		—		(497)
Issuance of common stock upon exercise of vested options	—	—		107,645	—		200		—		200
Repurchase of shares related to early exercised options	—	—		—	—		1		—		1
Vesting of early exercised options	—	—		—	—		132		—		132
Stock-based compensation	—	—		—	—		8,375		—		8,375
Net loss and comprehensive loss	—	—		—	—		—		(42,755)		(42,755)
Balance at March 31, 2021	—	—		84,136,987	8		519,828		(317,198)		202,638
Purchase of Capped Calls (Note 7)	—	—		—	—		(28,391)		—		(28,391)
Issuance of common stock upon exercise of vested options	—	—		31,679	—		101		—		101
Repurchase of shares related to early exercised options	—	—		(5,849)	—		—		—		—
Vesting of early exercised options	—	—		—	—		114		—		114
Stock-based compensation	—	—		—	—		5,651		—		5,651
Net loss and comprehensive loss	—	—		—	—		—		(31,661)		(31,661)
Balance at June 30, 2021	—	—		84,162,817	8		497,303		(348,859)		148,452
Issuance of common stock upon exercise of vested options	—	—		134,415	—		99		—		99
Repurchase of shares related to early exercised options	—	—		(16,160)	—		—		—		—
Vesting of early exercised options	—	—		—	—		142		—		142
Stock-based compensation	—	—		—	—		5,526		—		5,526
Net loss and comprehensive loss	—	—		—	—		—		(37,389)		(37,389)
Balance at September 30, 2021	—	$	—	84,281,072	$	8	$	503,070	$	(386,248)	$	116,830

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Stockholders' Equity

(in thousands, except share and per share amounts)

(unaudited)


	Convertible Preferred Stock			Common Stock			Additional Paid-in Capital		Accumulated Deficit		Total Stockholders’ Equity (Deficit)
	Shares	Amount		Shares	Amount
Balance at December 31, 2019	255,237,101	$	223,631	37,432,555	$	3	$	34,997	$	(215,297)	$	(180,297)
Retroactive application of recapitalization	(255,237,101)	(223,631)		(6,037,592)	—		223,631		—		223,631
Adjusted balance, beginning of period	—	—		31,394,963	3		258,628		(215,297)		43,334
Issuance of common stock upon exercise of vested options	—	—		38,860	—		59		—		59
Vesting of early exercised options	—	—		—	—		41		—		41
Stock-based compensation	—	—		—	—		327		—		327
Net loss and comprehensive loss	—	—		—	—		—		(12,331)		(12,331)
Balance at March 31, 2020	—	—		31,433,823	3		259,055		(227,628)		31,430
Issuance of common stock upon exercise of vested options	—	—		24,189	—		28		—		28
Vesting of early exercised options	—	—		—	—		89		—		89
Stock-based compensation	—	—		—	—		492		—		492
Net loss and comprehensive loss	—	—		—	—		—		(18,993)		(18,993)
Balance at June 30, 2020	—	—		31,458,012	3		259,664		(246,621)		13,046
Issuance of common stock upon exercise of vested options	—	—		686,398	—		697		—		697
Vesting of early exercised options	—	—		—	—		476		—		476
Repurchase of shares related to early exercised options	—	—		(3,208)	—		—		—		—
Stock-based compensation	—	—		—	—		817		—		817
Net loss and comprehensive loss	—	—		—	—		—		(23,320)		(23,320)
Balance at September 30, 2020	—	$	—	32,141,202	$	3	$	261,654	$	(269,941)	$	(8,284)

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)


	Nine Months Ended September 30,
	2021		2020
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(111,805)	$	(54,644)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	4,489		3,258
Stock-based compensation expense	18,944		1,455
Change in fair value of financial instruments	(17,591)		6,211
Contra-revenue associated with milestones	478		478
Amortization of debt discounts	2,429		3,275
Changes in operating assets and liabilities:
Accounts receivable	(4,363)		(6,085)
Inventory	(39,799)		(15,287)
Prepaid expenses and other current assets	255		7
Other non-current assets	44		(54)
Accounts payable	867		7,515
Accrued expenses and other current liabilities	17,497		7,983
Other non-current liabilities	391		(52)
Net cash, cash equivalents, and restricted cash used in operating activities	(128,164)		(45,940)

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment	(5,094)		(407)
Capitalized website internal-use software costs	(4,604)		(2,857)
Net cash, cash equivalents, and restricted cash used in investing activities	(9,698)		(3,264)

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from flooring line of credit facility	227,662		67,413
Repayment of flooring line of credit facility	(191,363)		(63,102)
Proceeds from Delayed Draw Term Loan	—		12,500
Proceeds from SBA PPP Loans	—		6,055
Proceeds from Convertible Notes (Note 6)	143,768		—
Premiums paid for Capped Call Transactions (Note 7)	(28,391)		—
Exchange of warrants for cash	(497)		—
Proceeds from stock option exercises, including from early exercised options	366		1,740
Repurchase of shares related to early exercised options	(67)		(7)
Net cash, cash equivalents, and restricted cash provided by financing activities	151,478		24,599
Net increase (decrease) in cash, cash equivalents and restricted cash	13,616		(24,605)
Cash, cash equivalents and restricted cash, beginning of period	235,541		44,576
Cash, cash equivalents and restricted cash, end of period	$	249,157	$	19,971

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest	$	760	$	650

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
Capital expenditures in accounts payable	$	154	$	—
Vesting of exercised options	$	388	$	605
Other receivables resulting from stock option exercises	$	35	$	269
Stock-based compensation capitalized to internal-use software	$	608	$	182

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

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. DESCRIPTION OF THE BUSINESS AND ACCOUNTING POLICIES

Shift Technologies, Inc., which, together with its subsidiaries we refer to as Shift, we, us, our, SFT, or the Company, conducts its business through its wholly owned subsidiaries Shift Platform, Inc., Shift Operations, LLC, Shift Transportation LLC, and Shift Finance, LLC. Shift Platform, Inc., formerly known as Shift Technologies, Inc. (“Legacy Shift”) was incorporated in the State of Delaware on December 9, 2013.

