# IMPINJ INC (PI) FY 2021 MD&A Verbatim Item 7 Management's Discussion and Analysis from IMPINJ INC's 10-K for fiscal year 2021. SEC filing source: https://www.sec.gov/Archives/edgar/data/1114995/000156459022004981/pi-10k_20211231.htm Accession: 0001564590-22-004981 Filing date: 2022-02-14 Report date: 2021-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture. Confidence: high Company profile: /company/PI/ All MD&A years: /company/PI/mda/ Next year: /company/PI/mda/fy2022/ (FY 2022) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion and analysis together with our consolidated financial statements and the related notes to those statements included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” and elsewhere in this report, our actual results may differ materially from those anticipated in these forward-looking statements. Overview Our vision is a boundless Internet of Things, or IoT. We are driving a future in which everyday physical items are wirelessly connected to digital counterparts, or digital twins, in the cloud, and in which businesses and people access information about an item from its digital twin. Our mission is to connect every thing. We deliver a platform that powers item-to-cloud connectivity, and on which enterprise solution providers innovate IoT whole products. Today, we deliver the identity, location and authenticity of billions of physical items. We believe our future is extending that delivery to trillions of physical items and enabling ubiquitous access to cloud-based digital twins of those items, each storing an item’s ownership, history and links. We believe the item-to-cloud connectivity that our platform will deliver will enhance businesses efficiencies and commerce and, ultimately, improve peoples’ lives. Our platform, which comprises multiple product families, wirelessly connects individual items and delivers data about the connected items to business and consumer applications enabled by our partner network. We link the products within our platform to deliver capabilities and performance that surpasses mix-and-match solutions built from competitor products. We and our partners connect the items via a miniature radio chip embedded in the item or in its packaging, reading and delivering each item’s identity, location and authenticity. To date, we have enabled connectivity to more than 60 billion items, enabling businesses and consumers to derive timely information from those connected items. Our platform uses RAIN, a type of radio-frequency identification, or RFID, technology we pioneered. We spearheaded development of the RAIN radio standard, lobbied governments to allocate frequency spectrum and cofounded the RAIN Alliance that today has more than 160 member companies. Our industry uses free spectrum in 81 countries encompassing roughly 95% of the world’s GDP and has connected many tens of billions of items to date. We believe RAIN’s capabilities – in particular, endpoint ICs with serialized identifiers, 30-foot range reading up to 1,000 items per second without line-of-sight, radio-frequency energy harvesting for battery-free operation, essentially unlimited life and, in the future, cryptographic item authentication – position RAIN to be the leading item-to-cloud connectivity technology for the IoT. Factors Affecting Our Performance Covid-19 We are actively monitoring and mitigating the impacts of Covid-19 in all aspects of our business, including for our employees, suppliers, partners and end users. For our endpoint IC business, forecasting was already difficult without Covid-19, because we sell our ICs to inlay partners and therefore have limited visibility to end-user demand. The myriad uncertainties that Covid-19 introduced, and continues introducing, especially at retail end users, has exacerbated that forecasting difficulty. Covid-19’s impact has been further complicated by countries vaccinating and reopening at different rates and with varying levels of effectiveness, as well as the impacts of various Covid-19 variants. Covid-19 also caused long-term shifts, many negative, in other industries important to us, such as aviation and sports. Even in supply chain and logistics, or SC&L, which saw shipment volumes surge in the depths of Covid-19, end users had been reticent to deploy new technologies. 40 Table of Contents We built endpoint IC inventory through much of 2020, anticipating tight 200mm wafer foundry capacity ahead of our transition to our 300mm M700 product family. We introduced our new Impinj M700 in 2020 and, although it was in production by the end of 2020, we initially saw a slower demand ramp than we expected. Beginning in fourth-quarter 2020, demand for all our endpoint ICs, including our M700, increased dramatically. Worldwide IC wafer demand also increased, leading to wafer shortfalls in many industries, including ours. In first-quarter 2021, we consumed the inventory we built in 2020 at a pace that exceeded our first-quarter 2021 wafer supply and post-processing capacity. In the second and third quarters we moderated that inventory burndown, stretching our IC supply to our partners and market but constraining our ability to fully capitalize on the increased endpoint IC demand, while also expanding and maturing additional post-processing capacity. Despite that moderation, by end of third-quarter 2021 we had mostly consumed that prebuilt inventory. This trend continued in fourth-quarter 2021 with demand for our endpoint IC inventory exceeding our ability to meet that demand. For our systems business, Covid-19 delayed pilots and deployments throughout 2021. These delays were due in some cases to businesses being closed by local regulations and in others by businesses reducing or deferring capital expenditures. Some end users accelerated their investments in business-process modernization technologies like RAIN during the pandemic, but even in those cases, Covid-19 delayed deployments for reasons of health and safety, product and labor availability, and store closures. We also saw our distributors normalize their inventory to match Covid-19 demand levels. Although we built additional systems inventory during 2021, like with endpoint ICs, supply constraints limited our ability to accumulate inventory sufficient to meet demand. We saw increased systems demand but packaging delays and packaging price increases causing short supply of our reader ICs, low inventory levels at our distributors, and price increases and component shortfalls for analog, specialized logic, and memory chips constraining reader and gateway supply. Consequently, like for our endpoint ICs, our ability to capitalize on the increased systems demand is constrained. Our business operations have also been affected by Covid-19. Government restrictions in the early days of the pandemic caused us to mostly close our offices in early 2020. Today, except for a small number of employees who need to be in our offices to fulfill their roles, almost all our employees continue to work from home. As we evaluate how to safely reopen our offices, our first priority is protecting our employees’ health and safety, and we will prioritize health and safety over a rapid office return. Recently, a resurgence of Covid-19 in geographies where our manufacturing subcontractors are located has caused governments to reinstitute mandatory factory staff reductions, facility closures or both, periodically impacting our endpoint IC and systems production and our ability to ship products. Covid-19 travel restrictions adversely affected our business by slowing new-product launches and typical sales activities, and those activities remain restricted. We previously anticipated that second half 2021 would bring a return to some semblance of travel and sales normalcy, but for the most part our anticipations were not met. Moreover, there can be no assurance that Covid-19’s impact on our employees or business activities will return to normal in the first-half of 2022. Our compliance with legal and regulatory requirements related to Covid-19 may subject us to future challenges, particularly as requirements evolve. Despite ongoing uncertainties related to Covid-19, we continue investing in research and development and long-term RAIN opportunities. Although we plan to continue making these investments into 2022, we may, depending on the business environment, choose to slow or suspend our investments, potentially impairing our ability to meet our long-term strategic objectives. Covid-19 negatively impacted our results of operations, cash flows and financial position in 2020. It caused supply and travel disruptions in 2021. We expect it to continue disrupting our business in 2022, in ways that are difficult for us to fully predict. Given the ongoing uncertainty over Covid-19’s epidemiological, economic and operational impacts we cannot reasonably estimate the extent or duration of Covid-19’s continuing impact on our business. The extent to which Covid-19 impacts our future results will depend on developments that are inherently unpredictable, including the emergence of new Covid-19 variants and actions we and others take in response to Covid-19. For more information on Covid-19’s impact on our business, please refer to Part I, Item 1A (Risk Factors) of this report. 