Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and operating results together with our financial statements and related notes included elsewhere in this annual report. This discussion and analysis contains forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or in other parts of this annual report. Unless expressly stated otherwise, for discussion and analysis of results for the year ended December 31, 2018 and the comparison of 2019 and 2018 results, please refer to Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2019, which was filed with the United States Securities and Exchange Commission on February 28, 2020 and is incorporated herein by reference.
Business Overview
We are a leading provider of advanced wireless connectivity solutions and technologies used to enable high performance wireless networking across a broad and increasing range of devices and markets, including consumer, enterprise and automotive. Our mission is to connect the world through advanced antenna systems and integrated wireless solutions. Our innovative antenna systems are designed to address key challenges with wireless system performance faced by our customers. We provide solutions to complex RF, engineering challenges to help improve wireless services that require higher throughput, broad coverage footprint, and carrier grade quality.
We are transitioning from a passive antenna and related services provider to a wireless system solutions provider, targeting higher levels of integration and complexity, and therefore, higher selling prices and margins and in 2020 we announced our new patented AirgainConnect ®
platform. The first product from this platform is the FirstNet Ready ™
AirgainConnect AC-HPUE antenna-modem, targeting vehicles used by first responders. The AC-HPUE antenna-modem includes an integrated high-power LTE modem supporting the 3GPP Band 14 HPUE (or high-power user equipment) output power functionality and is certified to run on the AT&T FirstNet network.
On January 7, 2021 we purchased 100% of the outstanding shares of Minnesota-based NimbeLink Corp., an IIoT company focused on the design, development, and delivery of cellular solutions for enterprise customers. NimbeLink provides carrier-certified embedded modems and asset tracking solutions that minimize or often eliminate RF design and certification time from project schedules, significantly reducing costs and time to market. The acquisition of NimbeLink supports our transition toward becoming a more system-level company and will play an important role in our overall growth strategy to broaden market diversification, especially within the IIoT space. NimbeLink’s IIoT expertise puts them squarely in one of our targeted enterprise submarkets and extends the breadth and opportunity for our AirgainConnect platform. Our worldwide salesforce represents a present opportunity to expand NimbeLink’s reach and NimbeLink will now gain access to design opportunities they were not previously able to win. The result is an increase in the opportunities for Airgain in the enterprise market and a more diverse offering of products and expertise for our customers.
The consumer market encompasses a large and growing market of consumers using wireless-enabled devices and our antennas are deployed in consumer access points, wireless gateways, Wi-Fi
Mesh systems and extenders, smart TVs, smart home devices, and set-top
boxes. Our Antennas support an array of technologies, including WLAN, Wi-Fi,
LTE, 5G and LPWAN.
The enterprise market is characterized by devices that provide reliable wireless access for high-density environments such as buildings, campuses, transportation terminals and stadiums. Within this market our antennas are deployed across a wide range of systems, devices, and applications that include access points and gateways, fixed wireless access infrastructure, small cells, and remote radio heads. In addition we support an array of technologies, including WiFi, LTE, 5G and LPWAN and NimbeLink’s products are well positioned to increase our growth in this market.
In the automotive market, our antennas are deployed in a wide range of vehicles to support a variety of wireless connectivity solutions in the fleet and aftermarket segment and support a variety of technologies that include WiFi, 3G, LTE, Satellite and LPWAN. The fleet and aftermarket segment of the automotive market consists of applications whereby rugged vehicular wireless routers are paired with external antenna systems to provide connectivity to fixed and mobile assets. Within the fleet and aftermarket market segment, there has been a rise in the number of antennas per vehicle. The majority of our revenues are currently derived from fleet and aftermarket sales and going forward, our strategy is to augment our current sales in the automotive aftermarket with design wins and sales into the automotive OEMs and in 2018 we announced two design wins with automotive OEMs.
Our design teams partner with customers from the early stages of antenna prototyping to device throughput testing to facilitate optimal performance and quick time to market. Our capabilities include design, custom engineering support, integration, and OTA testing. These capabilities have resulted in a strong reputation across the OEM, ODM and chipset manufacturer ecosystem. Our competencies and strengths have helped us secure design wins used in multiple reference designs from leading Wi-Fi
chipset vendors, OEMs, ODMs, chipset manufacturers and service providers rely on these reference designs and our engineering skills to deliver superior throughput performance. We view our relationship with OEM, ODM, chipset manufacturers and service providers as an important attribute to our long-term strategy and success.