The Company is headquartered in San Francisco, California and operates hubs to purchase, recondition and/or sell vehicles in major cities in California, Oregon, Washington, Texas, and Nevada. Shift operates an innovative platform to make car purchases, car sales and ownership simple. Shift’s innovative platform, which includes proprietary pricing technology, provides consumers with a digital purchase and selling experience, and includes offerings throughout the sales cycle, including vehicle pickup and delivery at a customer’s location.

The Company currently is organized into two reportable segments: Retail and Wholesale. The Retail segment represents retail sales of used vehicles through the Company’s ecommerce platform and fees earned on sales of value-added products associated with those vehicles sales such as vehicle service contracts, guaranteed asset protection waiver coverage, prepaid maintenance plans, and appearance protection plans. The Wholesale segment represents sales of used vehicles through wholesale auctions or directly to a wholesaler (“DTW”).

Insurance Acquisition Corp. Merger

On October 13, 2020, Insurance Acquisition Corp. (“IAC”), an entity listed on the Nasdaq Capital Market under the trade symbol “INSU”, acquired Legacy Shift by the merger of IAC Merger Sub, Inc., a direct wholly owned subsidiary of IAC, with and into Legacy Shift, with Legacy Shift continuing as the surviving entity and a wholly owned subsidiary of IAC (the “Merger”). The public company resulting from the merger was renamed Shift Technologies, Inc. Upon the consummation of the Merger, Shift received approximately $300.9 million, net of fees and expenses. See Note 2 - Merger for additional details regarding this transaction.

COVID-19

In March 2020, the World Health Organization declared the outbreak of the novel coronavirus disease (“COVID-19”) as a pandemic, and the Company expects its operations in all locations to be affected as the pandemic progresses. The Company saw a slowing of vehicle sales immediately following the shelter in place ordinances in March; however, within five weeks, weekly sales volume rebounded nearly to pre-COVID-19 volumes. The Company has adjusted certain aspects of its operations to protect its employees and customers while still meeting customers’ needs for vital technology, including implementing contactless purchase and delivery processes and applying long-term antimicrobial surface and air protection systems for its entire inventory.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), was signed into law in response to the COVID-19 pandemic. The CARES Act includes several significant income tax relief provisions as well as the deferral of the employer portion of the social security payroll tax. The income tax benefits include a favorable increase in the interest expense limitation under section 163(j), allowing a five-year net operating loss (“NOL”) carryback provision for certain NOLs, and increasing the amount of NOLs corporations may use to offset income for taxable years beginning before 2021. The Company has evaluated the income tax impacts of the CARES Act and does not expect that the income tax relief provisions of the CARES Act will significantly impact the Company, since it has had taxable losses since inception. In addition, the Company has adopted the deferral of the employer portion of the social security payroll tax. The deferral was effective from the enactment date through December 31, 2020. As of September 30, 2021, the Company had deferred $1.3 million. The deferred amount will be paid in two installments and the amount will be considered timely paid if 50% of the deferred amount is paid by December 31, 2021 and the remainder by December 31, 2022.

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Basis of Presentation

Our unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

The interim condensed consolidated balance sheets as of September 30, 2021 and December 31, 2020, the interim condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2021 and 2020, condensed consolidated statements of stockholders' equity for the three and nine months ended September 30, 2021 and 2020, and condensed consolidated statements of cash flows for the nine months ended September 30, 2021 and 2020, and amounts relating to the interim periods included in the accompanying notes to the interim condensed consolidated financial statements are unaudited. The unaudited interim financial statements have been prepared on the same basis as the audited consolidated financial statements contained in the Company's most recent Annual Report on Form 10-K , and in management’s opinion, includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair presentation of the Company’s condensed consolidated balance sheet as of September 30, 2021, and its results of operations for the three and nine months ended September 30, 2021 and 2020, and cash flows for the nine months ended September 30, 2021 and 2020. The results for the three and nine months ended September 30, 2021 are not necessarily indicative of the results expected for the fiscal year or any other periods. These interim financial statements should be read in conjunction with the Company’s consolidated financial statements and related notes for the fiscal year ended December 31, 2020 included in our Annual Report on Form 10-K filed with the United States Securities and Exchange Commission ("SEC") on March 19, 2021.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates and assumptions, including those related to the valuation of vehicle inventory, capitalized website and internal-use software development costs, fair value of common stock, financial instruments, convertible debt, stock-based compensation and income taxes.

The COVID-19 pandemic has adversely impacted the global economy, as well as the Company’s operations, and the extent and duration of the impacts remain unclear. The Company’s future estimates, including, but not limited to, the inventory valuations, and fair value measurements, may be impacted and continue to evolve as conditions change as a result of the COVID-19 pandemic.

Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from those estimates.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.

The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:

Level 1 — Quoted prices in active markets for identical assets or liabilities.

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

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

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. As of September 30, 2021 and December 31, 2020, all liability-classified financial instruments that are remeasured on a recurring basis have been valued using Level 3 inputs. The determination of the fair value of the Lithia warrants subject to remeasurement was based on the Black-Scholes valuation model, which requires significant estimates including the expected volatility of our common stock, expected dividend yield, option term and risk-free rate.

The fair value of the Escrow Shares was determined using a Monte Carlo valuation model, which requires significant estimates including the expected volatility of our common stock. The liability arising from the Escrow Shares is included in financial instruments liability in the condensed consolidated balance sheets. The expected annual volatility of our common stock was estimated to be 65.53% and 63.93% as of September 30, 2021 and December 31, 2020, respectively, based on the historical volatility of comparable publicly traded companies.

The table below illustrates the changes in the fair value of the Company’s Level 3 financial instruments liability:


(in thousands)	2021		2020
Balance as of January 1,	$	25,230	$	4,810
Remeasurement of Lithia warrants	—		6,211
Remeasurement of Escrow Shares liability	(17,591)		—
Balance as of September 30,	$	7,639	$	11,021

All Legacy Shift warrants outstanding prior to the merger were exercised and settled via net share settlement. The number of shares issued upon the exercise of the warrants was reduced in lieu of cash payment for the exercise price of the warrants. There were no warrants outstanding at September 30, 2021.