41 Table of Contents Investing for Growth We have invested in, and plan to continue investing in, research and development to enhance and extend our platform, including enhancing existing products, introducing new products and tightening the platform linkages between our products. Although we sell our products into many end markets, relying significantly on our partner channel, we are today focusing particular attention on retail self-checkout and loss prevention and SC&L portal and conveyor opportunities. Most of our investments precede any sales benefits from the investments and, in some instances, we may never see any benefits if the market is not receptive to our product or sales approach, product development is late or fails, or for other causes. We sometimes enter into arrangements with end users, suppliers or channel partners for them to fund a portion of our investment, but even in those instances the results of our investments remain uncertain, and in some instances, we may be required to refund the investment if the development is unsuccessful or the market opportunity fails to materialize. In some instances, we delay or cancel investments without or until we obtain such funding. The outcome of an investment is almost always uncertain, and if our results do not meet expectations then our operating results, profitability and stock price may be adversely affected. While our long-term plan to invest for growth remains unchanged, Covid-19 has introduced new uncertainty to our business. We will continue to monitor the impacts of Covid-19 on our supply chain, market and opportunities and adjust our investment strategy as appropriate. Market Adoption Our financial performance depends on the pace and scope of end-user adoption of our products in multiple industries, but especially in retail apparel, which is our largest market. Covid-19 has had, and we expect it to continue to have, a materially adverse impact on the retail industry. Covid-19 may also accelerate an ongoing shift in consumer shopping away from physical stores, which could adversely affect demand for endpoint ICs by retailers. The extent to which Covid-19 materially impacts the retail industry is unclear, as is the extent to which it will impact our product sales. Other industries that are potential future drivers of RAIN adoption have also been impacted by Covid-19, although the long-term impact on our business is unclear. For example, the aviation industry, which had proposed widespread luggage tagging, has been negatively impacted by Covid-19. By contrast, SC&L has experienced increased demand which could positively impact our financial performance if SC&L further adopts RAIN. See the section captioned “Covid-19” for additional information. The pace and scope of end-user adoption, slowed in 2020 by Covid-19, remains uncertain today, potentially causing large fluctuations in our operating results. For a first historical example of the potential impact of those fluctuations, in 2015 and 2016 several major retailers commenced deployments that significantly increased our endpoint IC sales, lengthening our product lead times. In 2017 we invested in endpoint IC inventory to reduce those lead times, but in second-half 2017 the endpoint IC growth rate slowed, we believe due primarily to delays in new deployments at several large retailers. That decelerating growth rate engendered an endpoint IC channel inventory correction that negatively impacted our operating results for several subsequent quarters. For a second historical example, in late 2018 and in 2019 a large North American logistics provider purchased and deployed significant quantities of our gateways, positively impacting our operating results for several quarters, then transitioned to an operational phase in first-half 2020, reducing our gateway sales. For a third historical example, in first-quarter 2020 we saw high endpoint IC demand as our inlay partners built inventory ahead of Covid-19, followed by several quarters of depressed demand as those same inlay partners consumed that inventory, followed by high demand in 2021 as those same inlay partners deliver into recovering end-user opportunities. Given the uncertainties in our market, we cannot be certain that RAIN adoption will continue; that we will have appropriate product inventory; that we will not experience future product inventory shortfalls or overages; or that Covid-19 will not materially impact our business going forward. We also cannot be certain that we will be able to maintain or grow our market share for any of our products, whether because of insufficient inventory, Covid-19, competitors copying our products, insufficient wafer or other product supply, competition generally or for a host of other reasons, many of which are outside our control. Regardless of the uneven pace of retail, SC&L and other industry adoption, we believe the underlying, long-term trend is continued RAIN adoption and as a result we have continued investing in new products. In our endpoint IC business, in 2020 we introduced our new Impinj M700, which offers significant performance 42 Table of Contents advantages over other endpoint ICs on the market and which we believe will foster adoption. In our systems business, in 2020 we introduced our new Impinj R700 reader and in 2021 our new Impinj E710, E510 and E310 reader ICs, which likewise offer significant performance advantages over other readers and reader ICs on the market and which we believe will also foster adoption. Market adoption could be impacted by product availability. See further discussion of product availability under “Inventory Supply”. We sell our products through partners and distributors and have limited ability to determine end-user demand. Consequently, we may incorrectly forecast that demand or not identify market shifts in a timely fashion, potentially affecting our business adversely. If RAIN market adoption, and adoption of our products specifically, does not meet our expectations or if we are unable to meet partner or end-user volume or performance expectations, because of the impact of Covid-19, recovering demand, or otherwise, then our operating results and growth prospects will be adversely affected. If we reduce prices to win opportunities, then our gross margins may be negatively affected. In contrast, if our endpoint IC, reader IC, reader or gateway sales exceed expectations, then our revenue and profitability may be positively affected. Timing and Complexity of End User Deployments From 2010 to 2021, our endpoint IC sales volumes increased at a compounded annual growth rate of 27%. However, the pace has been uneven and unpredictable. For example, our endpoint IC unit sales volumes increased significantly in 2016, declined in second-half 2017 and in first-half 2018, returned to growth in second-half 2018 and in 2019 (the latter albeit not at the same pace as in 2016), declined again in second- and third-quarter 2020 due to Covid-19, and recovered in fourth-quarter 2020, and in 2021. We expect short-term demand to remain unpredictable in scope and timing. Longer term, we believe our endpoint IC opportunity will continue to grow, but we cannot predict whether historical annual growth rates are indicative of the pace of future growth. Our systems business, at least for our readers and gateways, relies disproportionally on large-scale deployments at discrete end users. The timing of those large deployments causes large variability in our systems revenue. For example, we generated 14% of total 2019 revenue from a large North American SC&L provider in connection with a project-based gateway deployment. We did not have comparable new project-based revenue in 2020. As another example, in second-quarter 2021, we generated 13% of our quarterly revenue from a project-based gateway deployment for RAIN-based loss-prevention at a large European retailer. Finally, although we promote our platform as an integrated offering, we sell our products individually, and end users often use only certain of our products. For any given end-user solution, whether an end user chooses to deploy our entire platform or only a portion will also affect our operating results. Average Selling Price Our product ASPs fluctuate based on competitive pressures and the discounting we offer to win opportunities, but generally decline over time. Historically, we have been able to compensate these ASP declines by reducing the per-unit cost of most of our products, by reducing supplier costs and implementing manufacturing and quality improvements, as well as by introducing newer and lower-cost products, but the timing of these cost reductions and new-product introductions fluctuates and may not materialize in any given quarter or year. In the second half of 2021, due to wafer and component supply shortfalls at many of our suppliers, we began to experience increasing rather than decreasing costs for both endpoint ICs and systems. In October 2021, we began raising prices to offset the impact of those increased costs. If we are unable to successfully increase our prices or if our customers choose competitors’ products due to our higher prices, then our product margins, operating results or both may suffer. In the near term, we expect margins to be volatile based on product mix and the timing of our price changes. Seasonality We typically renegotiate pricing with most of our endpoint IC OEMs with an effective date of the first quarter of the calendar year, reducing both revenue and gross margins in the first quarter compared to prior periods. Historically, the impact tends to decline in subsequent quarters as we reduce costs and, to the extent we can migrate our customers to newer, lower-cost products, adjust product mix. Endpoint IC volumes also tend to be historically lower in the fourth quarter than in the third quarter. We may not see these historical trends hold in 2022 due to the price increases noted above, and ongoing demand and supply impacts from Covid-19. 