We believe demand is growing rapidly for our advanced wireless connectivity solutions and technologies and there is a significant market opportunity. As the ability to provide mobile internet access grows, our solutions and expertise become more important to prospects and customers. As a passive component, embedded antennas can be viewed as a commodity. However, our design, engineering, and research show that antenna selection, placement, and testing can have significant improvements in device performance. We believe that we are chosen when performance is a more significant factor than price, and our distinctive focus on superior designs that provide increased range and throughput has allowed us to build a leadership position in the in-home
WLAN device market.
Our financial highlights for 2020 include the following:
•
Sales decreased by 13% in 2020 compared to 2019. The decrease in sales was primarily driven by the impacts from COVID-19
and a product cycle transition for several large volume embedded antenna products.
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•
Gross profit as a percentage of sales increased to 46.6% in 2020 compared to 45.4% in 2019. The increase in gross profit as a percentage of sales was largely due to product cost reductions for the year ended December 31, 2020.
•
Income from operations decreased by $3.6 million in 2020 compared to 2019. This decrease was primarily due to an increase of $0.8 million in operating expenses along with a $2.7 million decrease in gross profit due to lower sales volumes.
•
Our effective tax rate was (9.0)% in 2020 compared to 15.0% in 2019.
•
We ended 2020 with cash, cash equivalents totaling $38.2 million.
We believe that our performance and future success depend upon several factors including the growth in sales of AirgainConnect AC-HPUE product and success in integrating NimbeLink and increasing its sales, as well as historical factors such as manufacturing costs, continued investments in our growth, our ability to expand into growing addressable markets, including consumer, enterprise, and automotive, the ASP of our products per device, the number of antennas per device, and our ability to diversify the number of devices that incorporate our antenna products. Our customers are price conscious, and our operating results are affected by pricing pressure which may force us to lower prices below our established list prices. In addition, a few end-customer
devices which incorporate our antenna products comprise a significant amount of our sales, and the discontinuation or modification of such devices may materially and adversely affect our sales and results of operations. Our ability to maintain or increase our sales depends on, among other things, new and existing end-customers
selecting our antenna solutions for their wireless devices and networks, the proliferation of Wi-Fi
connected home devices and data intensive applications, investments in our growth to address customer needs, our ability to target new end markets, development of our product offerings and technology solutions, and international expansion, as well as our ability to successfully integrate past and any future acquisitions. While each of these areas presents significant opportunities for us, they also pose significant risks and challenges we must successfully address. We discuss many of these risks, uncertainties and other factors in this annual report in greater detail under the section entitled “Risk Factors.”
Covid-19 Pandemic
The United States and other countries around the world are experiencing a major health pandemic related to COVID-19, which has created considerable instability and disruption in the U.S. and world economies. Governmental authorities in impacted regions are taking actions in an effort to slow COVID-19’s spread, resulting in limitations on business operations and consumer and employee travel. We have worked, and continue to work, to comply within the framework of local, county, state, and federal laws. In that regard, we have implemented a wide range of practices to protect and support our employees and to modify and monitor the engagement with our customers, suppliers, and contract manufacturers. Specifically, in response to intensifying efforts to contain the spread of COVID 19, we began to monitor or modify our hours of operation and the hours of our employees based in China, as did our contract manufacturers. As the situation progressed and the outbreak was stabilized in China, our workers and facilities, as well as those of our contract manufacturers, returned to full function with precautions in place to help prevent outbreak or spread of the virus. In the United States, most of our employees in the San Diego office are working from home and our offices are reserved for only those who cannot perform certain functions remotely, such as prototyping and testing. In accordance with local regulations, engineering, testing, and production operations in our Scottsdale office, as well as testing operations in our remote facilities, have resumed with protocols in place to prevent and limit the spread of the virus. In each work location, protocols have been established and remain in place, in accordance with government guidance, in order to minimize the risk to those employees whose presence in the office is necessary or allowed. Our salespeople continue to engage with customers in order to secure sales of, and opportunities for, our products and services remotely rather than in-person.
The continued spread of COVID-19 and its related effects on our business have had a material and adverse effect on our business operations. Through the date of this filing, these disruptions or restrictions include restrictions on our ability to travel, temporary closures of our office buildings or the facilities of our customers or suppliers, and during the fourth quarter, disruptions with certain components in our supply chain located in Asia. Such disruptions of our customers have had a negative impact on our sales and operating results, particularly in the first quarter. Related to sales, we saw orders begin to rebound in the second and third quarters. However, the continued spread of COVID-19 may adversely affect such rebound and have a negative effect on our operating results in future quarters.