Correction of Immaterial Errors

During the quarter ended September 30, 2021, the company recorded a charge of $3.1 million related to certain sales tax amounts (including penalties and interest) which should have been recorded in prior periods from 2018 through the periods ended June 30, 2021. This out of period charge represents the Company’s best estimate of the probable amount due to the applicable taxing authorities and includes sales tax amounts collected from customers that were remitted to the incorrect jurisdiction as well as additional sales tax amounts in certain jurisdictions that were not correctly determined at the time of the customer transaction. The Company is currently working with the applicable jurisdictions to resolve the outstanding balances. We have determined that the impact of this out of period charge is quantitatively and qualitatively immaterial to all prior periods. The amounts are also immaterial to the expected results for the full year 2021 and to trends in the Company’s financial results. The correction of the $3.1 million was recorded as an increase to selling, general, and administrative expenses on the condensed consolidated statement of comprehensive loss in the three months ended September 30, 2021.

As a result of the errors described above, selling, general and administrative expenses and net loss are understated by $0.7 million and $0.6 million for the years ended December 31, 2020 and 2019, respectively. Accumulated deficit is understated and stockholder's equity is overstated by $1.8 million as of December 31, 2020. Selling, general and administrative expenses and net loss are understated by $0.2 million and $0.5 million for the three and nine months ended September 30, 2020. Selling, general and administrative expenses and net loss are understated by $0.5 million and $0.8 million for the three months ended March 31, 2021 and June 30, 2021, respectively, resulting in an understatement of $1.3 million for the six months ended June 30, 2021. Selling, general and administrative expenses and net loss are understated by $0.1 million and $0.2 million for the three months ended March 31, 2020 and June 30, 2020, respectively, resulting in an understatement of $0.3 million for the six months ended June 30, 2020.

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Recently Issued Accounting Standards

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-to-use asset representing its right to use the underlying asset for the lease term. This ASU is effective for public and private companies’ fiscal years beginning after December 15, 2018, and December 15, 2021, respectively, with early adoption permitted. The Company expects to adopt ASU 2016-02 under the private company transition guidance beginning January 1, 2022, using the optional transition method provided by ASU 2018-11. Based upon that analysis and our current evaluation of the standard, we estimate the adoption will result in the addition of $25 million to $31 million of assets and liabilities to our consolidated balance sheet, with no significant change to our consolidated statements of operations or cash flows. The actual amount of additional assets and liabilities that will be recorded upon adoption will depend on the discount rates that are in effect as of the adoption date, as well as assets and liabilities associated with leases that will be executed before the adoption date.

In June 2016, the FASB issued ASU 2016-13, Financial instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, and subsequent related ASUs, which amends the guidance on the impairment of financial instruments by requiring measurement and recognition of expected credit losses for financial assets held. This ASU is effective for public and private companies’ fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2019, and December 15, 2022, respectively. The Company expects to adopt ASU 2016-13 under the private company transition guidance beginning January 1, 2023, and is currently evaluating the impact on the Company’s condensed consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”). ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 will be effective for public entities for interim and annual periods beginning after December 15, 2020, with early adoption permitted. ASU 2019-12 will be effective for the Company for annual periods beginning after December 15, 2021, and interim periods beginning after December 15, 2022, with early adoption permitted. The Company is currently assessing the impact, if any, the guidance will have on the Company’s condensed consolidated financial statements.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The guidance is effective for all entities during the period March 12, 2020, through December 31, 2022. The Company is currently assessing the impact, if any, the guidance will have on the Company’s consolidated financial statements.

Recently Adopted Accounting Standards

In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging— Contracts in Entity’s Own Equity (Subtopic 815-40), which simplifies the accounting for convertible debt by removing the requirements to separately present certain conversion features in equity. In addition, the amendments in the ASU also simplify the guidance in ASC 815-40, Derivatives and Hedging: Contracts in Entity’s Own Equity, by removing certain criteria that must be satisfied in order to classify a contract as equity. Early adoption is permitted for fiscal years beginning after December 15, 2020. The Company early-adopted the ASU on January 1, 2021. There was no impact to the Company's condensed consolidated financial statements on the date of adoption.

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

2. MERGER

On October 13, 2020, Legacy Shift and IAC consummated the Merger, with Legacy Shift surviving the Merger as a wholly-owned subsidiary of IAC, which was renamed “Shift Technologies, Inc.” Immediately prior to the closing of the Merger, all shares of outstanding redeemable convertible preferred stock of Legacy Shift were automatically converted into shares of Legacy Shift common stock, and all outstanding warrants for Legacy Shift shares were exercised. Upon the consummation of the Merger, each share of Legacy Shift common stock issued and outstanding was canceled and converted into the right to receive 0.1073 shares (the “Exchange Ratio”) of Class A common stock of IAC, including the contingently cancellable Escrow Shares described below.

In connection with the execution of the merger agreement, IAC entered into separate subscription agreements (each, a “Subscription Agreement”) with a number of investors (each a “Subscriber”), pursuant to which the Subscribers agreed to purchase, and IAC agreed to sell to the Subscribers, an aggregate of 18,900,000 shares of common stock (the “PIPE Shares”), for a purchase price of $10 per share and an aggregate purchase price of $189.0 million, in a private placement pursuant to the subscription agreements (the “PIPE”). The PIPE investment closed simultaneously with the consummation of the Merger.

The Merger is accounted for as a reverse recapitalization in accordance with GAAP. Under this method of accounting, IAC was treated as the “acquired” company for financial reporting purposes (See Note 1 - Description of the Business and Accounting Policies). Accordingly, for accounting purposes, the Merger was treated as the equivalent of Shift issuing stock for the net assets of IAC, accompanied by a recapitalization. The net assets of IAC of $0.1 million are stated at historical cost, with no goodwill or other intangible assets recorded.