43 Table of Contents System sales tend to be stronger in the fourth quarter of the calendar year, and less strong in the first quarter. We believe this seasonality is due to the availability of residual funding for capital expenditures prior to the end of many customers’ fiscal years. Like for our endpoint ICs, we may not see these historical trends hold in 2022 due to the price increases noted above and ongoing demand and supply impacts from Covid-19. While, over the longer term, we expect these seasonal trends to continue, quarter-to-quarter variability in our revenue can be caused by a number of factors including uncertainty in demand and supply as a result of Covid-19, the timing of large deployments, competitor product availability as well as supply constraints, any or all of which can mask seasonality in any given period. These risks and uncertainties, as well as other risks and uncertainties, including but not limited to the impacts of Covid-19, can cause our actual results to differ significantly from our expectations, as described in greater detail in the sections of this report captioned “—Covid-19” and in Part I, Item 1A (Risk Factors). Inventory Supply From time to time, we experience inventory overages or shortages, either due to us mis-estimating customer or end-user demand; constrained supplier manufacturing capacity or product availability; fluctuations in our market, including competitor product availability or in the global economy; changes in regulations or tariffs; or for a host of other reasons. These inventory dynamics can impact some or all of our products. High inventory levels can result in product obsolescence, increases in reserves or unexpected expenses that adversely affect our business. Low inventory levels can affect our ability to meet customer demand, lengthen lead times and potentially causing us to miss opportunities, lose market share and/or damage customer relationships, also adversely affecting our business. For example, in 2010 we experienced wafer shortages relative to our submitted endpoint IC wafer purchase orders because of high worldwide demand for semiconductor foundry capacity. These shortages adversely affected our ability to meet our customers’ demand and, in some cases, caused customers to cancel orders, qualify alternative suppliers or purchase from our competitors. In 2021, we again experienced wafer shortages due to both significant worldwide demand from multiple industries and semiconductor foundries wafer shortfalls. In 2020, we anticipated a 2021 200mm shortfall and, in the depths of the pandemic, both built 200mm wafer inventory and accelerated our investment in 300mm M700 post-processing capacity. Regardless, the worldwide semiconductor wafer supply imbalance exceeded our prior expectations. We focused our 2021 efforts on moderating our 200mm wafer supply, accelerating and maturing our 300mm post-processing capacity, and maximizing our total unit volumes to best support our inlay partners and capture the market opportunity. Looking forward, our foundry partner has signaled tight wafer availability, at least in the older-generation semiconductor nodes we use, well into 2022. We therefore continue our focus in 2022 on wafer availability, expanding and maturing our 300mm post-processing capacity, and total unit volumes in light of anticipated strong endpoint IC demand against that constrained wafer supply. We have wafer supply commitments similar to fourth-quarter levels through at least mid-2022, but our supply in subsequent periods is less certain. Any inability to obtain sufficient wafer supply at reasonable prices or at all would negatively impact our operating results and prospects. In our systems business, we experienced lengthened packaging lead times for our reader ICs, which negatively impacted our ability to meet reader IC demand for 2021. We expect those lengthened lead times, and our ability to meet demand, to stabilize in first-half 2022. At the same time, we anticipate reader IC cost increases, at least for several quarters. We have also experienced and expect to continue experiencing shortages and price increases for the electronic and other components our subcontractors use to build our readers and gateways, impacting current and future reader and gateway availability and costs. Results of Operations [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands, except percentages)","","2021","","","2020","","","2019","","","Change","","","Change"],["Revenue","","$","190,283","","","$","138,923","","","$","152,836","","","$","51,360","","","$","(13,913",")"],["Gross profit","","$","98,954","","","$","65,140","","","$","74,002","","","$","33,814","","","$","(8,862",")"],["Gross margin","","","52.0","%","","","46.9","%","","","48.4","%","","","5.1","%","","","(1.5",")%"],["Loss from operations","","$","(37,249",")","","$","(47,071",")","","$","(21,661",")","","$","9,822","","","$","(25,410",")"]] [[/GREPCENT_TABLE]] 44 Table of Contents Year ended December 31, 2021 compared with year ended December 31, 2020 Revenue and gross profit increased due primarily to higher endpoint IC and systems revenue. Gross margin increased due primarily to prior-year excess and obsolescence charges as well as current-year sales of fully reserved inventory and increased product margins. The increased product margins were primarily driven by the increase in endpoint IC margin due to product mix. Loss from operations decreased due primarily to increased gross profit offset by increased operating expenses. The increase in operating expenses was primarily due to increased stock-based compensation expense, increased research and development and sales and marketing personnel expenses and increased non-settlement related legal fees. Year ended December 31, 2020 compared with year ended December 31, 2019 Revenue and gross profit decreased due primarily to lower systems revenue, partially offset by higher endpoint IC revenue. Gross margin decreased due primarily to revenue mix with systems revenue comprising a smaller portion of our total revenue. Loss from operations increased due primarily to increased operating expenses and decreased gross profit. The increase in operating expenses was primarily due to increased stock-based compensation expense, litigation-settlement and related costs incurred in second-quarter 2020, and increased research and development personnel expenses, partially offset by decreased sales and marketing personnel expenses. Revenue [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Endpoint ICs","","$","139,250","","","$","102,326","","","$","97,657","","","$","36,924","","","$","4,669"],["Systems","","","51,033","","","","36,597","","","","55,179","","","","14,436","","","","(18,582",")"],["Total revenue","","$","190,283","","","$","138,923","","","$","152,836","","","$","51,360","","","$","(13,913",")"]] [[/GREPCENT_TABLE]] We currently derive substantially all our revenue from sales of endpoint ICs, reader ICs, readers and gateways. We sell our endpoint ICs primarily to inlay manufacturers; our reader ICs primarily to OEMs and ODMs through distributors; and our readers and gateways to value-added resellers, or VARs, and system integrators, or SIs, primarily through distributors. We expect endpoint IC sales to represent the majority of our revenue for the foreseeable future. Year ended December 31, 2021 compared with year ended December 31, 2020 Endpoint IC revenue increased $36.9 million, due primarily to a $44.5 million increase in shipment volumes, offset by a $7.6 million decrease due to lower ASPs. The increase in shipment volumes was due, in part, to prior year volumes being low, a result of Covid-19 which negatively impacted several markets we sell to, including retail, our largest endpoint IC market, as well as growth in our customers’ underlying business. The ASP decrease was due to our annual price negotiations as discussed above under “—Factors Affecting Our Performance—Seasonality” and product mix with a higher contribution from our M700 product line which has a lower ASP, both of which were slightly offset by higher contribution from industrial and specialized products. Systems revenue increased $14.4 million, due primarily to increases of $12.2 million in reader revenue, $1.4 million in gateway revenue and $629,000 in NRE revenue. Reader revenue increased primarily due to higher shipment volumes and ASPs, gateway revenue increased primarily due to higher ASPs; and NRE revenue increased due to timing of revenue recognition. For more information, see the sections captioned “—Factors Affecting Our Performance—Covid-19” and “Risk Factors—Risks Relating to Our Platform, Products and Technologies—Covid-19 has adversely affected our business, and the magnitude and duration of future Covid-19 effects on our financial position, results of operations, cash flows and business prospects are uncertain.” Year ended December 31, 2020 compared with year ended December 31, 2019 Endpoint IC revenue increased $4.7 million, due primarily to a $7.0 million increase in shipment volumes, partially offset by a $2.3 million decrease due to lower ASPs. The ASP decrease was due primarily to our annual price negotiations as discussed above under “—Factors Affecting Our Performance—Seasonality”, partially