The impact of the COVID-19 pandemic on the U.S. and world economies generally, and our future results in particular, could be significant and will largely depend on future developments, which are highly uncertain and cannot be predicted. This includes new information that may emerge concerning COVID-19, the success of vaccinations and other actions taken to contain or treat COVID-19 and additional reactions by consumers, companies, governmental entities and capital markets.
Seasonality
Our operating results historically have not been subject to significant seasonal variations. However, our operating results are affected by how customers make purchasing decisions around local holidays in China. For example, a national holiday the first week of October in China may cause customers to purchase product in the third quarter ahead of their holiday season to account for higher volume requirements in the fourth quarter. In addition, although it is difficult to make broad generalizations, our sales tend to be lower in the first quarter of each year compared to other quarters due to the Chinese New Year. Resurfacing of outbreaks of COVID-19
in China may also contribute the traditionally slower first quarter sales this year. Results for any quarter may not be indicative of the results that may be achieved for the full fiscal year and these patterns may change as a result of general customer demand or product cycles.
Key Components of Our Results of Operations and Financial Condition
Sales
We primarily generate revenue from the sales of our products. As discussed further in “Critical Accounting Policies and Significant Judgments and Estimates” below, we recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled for those goods or services. We generally recognize sales at the time of shipment to our customers, provided that all other revenue recognition criteria have been met. Although currently insignificant, we also generate service revenue derived from agreements to provide design, engineering, and testing for a customer.
Cost of Goods Sold
The cost of goods sold reflects the cost of producing antenna products that are shipped for our customers’ devices. This primarily includes manufacturing costs of our products payable to our third-party contract manufacturers, as well as manufacturing costs incurred at our facility in Arizona. The cost of goods sold that we generate from services provided to customers primarily includes personnel costs.
Operating Expenses
Our operating expenses are classified into three categories: research and development, sales and marketing, and general and administrative. For each category, the largest component is personnel costs, which includes salaries, employee benefit costs, bonuses, and stock-based compensation. Operating expenses also include allocated overhead costs for depreciation of equipment, facilities and information technology. Allocated costs for facilities consist of leasehold improvements and rent. Operating expenses are generally recognized as incurred.
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Research and Development
. Research and development expenses primarily consist of personnel and facility-related costs attributable to our engineering research and development personnel. These expenses include work related to the design, engineering and testing of antenna designs, and antenna integration, validation and testing of customer devices. These expenses include salaries, including stock-based compensation, benefits, bonuses, travel, communications, and similar costs, and depreciation and allocated operating expenses such as office supplies, premises expenses and insurance. We may also incur expenses from consultants and for prototyping new antenna solutions. We expect research and development expenses to increase in absolute dollars in future periods as we continue to invest in the development of new solutions and markets and as we invest in improving efficiencies within our supply chain, although our research and development expense may fluctuate as a percentage of total sales.
Sales and Marketing
. Sales and marketing expenses primarily consist of personnel and facility-related costs for our sales, marketing, and business development personnel, stock-based compensation and bonuses earned by our sales personnel, and commissions earned by our third-party sales representative firms. Sales and marketing expenses also includes the costs of trade shows, marketing programs, promotional materials, demonstration equipment, travel, recruiting, and allocated costs for certain facilities. We expect sales and marketing expenses to fluctuate as a percentage of sales.
General and Administrative
. General and administrative expenses primarily consist of personnel and facility- related costs for our executive, finance, and administrative personnel, including stock-based compensation, as well as legal, accounting, and other professional services fees, depreciation, and other corporate expenses. We expect general and administrative expenses to fluctuate as we grow our operations.
Other Income
Interest Income.
Interest income consists of interest from our cash and cash equivalents and short-term investments.
Interest Expense.
Interest expense consists of interest charges on credit card charges and certain vendor bills.
Provision for Income Taxes
Provision for income taxes consists of federal and state income taxes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carryforward periods), projected future taxable income, and tax-planning
strategies in making this assessment. It is difficult for us to project future taxable income as the timing and size of sales of our products are variable and difficult to predict. We concluded that it is not more likely than not that we will utilize our deferred tax assets other than those that are offset by reversing temporary differences.
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Results of Operations
The following tables set forth our operating results for the periods presented as a percentage of our total sales for those periods. The period-to-period
comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.