Escrow Shares

In connection with the closing of the Merger, 6,000,218 shares of the Company’s common stock (the “Escrow Shares”) were deposited into an escrow account, with each former Legacy Shift stockholder listed as beneficiary in proportion to their percentage ownership of Legacy Shift common shares immediately prior to the Merger. The Escrow Shares will be released to the beneficiaries if the following conditions are achieved following October 13, 2020, the date of the closing of the Merger:

i.if at any time during the 12 months following the closing, the closing share price of the Company’s common stock is greater than $12.00 over any 20 trading days within any 30 trading day period, 50% of the Escrow Shares will be released; and

ii. if at any time during the 30 months following the closing, the closing share price of the Company’s common stock is greater than $15.00 over any 20 trading days within any 30 trading day period, 50% of the Escrow Shares will be released.

iii.If, during the 30 months following the closing, there is a change of control (as defined in the Merger Agreement) that will result in the holders of the Company’s common stock receiving a per share price equal to or in excess of $10 per share (as equitably adjusted for stock splits, stock dividends, special cash dividends, reorganizations, combinations, recapitalizations and similar transactions affecting the common stock after the date of the Merger), then all remaining Escrow Shares shall be released to the Legacy Shift stockholders effective as of immediately prior to the consummation of such change of control.

The Escrow Shares are legally outstanding and the beneficiaries retain all voting, dividend and distribution rights applicable to the Company’s common stock while the shares are in escrow. If the conditions for the release of the Escrow Shares are not met, the shares and any dividends or distributions arising therefrom shall be returned to the Company. The Escrow Shares are not considered outstanding for accounting purposes, and as such are excluded from the calculation of basic net loss per share (see Note 12).

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SHIFT TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

The Escrow Shares meet the accounting definition of a derivative financial instrument. As the number of Escrow Shares that will ultimately be released is partially dependent on variables (namely, the occurrence of a change in control) that are not valuation inputs to a “fixed for fixed” option or forward contract, the Escrow Shares are not considered to be indexed to the Company’s common stock and are therefore classified as a liability. The Company’s obligation to release the Escrow Shares upon achievement of the milestones was recorded to financial instruments liability on the condensed consolidated balance sheets at fair value as of the date of the Merger. Subsequent changes in the fair value of the liability are recorded to change in fair value of financial instruments on the condensed consolidated statements of operations and comprehensive loss. No Escrow Shares had been released as of September 30, 2021. During the three and nine months ended September 30, 2021, the Company recognized gains related to the change in fair value of the Escrow Shares of $12.0 and $17.6 million, respectively, which are included in change in fair value of financial instruments on the condensed consolidated statements of operations and comprehensive loss.

As of the first anniversary of the Merger on October 13, 2021, the first tranche of 3,000,109 Escrow Shares had failed to satisfy the $12.00 stock performance hurdle. As a result, the shares will be returned to the Company for cancellation.

3. PROPERTY AND EQUIPMENT, NET

Property and equipment, net consists of the following (in thousands):


	As of September 30, 2021		As of December 31, 2020
Equipment	$	6,516	$	2,132
Furniture and fixtures	225		158
Leasehold improvements	1,056		1,408
Total property and equipment	7,797		3,698
Less: accumulated depreciation	(1,825)		(1,575)
Property and equipment, net	$	5,972	$	2,123

Depreciation expense related to property and equipment was $0.4 million and $0.2 million for the three months ended September 30, 2021 and 2020, respectively. Depreciation expense related to property and equipment was $1.4 million and $0.7 million for the nine months ended September 30, 2021 and 2020, respectively. Depreciation expense is included in depreciation and amortization in the condensed consolidated statements of operations and comprehensive loss.

4. CAPITALIZED WEBSITE AND INTERNAL-USE SOFTWARE COSTS, NET

Capitalized website and internal use software costs, net consists of the following (in thousands):


	As of September 30, 2021		As of December 31, 2020
Capitalized website domain costs – nonamortizable	$	385	$	385
Capitalized website and internal-use software development costs – amortizable	22,351		17,308
Less: accumulated amortization	(14,241)		(11,151)
Capitalized website and internal-use software development costs, net	$	8,495	$	6,542

Amortization of capitalized software development costs is included in depreciation and amortization in the condensed consolidated statements of operations and comprehensive loss. Amortization of capitalized software development costs amounted to $1.2 million and $0.9 million for the three months ended September 30, 2021 and 2020, respectively, and $3.1 million and $2.5 million for the nine months ended September 30, 2021 and 2020, respectively.

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consist of the following (in thousands):


	As of September 30, 2021		As of December 31, 2020
Liability for vehicles acquired under OEM program	$	3,670	$	11,461
Accrued payroll related costs	11,479		4,155
Provision for DMV refunds	1,173		1,093
Accrued sales taxes	11,587		1,503
Common stock subject to repurchase liability, current	160		524
Interest payable	2,475		18
Other accrued expenses	8,706		3,532
Total accrued expenses and other current liabilities	$	39,250	$	22,286

In November 2019, the Company entered into an arrangement with an original equipment manufacturer (“OEM”) to sell vehicles sourced locally through the trade-in program of the OEM on the Company’s platform. Under the terms of the arrangement, the Company has the option to provisionally accept any trade-ins based on information provided by the OEM. The Company transports any accepted vehicles to one of its inspection and reconditioning centers where Shift inspects the vehicle and makes a final purchasing decision regarding the vehicle. Any rejected vehicles are sent to wholesale auction facilities at Shift’s expense, at which point Shift has no further obligations to the automaker for the rejected vehicle. The Company records inventory received under the arrangement with the OEM equal to the amount of the liability due to the OEM to acquire such vehicles. The liability due to the OEM provider for such acquired vehicles is equal to the OEM’s original acquisition price. The final price paid to the OEM upon sale of the vehicle includes an additional amount equal to 50% of the excess of the sales price over the original acquisition price.

Interest payable in the table above as of December 31, 2020 has been reclassified to be shown separately from other accrued expenses to conform to the presentation as of September 30, 2021.

6. BORROWINGS

Convertible Notes

On May 27, 2021, the Company completed a private offering of its 4.75% Convertible Senior Notes due 2026 (the “Notes”). The aggregate principal amount of the Notes sold in the offering was $150.0 million. The Notes are the Company’s senior unsecured obligations and will rank equally in right of payment with the Company’s future senior unsecured indebtedness, senior in right of payment to the Company’s future indebtedness that is expressly subordinated to the Notes and effectively subordinated to the Company’s future secured indebtedness, to the extent of the value of the collateral securing that indebtedness.