offset by favorable product mix. The increase in shipment volumes was due primarily to growth in our customers’ 45 Table of Contents underlying business before Covid-19 negatively impacted global retail apparel sales starting second-quarter 2020 and subsequent demand recovery in fourth-quarter 2020. Systems revenue decreased $18.6 million, due primarily to decreases of $14.8 million in gateway revenue and $5.2 million in reader revenue, partially offset by a $1.3 million increase in reader IC revenue. Gateway revenue decreased due primarily to the North American logistics provider in connection with a project-based gateway deployment described above; reader revenue decreased due primarily to lower shipment volumes, in part caused by Covid-19 related delays in systems deployments; reader IC revenue increased primarily due to higher shipment volumes. Gross Profit and Gross Margin [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands, except percentages)","","2021","","","2020","","","2019","","","Change","","","Change"],["Cost of revenue","","$","91,329","","","$","73,783","","","$","78,834","","","$","17,546","","","$","(5,051",")"],["Gross profit","","$","98,954","","","$","65,140","","","$","74,002","","","$","33,814","","","$","(8,862",")"],["Gross margin","","","52.0","%","","","46.9","%","","","48.4","%","","","5.1","%","","","(1.5",")%"]] [[/GREPCENT_TABLE]] Cost of revenue includes costs associated with manufacturing our endpoint ICs, reader ICs, readers and gateways, including direct materials and outsourced manufacturing costs as well as associated overhead costs such as logistics, quality control, planning and procurement. Cost of revenue also includes charges for excess and obsolescence and warranty costs. Our gross margin varies from period to period based on mix of endpoint IC and systems, underlying product margins driven by changes in ASPs or costs, as well as from inventory excess and obsolescence charges. Year ended December 31, 2021 compared with year ended December 31, 2020 Cost of revenue increased $17.5 million, due primarily to increased endpoint IC and systems revenue. Gross margin increased 5.1%, due to inventory excess and obsolescence charges that had an unfavorable net gross margin impact of 2.2% in 2020, sales of fully reserved inventory that had a positive 1.5% impact in 2021, and increased underlying product margins primarily related to favorable endpoint IC product mix with an increasing mix of M700 and higher contribution from industrial and specialized products. Year ended December 31, 2020 compared with year ended December 31, 2019 Cost of revenue decreased $5.1 million, due primarily to decreased systems revenue partially offset by increased endpoint IC revenue. Gross margin decreased 1.5%, due primarily to revenue mix with systems revenue comprising a smaller portion of our total revenue. Inventory excess and obsolescence charges had an unfavorable net gross-margin impact of 2.2% in 2020. Operating Expenses Research and Development [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Research and development","","$","64,058","","","$","48,590","","","$","38,880","","","$","15,468","","","$","9,710"]] [[/GREPCENT_TABLE]] Research and development expense comprises primarily personnel expenses (salaries, benefits and other employee related costs) and stock-based compensation expense for our product-development personnel; product development costs which include external consulting and service costs, prototype materials and other new-product development costs; and an allocated portion of infrastructure costs which include occupancy, depreciation and software costs. We expect research and development expense to increase in absolute dollars in future periods as we focus on new product development and introductions. Year ended December 31, 2021 compared with year ended December 31, 2020 Research and development expense increased $15.5 million, due primarily to increases of $6.9 million in stock-based compensation expense primarily related to PSU grant timing, and to a lesser extent, an increased number of equity grants outstanding. Other major factors driving the increase included $4.6 million in personnel 46 Table of Contents expenses from higher headcount; $2.9 million in product-development costs; and $1.1 million in infrastructure costs from increased software costs. Year ended December 31, 2020 compared with year ended December 31, 2019 Research and development expense increased $9.7 million, due primarily to increases of $4.2 million in personnel expenses from higher headcount, $3.9 million in stock-based compensation expense from PSUs and an increased number of equity grants outstanding and $1.2 million in product development costs as a result of fluctuations in the timing of development activities and $589,000 in infrastructure costs from increased software costs. Sales and Marketing [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Sales and marketing","","$","34,287","","","$","28,663","","","$","32,642","","","$","5,624","","","$","(3,979",")"]] [[/GREPCENT_TABLE]] Sales and marketing expense comprises primarily personnel expenses (salaries, incentive sales compensation, or commission, benefits and other employee related costs) and stock-based compensation expense for our sales and marketing personnel; travel, advertising and promotional expenses; and an allocated portion of infrastructure costs which include occupancy, depreciation and software costs. We expect sales and marketing expense to remain approximately constant on an absolute dollar basis, except for incentive sales compensation which fluctuates as a function of revenue. Expenses associated with our sales and marketing activities related to marketing events requiring travel will continue to fluctuate depending on current and future Covid-19 travel restrictions. Year ended December 31, 2021 compared with year ended December 31, 2020 Sales and marketing expense increased $5.6 million, due primarily to increases of $3.5 million in stock-based compensation expense primarily related to PSU grant timing, and an increased number of equity grants outstanding. Other major factors driving the increase included $2.2 million in personnel expenses from higher salaries and benefits, and commissions as a result of our increased revenue. Year ended December 31, 2020 compared with year ended December 31, 2019 Sales and marketing expense decreased $4.0 million, due primarily to decreases of $3.3 million in personnel expenses from lower commission expense and, to a lesser extent, lower headcount, and $1.3 million from travel related expense due to Covid-19. These decreases were partially offset by a $516,000 increase in infrastructure costs from increased software costs. General and Administrative [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["General and administrative","","$","36,137","","","$","34,958","","","$","24,141","","","$","1,179","","","$","10,817"]] [[/GREPCENT_TABLE]] General and administrative expense comprises primarily personnel expenses (salaries, benefits, and other employee related costs) and stock-based compensation expense for our executive, finance, human resources and information technology personnel; legal, accounting and other professional service fees; travel and insurance expense; and an allocated portion of infrastructure costs which include, occupancy, depreciation and software costs. Year ended December 31, 2021 compared with year ended December 31, 2020 General and administrative expense increased $1.2 million due primarily to increases of $3.6 million in stock-based compensation expense primarily related to PSU grant timing, and an increased number of equity grants outstanding. Other major factors comprising the increase included $3.1 million in professional services primarily 47 Table of Contents related to non-settlement related legal fees offset by decreases of $5.8 million in settlement and related costs incurred in 2020. Year ended December 31, 2020 compared with year ended December 31, 2019 General and administrative expense increased $10.8 million due primarily to increases of $5.4 million in the litigation settlement and related costs, $3.1 million in stock-based compensation expense from PSUs and an increased number of equity grants outstanding, $1.3 million in non-settlement related legal fees and $723,000 in personnel expenses from higher headcount. Induced Conversion Expense [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Induced conversion expense","","$","11,333","","","$","\u2014","","","$","\u2014","","","$","11,333","","","$","\u2014"]] [[/GREPCENT_TABLE]] In November 2021, we completed a privately negotiated repurchase of $76.4 million principal amount of the 2019 Convertible Notes (“2019 Note Repurchase”). The 2019 Notes Repurchase transaction was accounted for as an induced conversion in accordance with Accounting Standards Codification 470-20, Debt with Conversion and Other Options (ASC 470-20). As a result of the induced conversion, we recorded $11.3 million in induced conversion expense which is included in the Consolidated Statements of Operations for the year ended December 31, 2021. The induced conversion expense represents the fair value of the consideration issued upon conversion in excess of the fair value of the securities issuable under the original terms of the 2019 Convertible Notes. For further information on the 2019 Notes, please refer to Note 7 to our consolidated financial statements included elsewhere