For the year ended December 31,
2020
2019
(calculated as a percentage of associated sales)
Statement of Operations Data:
Sales
100.0
%
100.0
%
Cost of goods sold
53.4
54.6
Gross profit
46.6
45.4
Operating expenses:
Research and development
18.9
16.1
Sales and marketing
12.3
12.6
General and administrative
21.9
16.0
Total operating expenses
53.1
44.7
Income (loss) from operations
(6.5
)
0.7
Other income
(0.4
)
(1.3
)
Income (loss) before income taxes
(6.1
)
2.0
Provision for income taxes
0.6
0.3
Net income (loss)
(6.7
)%
1.7
%
Comparison of the Years Ended December 31, 2020 and 2019
(all tables—dollars in thousands)
Sales
For the year ended December 31,
2020
2019
Increase /
(Decrease)
% Change
Sales
$
48,502
$
55,739
$
(7,237
)
(13.0
)%
Sales decreased $7.2 million, or 13%, from $55.7 million for the year ended December 31, 2019, to $48.5 million for the year ended December 31, 2020, primarily due to the impacts from COVID-19
and a product cycle transition for several large volume embedded antenna products.
Cost of Goods Sold
For the year ended December 31,
2020
2019
Increase /
(Decrease)
% Change
Cost of goods sold
$
25,917
$
30,415
$
(4,498
)
(14.8
)%
Cost of goods sold decreased $4.5 million, or 14.8%, from $30.4 million for the year ended December 31, 2019 to $25.9 million for the year ended December 31, 2020 as a result of decreased sales volume and product cost reductions in the current year.
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Gross Profit
For the year ended December 31,
2020
2019
Increase /
(Decrease)
% Change
Gross profit
$
22,585
$
25,324
$
(2,739
)
(10.8
)%
Gross profit (percentage of sales)
46.6
%
45.4
%
1.2
%
Gross profit as a percentage of sales increased 1.2% for the year ended December 31, 2020, as compared to the year ended December 31, 2019. The increase in gross profit as a percentage of sales was primarily due to product cost reductions negotiated with our contract manufacturers in Asia.
Operating Expenses
For the year ended December 31,
2020
2019
Increase /
(Decrease)
% Change
Operating Expenses
Research and development
$
9,157
$
8,989
$
168
1.9
%
Sales and marketing
5,976
7,036
(1,060
)
(15.1
)%
General and administrative
10,636
8,919
1,717
19.3
%
Total
$
25,769
$
24,944
$
825
3.3
%
Research and Development
Research and development expense increased $0.2 million or 1.9% for the year ended December 31, 2020, compared to the year ended December 31, 2019. The increase was primarily due to increased product development expenses, partially offset by decreased personnel-related expenses and lower travel expenses.
Sales and Marketing
Sales and marketing expense decreased $1.1 million or 15.1% for the year ended December 31, 2020, compared to the year ended December 31, 2019. The decrease was primarily due to a decrease in personnel-related expenses, lower travel expenses, and tradeshow cancellations.
General and Administrative
General and administrative expense increased $1.7 million or 19.3% for the year ended December 31, 2020, compared to the year ended December 31, 2019. The increase was primarily due to an increase in personnel-related expenses and other operating expenses, partially offset by lower travel expenses.
Other Income
For the year ended December 31,
2020
2019
(Increase) /
Decrease
% Change
Other expense (income):
Interest income, net
$
(197
)
$
(709
)
$
512
(72.2
)%
Other expense
19
—
19
—
Total
$
(178
)
$
(709
)
$
531
(74.9
)%
Other income decreased $0.5 million for the year ended December 31, 2020, compared to the year ended December 31, 2019. The decrease was primarily due to lower interest income on cash and short-term investment balances along with the loss on disposal of fixed assets.
Liquidity and Capital Resources
We had cash and cash equivalents of $38.2 million at December 31, 2020.
Prior to 2013, and for the years ended 2018 and 2020, we have incurred net losses. As a result, we have an accumulated deficit of $47.3 million at December 31, 2020.
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Since inception, we have primarily financed our operations and capital expenditures through private sales of preferred stock, public offerings of our common stock and cash flows from our operations. We have raised an aggregate of $29.5 million in net proceeds from the issuance of our preferred stock and convertible promissory notes and $37.0 million from the sale of common stock in public offerings.
We previously had a revolving line of credit for $10.0 million under our second amended and restated loan and security agreement with Silicon Valley Bank. As of December 31, 2019, there was no balance owed on the line of credit. The revolving line of credit expired in January 31, 2020, and the loan agreement was terminated in accordance with its terms.