The Notes will accrue interest payable semi-annually in arrears on May 15 and November 15 of each year, beginning on November 15, 2021, at a rate of 4.75% per year. The Notes will mature on May 15, 2026, unless earlier converted, redeemed or repurchased by the Company.

The Notes are convertible into shares of the Company’s Class A common stock at an initial conversion rate of 118.6556 shares of the Company’s Class A common stock per $1,000 principal amount of Notes (which is equivalent to an initial conversion price of approximately $8.43 per share of the Company’s Class A common stock). The initial conversion price represents a premium of approximately 27.50% over the last reported sale price of the Company’s Class A common stock on May 24, 2021, which was $6.61 per share. The conversion rate will be subject to adjustment upon the occurrence of certain events prior to the maturity date. The Company will increase the conversion rate on a sliding scale to up to a maximum of 151.2859 per $1,000 principal amount for a holder who elects to convert its notes in connection with certain corporate events or the Company’s delivery of a notice of redemption, as the case may be, in certain circumstances.

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Noteholders may convert their notes at their option only in the following circumstances:

1.during any calendar quarter commencing after the calendar quarter ending on June 30, 2021, if the last reported sale price per share of our Class A common stock exceeds 130% of the conversion price for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter;

2.during the 5 consecutive business days immediately after any 10 consecutive trading day period (such 10 consecutive trading day period, the “measurement period”) in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price per share of our Class A common stock on such trading day and the conversion rate on such trading day;

3.upon the occurrence of certain corporate events or distributions on our Class A common stock;

4.if we call such notes for redemption; and

5.at any time from, and including, November 15, 2025 until the close of business on the second scheduled trading day immediately before the maturity date.

Conversions of the Notes will be settled in cash, shares of the Company's Class A common stock or a combination thereof, at the Company's election.

The Notes will be redeemable, in whole or in part (subject to a partial redemption limitation), at the Company’s option at any time, and from time to time, on or after May 20, 2024 and on or before the 40th scheduled trading day immediately before the Maturity Date, at a cash redemption price equal to the principal amount of the Notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date, but only if (i) the last reported sale price per share of the Company’s Class A common stock exceeds 130% of the conversion price on (1) each of at least 20 trading days, whether or not consecutive, during the 30 consecutive trading days ending on, and including, the trading day immediately before the date the Company sends the related redemption notice; and (2) the trading day immediately before the date the Company sends such notice; and (ii) a registration statement covering the resale of the shares of the Company’s Class A common stock, if any, issuable upon conversion of the Notes in connection with such optional redemption is effective and available for use and is expected, as of the date the redemption notice is sent, to remain effective and available during the period from, and including the date the redemption notice is sent to, and including, the business day immediately before the related redemption date, unless the Company elects cash settlement in respect of the conversions in connection with such optional redemption.

In addition, calling any Note for redemption will constitute a make-whole fundamental change with respect to that Note, in which case the conversion rate applicable to the conversion of that Note will be increased in certain circumstances if it is converted after it is called for redemption and on or prior to the business day immediately before the related redemption date. If the Company elects to redeem less than all of the outstanding Notes, at least $50.0 million aggregate principal amount of Notes must be outstanding and not subject to redemption as of the date the Company sends the related redemption notice.

Unamortized deferred borrowing costs at September 30, 2021 were $6.0 million, and are included as a reduction to convertible notes on the condensed consolidated balance sheets. For the three and nine months ended September 30, 2021, the Company recorded $1.8 million and $2.5 million of contractual interest expense, respectively, and $0.3 million and $0.4 million of deferred borrowing cost amortization, respectively to interest and other expense, net on the condensed consolidated statements of operations and comprehensive loss. The effective interest rate of the Notes is 5.73% for all periods presented.

The fair value of the Notes (Level 1) at September 30, 2021 was $179.6 million.

The Company used a portion of the net proceeds from the sale of the notes to pay the cost of the capped call transactions (see Note 7 - Stockholders' Equity), and intends to use the remaining proceeds for working capital and general corporate purposes.

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Flooring Line of Credit

On October 11, 2018, the Company entered into a flooring line of credit facility (“FLOC”) with U.S. Bank National Association (“US Bank”), with the proceeds from such arrangement available to finance the purchase of vehicles. The FLOC initially allowed for a $30.0 million commitment of advances, whereby the Company may borrow, prepay, repay and reborrow the advances. Advances may be prepaid in part or in full at any time without charge, penalty or premium. The terms of the facility allowed the Company to request a one-time increase in the commitment by an amount equal to $20.0 million, provided that certain conditions in the facility agreement are met. The expiration date of the facility was initially September 30, 2019. Advances under the facility accrue interest at LIBOR plus 2.00% and as of September 30, 2021, LIBOR was 0.08%. The obligations under the facility are secured by substantially all of the Company’s inventory, both currently owned or acquired thereafter. Repayment of obligations under the facility are guaranteed by Lithia. Upon expiration of the facility, Lithia guaranteed the provision of the flooring line of credit through October 11, 2021 if the Company is unable to secure an extension of the flooring line of credit facility with US Bank. With the signing of the flooring line of credit with US Bank, the Company entered into the commercial agreement for Milestone 1 and the related warrants were issued. Refer to Note 9 - Related Party Transactions for further details regarding the guarantee of the flooring line of credit, the commercial agreement and the warrants.

The loan and security agreement contained a financial covenant that required the Company to maintain a total balance of unrestricted cash and the amount of principal available to be drawn (together, the “Borrower’s Liquidity”) equal to or exceeding four times the decrease, if any, of the cash and cash equivalents balance on the determination date compared with the balance three months prior (together calculated with the Borrower’s Liquidity, the “Liquidity Covenant”). The loan and security agreement set forth negative covenants that restrict indebtedness, liens, investments, sales of assets, fundamental changes, distributions and other matters.

Subsequent amendments extended the expiration date to October 11, 2021 and increased the amount available under the FLOC to $50.0 million. The amendments also required the Company to pay a fee of 0.40% per annum on unused availability under the FLOC, and reduced the Liquidity Covenant to one times the three-month cash burn amount.

The FLOC was subject to customary subjective acceleration clauses, effective upon a material adverse change in the Company’s business or financial condition, or a material impairment in the Company’s ability to repay the borrowing. As of September 30, 2021, the Company was not in breach of any debt covenants or subjective acceleration clauses.