in this report. Restructuring costs [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Restructuring costs","","$","1,721","","","$","\u2014","","","$","\u2014","","","$","1,721","","","$","\u2014"]] [[/GREPCENT_TABLE]] On February 2, 2021, we restructured our go-to-market organization to strategically align our global sales, product, partner development and marketing teams. As part of the restructuring, we eliminated approximately seven full-time positions in our go-to-market organization, representing about 2% of our workforce. We incurred restructuring charges of $1.7 million for employee termination benefits as well as $50,000 in other associated legal costs for the year ended December 31, 2021. We substantially completed our restructuring by June 30, 2021. For further information on this restructuring, please refer to Note 17 to our condensed consolidated financial statements included elsewhere in this report. Other Income, Net [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Other income, net","","$","25","","","$","650","","","$","1,242","","","$","(625",")","","$","(592",")"]] [[/GREPCENT_TABLE]] Other income, net comprises primarily interest income on our short-term investments. Year ended December 31, 2021 compared with year ended December 31, 2020 Other income, net decreased $625,000, due primarily to a lower interest rate on our short-term and long-term investments. Year ended December 31, 2020 compared with year ended December 31, 2019 Other income, net decreased $592,000, due primarily to a lower interest rate on our short-term investments. Interest Expense [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Interest expense","","$","2,550","","","$","5,413","","","$","1,794","","","$","(2,863",")","","$","3,619"]] [[/GREPCENT_TABLE]] 48 Table of Contents Interest expense comprises primarily cash interest, amortization of debt issuance costs and debt discount on our debt. In August 2020, the FASB issued guidance on debt with conversion and other options, or ASU 2020-06. On January 1, 2021, we adopted ASU 2020-06 using the modified retrospective transition method, accounting for the 2019 Notes on a whole-instrument basis. Our condensed consolidated financial statements for the year ended December 31, 2021 use the new standard and we no longer record amortization of debt discount. We have not adjusted the comparative prior reporting period. Year ended December 31, 2021 compared with year ended December 31, 2020 Interest expense decreased $2.9 million, due primarily to the fact we no longer record amortization of debt discount as noted above, and to a lesser extent, the impact of the partial repurchase of $76.4 million principal amount of the 2019 convertible senior notes in November 2021. For further information on the 2019 Notes, please refer to Note 7 to our consolidated financial statements included elsewhere in this report. Year ended December 31, 2020 compared with year ended December 31, 2019 Interest expense increased $3.6 million, due primarily to an increase in amortization of debt discount related to our subordinated convertible notes, or the 2019 Notes. For further information on the 2019 Notes, please refer to Note 7 to our consolidated financial statements included elsewhere in this report. Loss on Debt Extinguishment [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Loss on debt extinguishment","","$","\u2014","","","$","\u2014","","","$","(576",")","","$","\u2014","","","$","576"]] [[/GREPCENT_TABLE]] In December 2019, we used $24.0 million of the net proceeds from the 2019 Notes to repay our senior credit facility in full, which was terminated pursuant to its terms. In connection with this repayment, we recorded a $576,000 loss on debt extinguishment, comprising a $470,000 prepayment penalty fees and a $106,000 write-off of unamortized debt issuance costs. Income Tax Benefit (Expense) [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Income tax expense","","$","(153",")","","$","(89",")","","$","(198",")","","$","(64",")","","$","109"]] [[/GREPCENT_TABLE]] We are subject to federal and state income taxes in the United States and foreign jurisdictions. Year ended December 31, 2021 compared with year ended December 31, 2020 Income tax expense remained comparable to the prior period. Year ended December 31, 2020 compared with year ended December 31, 2019 Income tax expense remained comparable to the prior period. Non-GAAP Financial Measures Our key non-GAAP performance measures include adjusted EBITDA and non-GAAP net income (loss), as defined below. We use adjusted EBITDA and non-GAAP net income (loss) as key measures to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget and to develop short- and long-term operating plans. We believe these measures provide useful information for period-to-period comparisons of our business to allow investors and others to understand and evaluate our operating results in the same manner as our management and board of directors. Our presentation of these non-GAAP financial measures is not meant to be considered in isolation or as a substitute for our financial results prepared in accordance with GAAP, and our non-GAAP measures may be different from similarly termed non-GAAP measures used by other companies. 49 Table of Contents Adjusted EBITDA We define adjusted EBITDA as net income (loss) determined in accordance with GAAP, excluding, if applicable for the periods presented, the effects of stock-based compensation; depreciation; investigation costs; restructuring costs; settlement and related costs; induced conversion expense; other income, net; interest expense; loss on debt extinguishment; and income tax benefit (expense). In fourth-quarter 2019, we revised our definition of adjusted EBITDA to exclude loss on debt extinguishment incurred in connection with the December 2019 repayment of our senior credit facility. In second-quarter 2020, we revised our definition of adjusted EBITDA to exclude litigation settlement costs for the class-action and derivative lawsuits, including related costs. In fourth-quarter 2021, we revised our definition of adjusted EBITDA to exclude the expense incurred in connection with the November 2021 induced conversion of our 2019 Notes. We have excluded these costs and expenses because we do not believe they reflect our core operations and us excluding them enables more consistent evaluation of our operating performance. Neither revision to the definition of adjusted EBITDA impacted adjusted EBITDA previously reported for prior periods preceding the revisions. The following table presents a reconciliation of net loss to adjusted EBITDA: [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Net loss","","$","(51,260",")","","$","(51,923",")","","$","(22,987",")","","$","663","","","$","(28,936",")"],["Adjustments:"],["Other income, net","","","(25",")","","","(650",")","","","(1,242",")","","","625","","","","592"],["Interest expense","","","2,550","","","","5,413","","","","1,794","","","","(2,863",")","","","3,619"],["Loss on debt extinguishment","","","\u2014","","","","\u2014","","","","576","","","","\u2014","","","","(576",")"],["Income tax expense","","","153","","","","89","","","","198","","","","64","","","","(109",")"],["Depreciation","","","4,602","","","","4,504","","","","4,809","","","","98","","","","(305",")"],["Stock-based compensation","","","40,498","","","","25,675","","","","18,486","","","","14,823","","","","7,189"],["Restructuring costs","","","1,721","","","","\u2014","","","","\u2014","","","","1,721","","","","\u2014"],["Settlement and related costs","","","(460",")","","","5,359","","","","\u2014","","","","(5,819",")","","","5,359"],["Induced conversion expense","","","11,333","","","","\u2014","","","","\u2014","","","","11,333","","","","\u2014"],["Adjusted EBITDA","","$","9,112","","","$","(11,533",")","","$","1,634","","","$","20,645","","","$","(13,167",")"]] [[/GREPCENT_TABLE]] Non-GAAP Net Income (Loss) We define non-GAAP net income (loss) as net income (loss), excluding, if applicable for the periods presented, the effects of stock-based compensation; depreciation; restructuring costs; settlement and related costs; induced conversion expense; amortization of debt discount related to the equity component of our convertible notes; and prepayment penalty on debt extinguishment. In fourth-quarter 2019, we revised our definition of non-GAAP net income (loss) to exclude the prepayment penalty on debt extinguishment incurred in connection with the December 2019 repayment of our senior credit facility and amortization of debt discount related to the equity component of the 2019 Notes. We have revised the prior period non-GAAP net income (loss) to conform to our current period presentation. In second-quarter 2020, we revised our definition of non-GAAP net income (loss) to exclude litigation settlement costs for the class-action and derivative lawsuits, including related costs. Excluding settlement and related costs did not impact non-GAAP net income (loss) previously reported for prior periods preceding the revision. In fourth-quarter 2021, we revised our definition of non-GAAP net income (loss) to exclude the expense incurred in connection with the November 2021 induced conversion of our 2019 Notes. 