On September 9, 2019, our board of directors approved a new share repurchase program pursuant to which the Company may purchase up to $7.0 million of shares of its common stock over the twelve-month period following the establishment of the program. The repurchases under the new share repurchase program are made from time to time in the open market or in privately negotiated transactions and are funded from our working capital. Repurchases will be made in compliance with Rule 10b-18
of the Securities Exchange Act of 1934, as amended, subject to market conditions, available liquidity, cash flow, applicable legal requirements and other factors. In September 2020, our board of directors approved an extension to our share repurchase program for an additional twelve-month period ending September 9, 2021. During the year ended December 31, 2020 we repurchased 69,000 shares of common stock under the new share repurchase program. These shares were repurchased at an average price per share of $8.78, for a total cost of $0.6 million. Since inception of the stock repurchase programs, including our prior share repurchase programs, we have purchased a total of 534,110 shares for a total cost of $5.3 million.
We plan to continue to invest for long-term growth, including expanding our sales force and engineering organizations and making additional capital expenditures to further penetrate markets both in the United States and internationally, as well as expanding our research and development for new product offerings and technology solutions. We anticipate that these investments will continue to increase in absolute dollars. We believe that our existing cash and cash equivalents balance together with cash proceeds from operations will be sufficient to meet our working capital requirements for at least the next 12 months.
The following table presents a summary of our cash flow activity for the periods set forth below (in thousands):
For the year ended December 31
2020
2019
Net cash provided by operating activities
$
3,704
$
2,368
Net cash provided by (used in) investing activities
20,886
(2,400
)
Net cash used in financing activities
561
(392
)
Net increase (decrease) in cash, cash equivalents, and restricted cash
$
25,151
$
(424
)
Net Cash Provided by Operating Activities.
Net cash provided by operating activities was $3.7 million for the year ended December 31, 2020. This was primarily driven by non-cash
operating expenses of $3.7 million and the change in operating assets and liabilities of $3.3 million but offset by a net loss of $3.3 million.
Net cash provided by operating activities was $2.4 million for the year ended December 31, 2019. This was primarily driven by net income of $0.9 million and further adjusted for non-cash
operating expenses of $3.1 million and offset by change in operating assets and liabilities of $1.6 million.
Net Cash Provided by (Used in) Investing Activities.
Net cash provided by investing activities was $20.9 million for the year ended December 31, 2020. This consisted of $22.4 million in maturities of available-for-sale
securities offset by $0.8 million in purchases of available-for-sale
securities and $0.7 million purchases of property and equipment.
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Net cash used in investing activities was $2.4 million for the year ended December 31, 2019. This consisted of $36.5 million in purchases of available-for-sale
securities, $1.2 million purchases of property and equipment, but offset by $35.3 million in maturities of available-for-sale
securities.
Net Cash Provided by (Used in) Financing Activities.
Net cash provided by financing activities was $0.6 million for the year ended December 31, 2020. This primarily consisted of $1.2 million proceeds from stock option exercises and our employee stock purchase plan, or the ESPP, but offset by $0.6 million in common stock repurchases.
Net cash used in financing activities was $0.4 million for the year ended December 31, 2019. This primarily consisted of $1.2 million in common stock repurchases but offset by $0.8 million in proceeds from stock option exercises and the ESPP.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations at December 31, 2020 (in thousands):
Payments due by period
Total
Less than
1 year
1-3
years
3-5
years
More than
5 years
Office operating leases
$
3,722
$
992
$
2,115
$
615
$
—
We have entered into lease agreements for office space and research facilities in San Diego, California; Scottsdale, Arizona; Melbourne, Florida; Taipei, Taiwan; Shenzhen and Jiangsu, China; and Cambridge, United Kingdom; under non-cancelable
operating leases that expire at various dates through 2025.
We subcontract with other companies to manufacture our products. During the normal course of business, our contract manufacturers procure components based upon orders placed by us. If we cancel all or part of the orders, we may still be liable to the contract manufacturers for the cost of the components purchased by the subcontractors to manufacture our products. We periodically review the potential liability, and as of December 31, 2020 we have no significant accruals recorded. Our financial position and operating results could be negatively impacted if we were required to compensate the contract manufacturers for any unrecorded liabilities incurred.
We entered into a supply agreement with a vendor to purchase up to $2.0 million of inventory during the initial term of the agreement through December 31, 2022. As of December 31, 2020, $0.3 million had been paid under this supply agreement.
Off-Balance
Sheet Arrangements
We do not have any off-balance
sheet arrangements (as defined by applicable regulations of the Securities and Exchange Commission) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies and Significant Judgments and Estimates
Our management’s discussion and analysis of financial condition and operating results is based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported sales and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.