The FLOC expired on October 11, 2021 and was repaid in full.

Delayed Draw Term Loan Agreement

Concurrent with the initial closing of the Series D Convertible Preferred Stock, the Company also entered into the Delayed Draw Term Loan Agreement (“DDTL”) with Lithia, whereby Lithia agreed to make up to two term loans (“Term Loan A” and “Term Loan B”) from November 29, 2019, to June 12, 2020 (extended by amendment to July 31, 2020), with a maximum principal amount of $12.5 million per term loan. Interest accrued on the outstanding principal amount of each Term Loan at a rate equal to LIBOR plus 0.50% The terms of the DDTL include various restrictive covenants, events of default, and security interests in the Company's assets.

In December 2019, the Company drew down on Term Loan A in the amount of $12.5 million. In July 2020, the Company drew down $12.5 million to fund Term Loan B. The DDTL, including both Term Loans A and B, was repaid in full in November 2020.

SBA PPP Loan

On April 22, 2020, the Company, through Shift Platform Inc. (then named Shift Technologies, Inc.), and its wholly owned subsidiary, Shift Operations LLC, obtained loans under the Paycheck Protection Program (the “PPP Loans”) with an outstanding principal amount of $6.1 million. The PPP Loans were made through Newtek Small Business Finance (the “Lender”), and the Company entered into two U.S. Small Business Administration Paycheck Protection Program Notes (the “Agreements”) with the Lender evidencing the PPP Loans. Interest accrued on the outstanding principal balances of the PPP Loans at a fixed rate of 1.0%, which is deferred for the first nine months of the term of the PPP Loans.

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

In conjunction with closing of the Merger in October 2020, the Company repaid the outstanding balance and accrued interest on the PPP Loans in full.

7. STOCKHOLDERS' EQUITY

Capped Call Transactions

On May 27, 2021, in connection with the issuance of the Notes (see Note 6 - Borrowings), the Company consummated privately negotiated capped call transactions (the “Capped Call Transactions”) with certain of the initial purchasers, their respective affiliates and other counterparties (the "Capped Call Counterparties"). The Capped Call Transactions initially cover, subject to anti-dilution adjustments substantially similar to those applicable to the Notes, the number of the Company’s Class A common shares underlying the Notes. The Capped Call Transactions are expected generally to reduce the potential dilution to holders of the Company’s Class A common stock upon conversion of the Notes and/or offset the potential cash payments that the Company could be required to make in excess of the principal amount of any converted Notes upon conversion thereof, with such reduction and/or offset subject to a cap. The Capped Call Transactions are settled from time to time upon the conversion of the Notes, with a final expiration date of May 15, 2026. The Capped Call Transactions are settled in the same proportion of cash and stock as the converted Notes. The proportion of cash and stock used to settle the Notes is at the discretion of the Company.

The cap price of the Capped Call Transactions was initially approximately $14.8725 per share, which represents a premium of approximately 125% above the last reported sale price per share of Class A common stock on NASDAQ on May 24, 2021, and is subject to certain adjustments under the terms of the Capped Call Transactions.

The Capped Call Transactions are separate transactions entered into by the Company with the Capped Call Counterparties, are not part of the terms of the Notes and will not change any holder’s rights under the Notes. Holders of the Notes will not have any rights with respect to the Capped Call Transactions.

The Company used approximately $28.4 million of the net proceeds from the offering of the Notes to pay the cost of the Capped Call Transactions. The Capped Call Transactions do not meet the criteria for separate accounting as a derivative as they are indexed to the Company's stock. The premiums paid for the Capped Call Transactions have been included as a net reduction to additional paid-in capital on the condensed consolidated balance sheets.

The following table presents the hypothetical settlement amount of the Capped Call Transactions at September 30, 2021, assuming the conversion of all outstanding Notes. The table also presents the hypothetical impact of a $1 increase or decrease in our share price on the settlement amounts. As the Company can receive settlement of the Capped Called Transactions in any combination of cash or common stock (depending on how the Company elects to settle the Notes), the table presents both the cash settlement amount assuming 100% cash settlement and the share settlement amount in common shares assuming 100% share settlement.


As of September 30, 2021	Cash Settlement Amount		Share Settlement Amount	Fair Value of Share Settlement
	(thousands)		(# of shares)	(thousands)
Hypothetical Capped Call Settlement Value	$	926	99,545	$	691
Capped Call Settlement Value - Share Price + $1	6,977		831,679	5,772
Capped Call Settlement Value - Share Price - $1	112		13,008	90

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Warrant Exchange

On December 24, 2020, the Company announced the preliminary results of its offer to exchange (“Offer”) 0.25 shares of Class A common stock and $1.00 in cash, without interest, for each of the 7,532,500 outstanding publicly traded warrants to purchase the Class A common stock of the Company, formerly known as Insurance Acquisition Corp. (“IAC”), in connection with the initial public offering of IAC’s securities on March 22, 2019, which entitle such warrant holders to purchase one share of Class A common stock at an exercise price of $11.50, subject to adjustments (the “Public Warrants”), upon the terms and subject to the conditions set forth in the Company’s Tender Offer Statement on Schedule TO originally filed by the Company with the Securities and Exchange Commission (the “SEC”) on November 5, 2020, as amended. The Offer to exchange expired on December 23, 2020. On December 28, 2020, the Company issued an aggregate of 1,744,088 shares of Class A common stock and $7.0 million in cash in exchange for the Public Warrants validly tendered and accepted for exchange in accordance with the Offer.

Pursuant to the terms of the Offer, on December 28, 2020, the Company issued an aggregate of 53,125 shares of Class A common stock and $0.2 million in cash to the holders of 212,500 privately placed warrants, at the same exchange ratio offered to the Public Warrant holders in the Offer (the "Private Exchange").

In connection with the Offer and the Private Exchange, the Company issued an aggregate of 1,798,203 shares of Class A common stock, representing approximately 2.1% of the shares of Class A Common Stock outstanding after such issuances. The Company subsequently issued 125,160 additional shares of Class A common stock and distributed $0.5 million in cash on January 14, 2021 in exchange for all remaining Public Warrants that were outstanding at December 31, 2020. There were no warrants outstanding at September 30, 2021.