50 Table of Contents GAAP requires that certain convertible debt instruments that may be settled in cash on conversion be accounted for as separate liability and equity components in a manner that reflects our non-convertible debt borrowing rate. This accounting results in the debt component being treated as though it was issued at a discount, with the debt discount being amortized as additional non-cash interest expense over the debt instrument term using the effective interest method. As a result, we believe that excluding this non-cash interest expense attributable to the debt discount in calculating our non-GAAP net income (loss) is useful because this interest expense is not indicative of our ongoing operational performance. On January 1, 2021, we adopted ASU 2020-06 using the modified retrospective transition method, accounting for the 2019 Notes on a whole-instrument basis. Our condensed consolidated financial statements for the year ended December 31, 2021 use the new standard and we no longer record amortization of debt discount. The following table presents a reconciliation of net loss to non-GAAP net income (loss): [[GREPCENT_TABLE]] [["","","Year Ended December 31,","","","2021 vs 2020","","","2020 vs 2019"],["(in thousands)","","2021","","","2020","","","2019","","","Change","","","Change"],["Net loss","","$","(51,260",")","","$","(51,923",")","","$","(22,987",")","","$","663","","","$","(28,936",")"],["Adjustments:"],["Depreciation","","","4,602","","","","4,504","","","","4,809","","","","98","","","","(305",")"],["Stock-based compensation","","","40,498","","","","25,675","","","","18,486","","","","14,823","","","","7,189"],["Restructuring costs","","","1,721","","","","\u2014","","","","\u2014","","","","1,721","","","","\u2014"],["Amortization of debt discount","","","\u2014","","","","3,566","","","","140","","","","(3,566",")","","","3,426"],["Prepayment penalty on debt extinguishment","","","\u2014","","","","\u2014","","","","470","","","","\u2014","","","","(470",")"],["Induced conversion expense","","","11,333","","","","\u2014","","","","\u2014","","","","11,333","","","","\u2014"],["Settlement and related costs","","","(460",")","","","5,359","","","","\u2014","","","","(5,819",")","","","5,359"],["Non-GAAP net income (loss)","","$","6,434","","","$","(12,819",")","","$","918","","","$","19,253","","","$","(13,737",")"]] [[/GREPCENT_TABLE]] 51 Table of Contents Quarterly Results of Operations The following tables set forth our unaudited quarterly statements of operations data for the last eight quarters. In the opinion of management, these data have been prepared on the same basis as the audited consolidated financial statements included elsewhere in this report and reflect all adjustments, including normal recurring adjustments, necessary for a fair presentation of the data. The results of historical periods are not indicative of expectations for any future period. You should read these data together with our audited consolidated financial statements and the related notes included elsewhere in this report.  [[GREPCENT_TABLE]] [["","","Three Months Ended"],["","","Dec. 31,","","","Sep. 30,","","","Jun. 30,","","","Mar. 31,","","","Dec. 31,","","","Sep. 30,","","","Jun. 30,","","","Mar. 31,"],["","","2021","","","2021","","","2021","","","2021","","","2020","","","2020","","","2020","","","2020"],["","","(in thousands, except percentages)"],["Statements of Operations Data:"],["Revenue","","$","52,574","","","$","45,193","","","$","47,268","","","$","45,248","","","$","36,448","","","$","28,196","","","$","26,457","","","$","47,822"],["Cost of revenue","","","23,391","","","","22,180","","","","22,491","","","","23,267","","","","19,034","","","","14,824","","","","13,497","","","","26,428"],["Gross profit","","","29,183","","","","23,013","","","","24,777","","","","21,981","","","","17,414","","","","13,372","","","","12,960","","","","21,394"],["Gross margin","","","55.5","%","","","50.9","%","","","52.4","%","","","48.6","%","","","47.8","%","","","47.4","%","","","49.0","%","","","44.7","%"],["Operating expenses:"],["Research and development expense","","","17,578","","","","16,789","","","","15,900","","","","13,791","","","","14,971","","","","11,901","","","","10,661","","","","11,057"],["Sales and marketing expense","","","9,710","","","","8,736","","","","8,196","","","","7,645","","","","8,086","","","","6,964","","","","6,123","","","","7,490"],["General and administrative expense","","","9,125","","","","9,860","","","","8,998","","","","8,154","","","","8,743","","","","7,527","","","","12,446","","","","6,242"],["Restructuring costs","","","458","","","","\u2014","","","","\u2014","","","","1,263","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014"],["Total operating expenses","","","36,871","","","","35,385","","","","33,094","","","","30,853","","","","31,800","","","","26,392","","","","29,230","","","","24,789"],["Loss from operations","","","(7,688",")","","","(12,372",")","","","(8,317",")","","","(8,872",")","","","(14,386",")","","","(13,020",")","","","(16,270",")","","","(3,395",")"],["Other income (expense), net","","","4","","","","2","","","","(4",")","","","23","","","","66","","","","49","","","","126","","","","409"],["Induced conversion expense","","","(11,333",")","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014"],["Interest expense","","","(974",")","","","(526",")","","","(525",")","","","(525",")","","","(1,392",")","","","(1,360",")","","","(1,349",")","","","(1,312",")"],["Loss on debt extinguishment","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014"],["Loss before income taxes","","","(19,991",")","","","(12,896",")","","","(8,846",")","","","(9,374",")","","","(15,712",")","","","(14,331",")","","","(17,493",")","","","(4,298",")"],["Income tax expense","","","(23",")","","","(28",")","","","(60",")","","","(42",")","","","(5",")","","","(15",")","","","(41",")","","","(28",")"],["Net loss","","","(20,014",")","","$","(12,924",")","","$","(8,906",")","","$","(9,416",")","","$","(15,717",")","","$","(14,346",")","","$","(17,534",")","","$","(4,326",")"],["Net loss per share \u2014 basic and diluted","","$","(0.81",")","","$","(0.53",")","","$","(0.37",")","","$","(0.40",")","","$","(0.68",")","","$","(0.63",")","","$","(0.77",")","","$","(0.19",")"],["Weighted-average shares:"],["Basic","","","24,581","","","","24,330","","","","24,120","","","","23,671","","","","23,218","","","","22,931","","","","22,716","","","","22,412"],["Diluted","","","24,581","","","","24,330","","","","24,120","","","","23,671","","","","23,218","","","","22,931","","","","22,716","","","","22,412"]] [[/GREPCENT_TABLE]] Liquidity and Capital Resources As of December 31, 2021, we had cash, cash equivalents and short-term investments of $193.3 million, comprising cash deposits held at major financial institutions and short-term investments in a variety of securities, including U.S. government agencies, treasury bills, corporate notes and bonds, commercial paper, asset-backed securities, and money market funds. As of December 31, 2021, we had working capital of $220.3 million. Historically, we have funded our operations primarily through cash generated from operations and by issuing equity securities, convertible-debt offerings and/or borrowing under our prior senior credit facility. In 2021, our principal use of cash is funding operations to capture our market opportunity and capital expenditures. We believe, based on our current operating plan, that our existing cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for at least the next 12 months. Over the longer term, we plan to continue investing to enhance and extend our platform. If available funds are insufficient to fund our future activities or execute on our strategy, we may raise additional capital through equity, equity-linked and debt financing, to the extent such funding sources are available. Alternatively, we may be required to reduce expenses to manage liquidity; however, any such reductions could adversely impact our business and competitive position. 52 Table of Contents Sources of Funds From time to time, we may explore additional financing sources and means to lower our cost of capital, which could include equity, equity-linked and debt financing. In addition, in connection with any future acquisitions, we may pursue additional funding which may be in the form of additional debt, equity or equity-linked financing or a combination thereof. We can provide no assurance that any additional financing will be available to us on acceptable terms. 2019 Notes In December 2019, we issued the 2019 Notes in an aggregate principal amount of $86.3 million. The 2019 Notes are our senior unsecured obligations. The 2019 Notes bear interest at a fixed rate of 2.00% per year, payable semi-annually in arrears on June 15 and December 15 of each year, beginning on June 15, 2020. The 2019 Notes will be convertible into cash, shares of our common stock or a combination thereof, at our election. The 2019 Notes will mature on December 15, 2026, unless earlier repurchased, redeemed, or converted in accordance with the terms of the indenture for the 2019 Notes. The net proceeds from issuing the 2019 Notes were approximately $83.5 million after deducting fees and expenses. We used the net proceeds from issuing the 2019 Notes to pay the cost of the capped call transactions and repay our senior credit facility. We intend to use the remainder of the net proceeds for general corporate purposes. In November 2021, we completed a privately negotiated repurchase of $76.4 million principal amount of the 2019 Convertible Notes (“2019 Note Repurchase”). The 2019 Notes Repurchase transaction was accounted for as an induced conversion in accordance with Accounting Standards Codification 470-20, Debt with Conversion and Other Options (ASC 470-20). In connection with the induced conversion, we paid approximately $183.6 million in cash, and paid accrued and unpaid interest thereon. For further information on the terms of this debt, please refer to Note 7 to our consolidated financial statements included elsewhere in this report. 