We have elected to use the extended transition period for complying with new or revised financial accounting standards available under Section 102(b)(2)(B) of the Securities Act of 1933, as amended. This election allows us to delay the adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies. As a result of this election, our financial statements may not be comparable to companies that comply with public company effective dates.
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While our significant accounting policies are more fully described in the notes to our financial statements in this annual report, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements and understanding and evaluating our reported financial results.
Revenue Recognition
On January 1, 2019, we adopted Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, Topic 606, Revenue from Contracts with Customers, or ASC 606, using the modified retrospective method. We generate revenue mainly from the sale of our antenna products. A portion of revenue is generated from service agreements with certain customers. The revenue generated from service contracts is insignificant. We recognize revenue to depict the transfer of control of the promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled for those goods or services. Control transfers to customers either when the products are shipped to or received by the customer, based on the terms of the specific agreement with the customer. We incur selling expenses to obtain design wins prior to revenue recognition, which is not a deliverable of a revenue arrangement.
The Company records revenue based on a five-step model in accordance with ASC 606 whereby the company (i) identifies the contract(s) with the customer, (ii) identifies the performance obligations in the contract, (iii) determines the transaction price, (iv) allocates the transaction price to the performance obligation(s) in the contract and (v) recognizes the revenue when (as) the entity satisfies performance obligations. The Company only applies the five-step model when it is probable that the entity will collect substantially all of the consideration it is entitled to in exchange for the goods or services it transfers to the customer.
For product sales, each purchase order, along with existing customer agreements, when applicable, represents a contract from a customer and each product sold represents a distinct performance obligation. The contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of our revenue is recognized on a “point-in-time” basis when control has passed to the customer. The revenue from service contracts is recognized “over time” which is typically one year or less.
A portion of our sales is made through distributors under agreements allowing for pricing credits and/or rights of return under certain circumstances. Pricing credits and returns under these provisions have been insignificant; accordingly, our allowance for sales returns and pricing credits was insignificant.
Our contracts with customers do not typically include extended payment terms. Payment terms may vary by contract and type of customer and generally range from 30 to 90 days from delivery.
We provide assurance-type warranties on all product sales ranging from one to two years. we accrue for the estimated warranty costs at the time of sale based on historical warranty experience plus any known or expected changes in warranty exposure. Warranty costs under these provisions have been insignificant, accordingly, our warranty reserve was insignificant for the years ended December 31, 2020 and 2019, respectively.
We have opted to not disclose the portion of revenues allocated to partially unsatisfied performance obligations, which represent products to be shipped within 12 months under open customer purchase orders, at the end of the current reporting period as allowed under ASC 606. We have also elected to record sales commissions when incurred, pursuant to the practical expedient under ASC 340, Other Assets and Deferred Costs, as the period over which the sales commission asset that would have been recognized is less than one year. Shipping and handling costs are immaterial and reported in operating expenses in the statement of operations.
Stock-based Compensation
We recognize compensation costs related to stock options and restricted stock units granted to employees and directors based on the estimated fair value of the awards on the date of grant. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option-pricing model. The grant date fair value of stock-based awards is expensed on a straight-line basis over the vesting period of the respective award.
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Our assumptions are as follows:
•
Fair value of our common stock.
Prior to our initial public offering, we estimated the fair value of our common stock. See “Significant Factors, Assumptions and Methodologies Used in Determining Fair Value of Our Common Stock” below. Our common stock is valued by reference to the publicly traded price of our common stock.
•
Expected term.
The expected term represents the period of time stock-based awards are expected to be outstanding.
•
Expected volatility.
We were a private company until August, 2016; therefore, from 2016 through 2017 we estimated expected volatility using weighted average historical volatilities of publicly traded companies within our industry that we consider to be comparable to our business. At the beginning of 2018 we began using our historical share prices for calculating a weighted average volatility using our volatility along with the volatilities of the selected comparable companies. Over time—as the Company accumulates enough historical data— this weighting formula favors our volatility more heavily, until such time our share price history is equal to the expected terms of future grants.
•
Risk-free interest rate.
The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant for zero coupon U.S. Treasury notes with maturities approximately equal to the expected term.
•
Expected dividend.
The expected dividend is assumed to be zero as we have never paid dividends and have no current plans to pay any dividends on our common stock.
Recent Accounting Pronouncements
See Note 1 of the Notes to Consolidated Financial Statements contained within this annual report for a discussion of recent accounting pronouncements.