8. STOCK-BASED COMPENSATION PLANS

The Company’s 2014 Stock Option Plan (the “2014 Plan”) provides for the grant of restricted stock awards and incentive and non-qualified options and to purchase common stock to officers, employees, directors, and consultants. Options granted to employees and non-employees generally vest ratably over four to five years, with a maximum contractual term of ten years. Outstanding awards under the 2014 Plan continue to be subject to the terms and conditions of the 2014 Plan. The number of shares authorized for issuance under the 2014 Plan was reduced to the number of shares subject to awards outstanding under the 2014 Plan immediately after the Merger. As a result, no further awards will be made under the 2014 Plan. Shares reserved for awards that are subsequently expired or forfeited will no longer be returned to the pool of shares authorized for issuance under the 2014 Plan.

Each Legacy Shift option from the 2014 Plan that was outstanding immediately prior to the Merger, whether vested or unvested, was converted into an option to purchase a number of shares of post-Merger common stock (each such option, a "Converted Option") equal to the product (rounded down to the nearest whole number) of (i) the number of shares of Legacy Shift common stock subject to such Legacy Shift option immediately prior to the Merger and (ii) the equity award exchange ratio. The per share exercise price for each share of post-Merger common stock issuable upon exercise of the Converted Option is equal to the exercise price per Legacy Shift share of each Legacy Shift option immediately before the Merger, with certain adjustments necessary to preserve ISO classification of awards for income tax purposes. The mechanism of conversion resulted in the fair value of each Converted Option award equaling the fair value of the corresponding Legacy Shift option award immediately prior to the consummation of the Merger. Except as specifically provided in the Merger Agreement, following the Merger, each Converted Option continues to be governed by the same terms and conditions (including vesting and exercisability terms) as were applicable to the corresponding former Legacy Shift option immediately prior to the consummation of the Merger. All stock option activity was retroactively restated to reflect the Converted Options.

At the Company's special meeting of stockholders held on October 13, 2020, the stockholders approved the 2020 Omnibus Equity Compensation Plan (the "2020 Plan"). The 2020 Plan provides for the grant of incentive and non-qualified stock option, restricted stock units ("RSUs"), restricted share awards, stock appreciation awards, and cash-based awards to employees, directors, and consultants of the Company. Awards under the 2020 Plan expire no more than ten years from the date of grant. The 2020 Plan became effective immediately upon the closing of the Merger.

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Activity related to employee and non-employee stock options issued under the 2014 Plan is set forth below:


	Number of Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value (000’s)
As of December 31, 2020	2,354,836	$	1.80	8.40	$	15,230
Granted	—	—
Exercised	(273,739)	1.42
Forfeited	(310,796)	2.88
Cancelled (expired)	(65,323)	3.89
As of September 30, 2021	1,704,978	$	1.61	7.40	$	9,250
Exercisable as of September 30, 2021	1,704,978	$	1.61	7.40	$	9,250

Activity related to employee and non-employee RSU awards issued under the 2020 Plan is set forth below:


	Number of Shares	Weighted Average Grant Date Fair Value		Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value (000’s)
As of December 31, 2020	—	$	—	—	$	—
Granted	9,603,494	7.23
Vested	—	—
Forfeited	(560,721)	7.70
As of September 30, 2021	9,042,773	$	7.20	1.58	$	62,757

The RSUs granted during the nine months ended September 30, 2021 include 1,771,220 RSUs that vest if the closing price of the Company's common stock exceeds thresholds ranging from $23 to $28 during the two year period following the second anniversary of the earlier of the closing of the Merger or the grantee's date of hire. The grant date fair values of awards with market-based vesting conditions were determined using a Monte Carlo valuation model, which requires significant estimates including the expected volatility of our common stock.

Stock-Based Compensation Expense

For the three months ended September 30, 2021 and 2020, the Company recorded stock-based compensation expense to selling, general and administrative expenses on the condensed consolidated statements of operations and comprehensive loss of $5.3 million and $0.8 million, respectively. For the nine months ended September 30, 2021 and 2020, the Company recorded stock-based compensation expense of $18.9 million and $1.5 million, respectively In addition, the Company capitalized stock-based compensation costs for the three months ended September 30, 2021 and 2020 of $0.2 million and $0.1 million, respectively, to capitalized website and internal use software costs, net. For the nine months ended September 30, 2021, the Company capitalized $0.6 million and $0.2 million.

As of September 30, 2021, there was $48.0 million of unrecognized stock-based compensation expense that is expected to be recognized over a weighted-average period of 2.42 years.

Common Stock Subject to Repurchase Related to Early Exercised Options

The Company typically allows employees to exercise options prior to vesting. Upon termination of service of an employee, the Company has the right to repurchase at the original purchase price any non-vested but issued common shares. Such an exercise is not substantive for accounting purposes. The consideration received for an exercise of an option is considered to be a deposit of the exercise price, and the related dollar amount is recorded as a liability. The liability is reclassified to additional paid in capital as the award vests.

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

As of September 30, 2021 and December 31, 2020, the Company has recorded a liability of $0.3 million and $0.7 million relating to 71,644 and 294,761 options that were exercised but not vested, respectively.

9. RELATED PARTY TRANSACTIONS

Sales with Related Party

The Company operates a one-sided marketplace (“OSM”) program whereby the Company acquires cars from various sources in Oxnard, California and sells them directly and solely to Lithia. The Company invoices Lithia based on the purchase price of the car plus an agreed upon margin. During the three months ended September 30, 2021 and 2020, the Company recognized approximately $4.8 million and $2.2 million, respectively, of sales from the OSM agreement with Lithia. During the nine months ended September 30, 2021 and 2020, the Company recognized approximately $11.7 million and $3.7 million, respectively, of sales from the OSM agreement with Lithia.

Accounts Receivable from Related Party

As of September 30, 2021 and December 31, 2020, the Company has $2.5 million and $0.2 million in outstanding accounts receivable from Lithia, which is comprised of $2.3 million and $0.1 million, respectively, in vehicle sales and $0.1 million and $43 thousand, respectively, in commissions based on the number of loan contracts booked with US bank. The Company operates under Lithia’s master agreement with US Bank where the collections pass through Lithia.