2021 Notes In November 2021, we issued the 2021 Notes in an aggregate principal amount of $287.5 million. The 2021 Notes are our senior unsecured obligations. The 2021 Notes bear interest at a fixed rate of 1.125% per year, payable semi-annually in arrears on May 15 and November 15 of each year, beginning on May 15, 2022. The 2021 Notes will be convertible into cash, shares of our common stock or a combination thereof, at our election. The 2021 Notes will mature on May 15, 2027, unless earlier repurchased, redeemed, or converted in accordance with the terms of the indenture for the 2021 Notes. The net proceeds from issuing the 2021 Notes were approximately $278.4 million after deducting initial debt issuance costs, and fees and expenses. We used approximately $183.6 million of the net proceeds for the cash repurchase of approximately $76.4 million aggregate principal amount of the 2019 Notes through individual privately negotiated transactions concurrent with the offering of the 2021 Notes described in the section “Partial Repurchase of the Convertible Senior Notes – 2019” as described in Note 7 to our consolidated financial statements included elsewhere in this report. We will use the remainder of the net proceeds from the offering for general corporate purposes. For further information on the terms of this debt, please refer to Note 7 to our consolidated financial statements included elsewhere in this report. Historical Cash Flow Trends The following table shows a summary of our cash flows for the periods indicated: [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["(in thousands)","","2021","","","2020","","","2019"],["Net cash provided by (used in) operating activities","","$","6,465","","","$","(16,877",")","","$","4,708"],["Net cash used in investing activities","","","(18,642",")","","","(36,287",")","","","(13,099",")"],["Net cash provided by financing activities","","","112,444","","","","9,902","","","","57,759"]] [[/GREPCENT_TABLE]] 53 Table of Contents Operating Cash Flows For the year ended December 31, 2021, we generated $6.5 million of net cash from operating activities. The net cash proceeds were driven primarily by $51.3 million of net loss adjusted for non-cash items, partially offset by $288,000 of working capital contribution. For the year ended December 31, 2020, we used $16.9 million of net cash from operating activities. The net cash usage was driven primarily by $17.8 million of net loss adjusted for non-cash items, partially offset by $963,000 of working capital contribution. For the year ended December 31, 2019, we generated $4.7 million of net cash from operating activities. The net cash proceeds were driven primarily by $4.1 million of working capital contribution and $584,000 of a net loss adjusted for non-cash items. The working capital contribution was primarily due to lower cash usage in inventory purchases, partially offset by lower cash collections in accounts receivable due to timing of when amounts became due. Investing Cash Flows For the year ended December 31, 2021, we used $18.6 million of net cash from investing activities. The net cash usage was driven primarily by investments and equipment purchases of $84.4 million and $16.2 million, respectively, partially offset by investment maturities of $82 million. For the year ended December 31, 2020, we used $36.3 million of net cash from investing activities. The net cash usage was driven primarily by investments and equipment purchases of $82.7 million and $3.1 million, respectively, partially offset by investment maturities of $49.5 million. For the year ended December 31, 2019, we used $13.1 million of net cash from investing activities. The net cash usage was driven primarily by investments and equipment purchases of $72.4 million and $2.4 million, respectively, partially offset by investment maturities of $61.7 million. Financing Cash Flows For the year ended December 31, 2021, we generated $112.4 million of net cash from financing activities. The net cash proceeds were driven primarily by $278.4 million net proceeds from issuing the 2021 Notes. This amount was offset by $183.6 million for the cash repurchase of approximately $76.4 million aggregate principal amount of the 2019 Notes through individual privately negotiated transactions concurrent with the offering of the 2021 Notes described in the section “Partial Repurchase of the Convertible Senior Notes – 2019” as described in Note 7 to our consolidated financial statements included elsewhere in this report. Other major factors included $17.6 million from exercised stock options and our employee stock purchase plan. For the year ended December 31, 2020, we generated $9.9 million of net cash from financing activities. The net cash proceeds were driven primarily by $10.2 million from exercised stock options and our employee stock purchase plan. For the year ended December 31, 2019, we generated $57.8 million of net cash from financing activities. The net cash proceeds were driven primarily by $83.5 million from issuance of the 2019 Notes, $9.1 million from exercised stock options and our employee stock purchase plan and $4.0 million in term loan borrowings, net of debt issuance costs. These proceeds were partially offset by repayments of indebtedness of $28.2 million of principal under our senior credit facility and $10.1 million of premium we paid for the capped call transactions. 54 Table of Contents Contractual Obligations The following table reflects a summary of our contractual obligations as of December 31, 2021: [[GREPCENT_TABLE]] [["","","Payments Due By Period"],["","","Total","","","Less Than 1 Year","","","1-3 Years","","","3-5 Years","","","More Than 5 Years"],["(in thousands)"],["Convertible senior notes (1)","","$","316,215","","","$","3,521","","","$","6,863","","","$","16,714","","","$","289,117"],["Operating lease obligations"],["Operating lease obligations","","","18,490","","","$","5,014","","","$","6,747","","","$","6,729","","","$","\u2014"],["Sublease income","","","(1,580",")","","$","(1,457",")","","$","(123",")","","$","\u2014","","","$","\u2014"],["Net operating lease commitments","","","16,910","","","","3,557","","","","6,624","","","","6,729","","","","\u2014"],["Purchase commitments (2)","","","60,734","","","","60,301","","","","433","","","","\u2014","","","","\u2014"],["Total","","$","393,859","","","$","67,379","","","$","13,920","","","$","23,443","","","$","289,117"]] [[/GREPCENT_TABLE]] (1) 2019 Notes include $986,000 of interest payments. 2021 Notes include $17.9 million of interest payments. (2) Purchase commitments comprise primarily non-cancelable commitments to purchase $54.4 million of inventory as of December 31, 2021, non-cancelable software license agreements with vendors, and equipment purchases. Off-Balance Sheet Arrangements Since inception, we have not had any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for another contractually narrow or limited purpose. Critical Accounting Policies and Significant Estimates Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which we have prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue and expenses at the date of the consolidated financial statements. Generally, we base our estimates on historical experience and on various other assumptions, in accordance with GAAP, that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under other assumptions or conditions. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies and estimates include those related to: [[GREPCENT_TABLE]] [["","\u2022","revenue recognition;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","inventory;"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","income taxes; and"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","stock-based compensation."]] [[/GREPCENT_TABLE]] Revenue Recognition We generate revenue primarily from sales of hardware products. We also generate revenue from software, extended warranties, enhanced maintenance, support services, and nonrecurring engineering development services, all of which are not material. 55 Table of Contents We recognize revenue when control of the promised goods or services is transferred to our customers, which for hardware sales is generally at the time of product shipment as determined by the agreed-upon shipping terms. We measure revenue based on the amount of consideration we expect to be entitled-to in exchange for those goods or services. The period between when we transfer control of promised goods or services and when we receive payment is expected to be one year or less, and that expectation is consistent with our historical experience. As such, we do not adjust our revenues for the effects of a significant financing component. We recognize any variable consideration, which primarily comprises sales incentives, as a reduction of revenue at the time of revenue recognition. We estimate sales incentives based on our historical experience and current expectations at the time of revenue recognition and update them at the end of each reporting period as additional information becomes available. Our reader and gateway products are highly dependent on embedded software and cannot function without this embedded software. In these cases, we account for the hardware and software license as a single performance obligation and recognize revenue at the point in time when control is transferred. Our contracts with customers with multiple performance obligations generally include a combination of hardware products, standalone software, extended warranty and enhanced maintenance and support services. For these contracts, we account for individual performance obligations separately if they are distinct. The transaction price is allocated to the separate performance obligations on a relative standalone selling-price basis. In instances where the standalone selling price is not directly observable, such as when we do not sell the product or service separately, we determine the standalone selling price using one, or a combination of, the adjusted market assessment or expected cost-plus margin. Amounts allocated to extended warranty and enhanced maintenance sold with our reader and gateway products are deferred and recognized on a straight-line basis over the term of the arrangement, which is typically from one to three years. Amounts allocated to support services sold with our reader and gateway products are deferred and recognized when control of the promised services is transferred to our customers. For nonrecurring engineering development agreements that involve significant production, modification or customization of our products, we generally recognize revenue over the performance period using the cost-input method because it best depicts the transfer of services to the customer. We receive payments under these agreements based on a billing schedule. Contract assets relate to our conditional right to consideration for our completed performance under these agreements. Accounts receivable are recorded when the right to consideration becomes unconditional. For the periods presented in this report, our contract assets, deferred revenue and the value of unsatisfied performance obligations for nonrecurring engineering development agreements are not material. If our customer pays consideration before we transfer a good or service to the customer under the contract, those amounts are classified as contract liabilities, or deferred revenue. Contract liabilities are recognized as revenue as we transfer control of the promised goods or services to our customers. Payment terms typically range from 30 to 120 days. We present revenue net of sales tax in our consolidated statements of operations. Shipping charges billed to customers are included in revenue and the related shipping costs are included in cost of revenue. Practical Expedients and Exemptions: We expense sales commissions when incurred because the amortization period would have been one year or less. We record these costs within sales and marketing expenses. We do not disclose the value of unsatisfied performance obligations for (1) contracts with an original expected length of one year or less and (2) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. Inventory Inventories are stated at the lower of cost or estimated net realizable value using the average costing method, which approximates the first-in, first-out method. Inventories comprise raw materials, work-in-process and finished goods. We continuously assess the value of our inventory and write down its value for estimated excess and obsolete inventory. This evaluation includes an analysis of inventory on hand, current and forecasted demand, product development plans, and market conditions. If future demand or market conditions are less favorable than our projections, or our product development plans change from current expectations, a write-down of excess or obsolete inventory may be required, and would be reflected in cost of goods sold in the period the updated information is known. 56 Table of Contents We had sales of fully reserved inventory, which had a favorable net impact of 1.5% on our gross margin for 2021 and recorded inventory excess and obsolescence charges which had an unfavorable net impact of 2.2% and 1.7% on our gross margin for 2020 and 2019, respectively. Income Taxes We use the asset and liability approach for accounting, which requires recognizing deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement and tax bases. We measure deferred tax assets and liabilities using enacted tax rates expected to be in effect when such assets and liabilities are recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the year that includes the enactment date. We determine deferred tax assets, including historical net operating losses, and deferred tax liabilities, based on temporary differences between the book and tax bases of assets and liabilities. We believe that it is currently more likely than not that our deferred tax assets will not be realized and as such, we have recorded a full valuation allowance for these assets. We evaluate the likelihood of our ability to realize deferred tax assets in future periods on a quarterly basis, and when appropriate evidence indicates we would revise our valuation allowance accordingly. We utilize a two-step approach for evaluating uncertain tax positions. First, we evaluate recognition, which requires us to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes. If a tax position is not considered more likely than not to be sustained, no benefits of the position are recognized. Second, we measure the uncertain tax position based on the largest amount of benefit which is more likely than not to be realized on effective settlement. This process involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and financial reporting purposes. If actual results differ from our estimates, our net operating loss and credit carryforwards could be materially impacted. Our realization of the benefits of the NOLs and credit carryforwards depends on sufficient taxable income in future years. We have established a valuation allowance against the carrying value of our deferred tax assets, as it is currently more likely than not that we will not be able to realize these deferred tax assets. In addition, using NOLs and credits to offset future income subject to taxes may be subject to substantial annual limitations due to the “change in ownership” provisions of the Code and similar state provisions. Events that cause limitations in the amount of NOLs that we may use in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined by Code Sections 382 and 383, over a three-year period. Utilizing our NOLs and tax credit carryforwards could be significantly reduced if a cumulative ownership change of more than 50% has occurred in our past or occurs in our future. We do not anticipate that the amount of our existing unrecognized tax benefits will significantly increase or decrease within the next 12 months. Due to the presence of NOLs in most jurisdictions, our tax years remain open for examination by taxing authorities back to 2000. Stock-Based Compensation We measure stock-based compensation costs for all share-based awards at fair value on the grant date and recognize compensation expense on a straight-line basis over the requisite service period, which typically vest over four years. We account for forfeitures as they occur. We determine the fair value of RSUs based on the closing price of our common stock at the date of grant. We determine the fair value of MSUs by using a Monte Carlo simulation in estimating the fair value at grant date and recognize compensation cost over the implied service period. We determine the fair value of stock options at the date of grant by using the Black-Scholes option-pricing model. We also use the Black-Scholes option-pricing model to determine the fair value of each common share issued under the ESPP. We determine the fair value of the ESPP grants on the first day of each offering period. 57 Table of Contents In 2019, we began granting RSUs with performance conditions, or PSUs, replacing what has historically been our annual cash-bonus program for our senior executives and other bonus-eligible employees. The number of PSUs that ultimately vest will depend on the extent to which we achieve specified fiscal year financial performance metrics. We record compensation expense each period on a straight-line basis based on our estimate of the most probable number of PSUs that will vest and recognize that expense over the requisite service period. In 2021, we began granting RSUs with market and service conditions, or MSUs to certain executives. The MSUs are eligible to vest based on our total stockholder return (“TSR”) relative to the TSR of the constituents comprising the S&P Semiconductor Select Industry Index over two measurement periods. Half of the MSUs are eligible to vest based on our relative TSR during the period from January 1, 2021 through December 31, 2022, and half of the MSUs are eligible to vest based on our relative TSR during the period from January 1, 2021 through December 31, 2023. We use a Monte Carlo simulation in estimating the fair value at grant date and recognize compensation cost over the implied service period. The aggregate grant-date fair value of these shares was estimated to be $6.4 million using the Monte Carlo simulation valuation method. Recent Accounting Pronouncements For information on recent accounting pronouncements, please refer to Note 2 in our consolidated financial statements included elsewhere in this report.