Warrant and Commercial Agreements

In September 2018, the Company entered into a warrant agreement (the “Warrant Agreement”) and a commercial agreement for Milestone 1 with Lithia and granted Lithia a warrant to purchase 86,661,588 shares of Legacy Shift common stock at an exercise price of $0.01 per share (the “Warrant Shares”). The Warrant Shares were scheduled to vest and become exercisable in six separate tranches of 14,443,598 shares each. Vesting and exercisability was dependent upon the achievement of the Milestones, as defined below. While the Warrant Agreement establishes general vesting terms for each of the six Milestones, each of the six Milestones contains substantive service or performance requirements, and were non-binding as neither the Company nor Lithia were obligated to perform until the commercial agreement associated with each Milestone was executed.

Two tranches of 14,443,598 Warrant Shares were scheduled to vest and become immediately exercisable upon the achievement of each of Milestone 1 and Milestone 2. The remaining four tranches of 14,443,598 Warrant Shares were scheduled to vest and become exercisable on January 12, 2020 (the “Vesting Cliff Date”), provided that Milestone 3, Milestone 4, Milestone 5 and Milestone 6 were achieved prior to such date. If such Milestone had not been achieved by the Vesting Cliff Date, such 14,443,598 Warrant Shares would vest and become immediately exercisable upon the achievement of such Milestone. With respect to any unvested Warrant Shares that had not vested by June 12, 2020 (the “Vesting Termination Date”), the Warrant would automatically terminate. All Warrant Shares became vested prior to the Vesting Termination Date and were exercised prior to the Merger.

•Milestone 1 — the Company, with Lithia’s assistance, enters into acceptable credit facilities with access to asset-based used vehicle floorplan financing.

•Milestone 2 — the Company and Lithia enter into a data sharing commercial agreement whereby Lithia agrees to transfer certain historical transaction and inventory data to the Company.

•Milestone 3 — the Company and Lithia enter into a lease and services agreement whereby Lithia will make available at least one of its locations for the Company’s use as a storage/reconditioning/retail delivery center.

•Milestone 4 — the Company and Lithia enter into a lease and services agreement whereby Lithia will make available at least three of its locations for the Company’s use as a storage/reconditioning/retail delivery center.

•Milestone 5 — the Company and Lithia enter a commercial agreement whereby Lithia agrees to use commercially reasonable best efforts to help the Company secure and maintain access to finance and insurance products on par with a typical Lithia store.

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SHIFT TECHNOLOGIES INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

•Milestone 6 — the Company and Lithia entering into a commercial agreement where Lithia will purchase mutually-agreed upon vehicles from the Company in a minimum of three existing Lithia markets.

2018 Milestones

The commercial agreement agreed to with Lithia in September 2018 was entered into concurrently with arrangements that provide for Lithia’s guarantee of the flooring line of credit for a three-year period and the provision by Lithia for the delayed draw facility, see Note 6 - Borrowings. The Company determined that there was significant value in the terms received related to both the guarantee and delayed draw facility, for which the Company transferred the warrants identified in Milestone 1 as compensation. Accordingly, upon entering into the arrangements, the Company measured the fair value of the guarantee received at $9.1 million and the fair value of the delayed draw facility at $5.7 million.

The fair value of the guarantee is treated as a deferred borrowing cost associated with the flooring line of credit and is included within deferred borrowing costs on the condensed consolidated balance sheets and is being amortized over the three-year guarantee period, which resulted in $0.6 million and $1.1 million of interest expense during the three months ended September 30, 2021 and 2020, respectively, and $2.1 million and $3.5 million for the nine months ended September 30, 2021 and 2020, respectively. The deferred loan commitment cost was amortized over the four-year loan commitment period and the remaining balance was written off when the DDTL was repaid on November 10, 2020. Amortization of the deferred loan commitment cost associated with the delayed draw facility resulted in total interest expense during the three and nine months ended September 30, 2020 of $0.3 million and $1.0 million, respectively.

The warrants issued with Milestone 1 were determined to be liability classified, subject to remeasurement, and were recorded as a non-current liability on the condensed consolidated balance sheets as of March 31, 2020. The warrants were exercised in connection with the Merger closing on October 13, 2020. The Company recognized remeasurement losses of $6.2 million for the three and nine months ended September 30, 2020.

2019 Milestones

In connection with the negotiations related to Milestone 5, Lithia facilitated an agreement with Automotive Warranty Services (“AWS”) to sell and market AWS’s service plans, whereby the Company receives commission rates from AWS of comparable terms to those received by Lithia. In substance the Company paid Lithia, in the form of Warrant Shares, to make an upfront payment to Company’s customers on behalf of the Company as the Company achieved favorable pricing from AWS. The benefits of this agreement were guaranteed by Lithia for an initial term of five years commencing on the signing date of the agreement. Such arrangement was the first of a number of agreements to be entered into under the terms of Milestone 5, see further discussion below. The estimated fair value of the in substance upfront payment to AWS was $2.8 million with an offsetting entry recorded to additional paid-in capital, representing a capital transaction with a related party.

Milestone 5 was met in October 2019 and the Company recorded the warrants to additional paid-in capital based on a fair value of $4.3 million. Milestone 5 was achieved after a mutual signed agreement was entered into evidencing that Lithia provided commercially best efforts to help the Company secure and maintain access to four finance and insurance products on par with a typical Lithia store. The fair value of the in substance upfront payment, other than the $2.8 million for AWS discussed above, was $0.4 million and was recorded to other non-current assets on the condensed consolidated balance sheets. The combined asset recorded of $3.2 million is subject to amortization over a five-year period expected period of benefit. During the three months ended September 30, 2021 and 2020, the Company amortized $0.2 million and $0.2 million, respectively of the asset as a reduction to finance and insurance sales, which is recorded within other revenue, net on the condensed consolidated statements of operations and comprehensive loss. During the nine months ended September 30, 2021 and 2020, the Company amortized $0.5 million and $0.5 million, respectively. As of September 30, 2021 and December 31, 2020, the remaining asset, net of amortization, was $1.4 million and $1.9 million, respectively.

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