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 results of operations together with our audited financial statements and related notes included elsewhere in this report. This discussion and other parts of this report contain forward-looking statements that involve risk and uncertainties, such as statements of our plans, objectives, expectations, and intentions. As a result of many factors, including those factors set forth in the “Risk Factors” section of this report, our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
For an overview of our business, see “Part I – Item 1. Business.”
Key Metrics
We monitor a variety of key financial metrics to help us evaluate trends, establish budgets, measure the effectiveness of our business strategies, and assess operational efficiencies. These financial metrics include revenue, gross margin, operating expenses, and operating income determined in accordance with generally accepted accounting principles in the United States (GAAP). Additionally, we monitor and project cash flow to determine our sources and uses for working capital to fund our operations. We also monitor Adjusted EBITDA, a non-GAAP financial measure, and design wins. We define Adjusted EBITDA as net income or loss adjusted for interest expense, taxes, depreciation and amortization, stock-based compensation expense, and restructuring costs, if any.
Adjusted EBITDA. Our management and board of directors use Adjusted EBITDA to understand and evaluate our operating performance and trends, to prepare and approve our annual budget and to develop short-term and long-term operating and financing plans. Accordingly, we believe that Adjusted EBITDA provides useful information for investors in understanding and evaluating our operating results in the same manner as our management and our board of directors. Adjusted EBITDA is a non-GAAP financial measure and should be considered in addition to, not as superior to, or as a substitute for, net income reported in accordance with GAAP. The following table presents a reconciliation of net income, the most directly comparable GAAP measure, to Adjusted EBITDA for the periods indicated:
Year Ended December 31,
2022
2021
Adjusted EBITDA reconciliation:
Net income
$
6,129
$
4,343
Depreciation and amortization
982
1,455
Stock-based compensation expense
4,408
3,227
Interest expense
274
547
Income tax expense
14
4
Adjusted EBITDA
$
11,807
$
9,576
Design wins . To continue to grow our revenue, we must continue to achieve design wins for our MRAM products. We consider a design win to occur when an OEM or contract manufacturer notifies us that it has qualified one of our products as a component in a product or system for production. Because the life cycles for our customers’ products can last for many years, if these products have successful commercial introductions, we expect to continue to generate revenues over an extended period of time for each successful design win. New design wins in each successive quarter of 2022 were 61, 49, 48, and 52, respectively, compared to 40, 37, 40, and 64 in each successive quarter of 2021, respectively.
Effect of the COVID-19 Pandemic on our Business
The COVID-19 outbreak has resulted in government authorities around the world implementing numerous measures to try to reduce the spread of COVID-19, such as travel bans and restrictions, quarantines, “shelter-in-place,” “stay-at-home,” total lock-down orders, business limitations or shutdowns and similar orders. More recently, new variants of COVID-19, such as the Omicron variant and its subvariants, that are significantly more contagious than previous strains have emerged. The spread of these new strains has caused many government authorities and businesses to reimplement the aforementioned measures to try to reduce the spread that had become less prevalent. While some of these restrictions have been lifted, the lingering impact of the COVID pandemic continues to create significant volatility throughout the
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global economy, including supply chain constraints, labor supply issues and higher inflation. Accordingly, it is unclear at this point the full impact COVID-19 and its variants will have on the global economy and on our company.
Overall, our business remained operational in the midst of the COVID-19 pandemic. However, as a result of the ongoing related responses from government authorities, our business, results of operations and financial condition have been, and continue to be, adversely impacted. For example, we have experienced electronics supply chain and demand disruptions from extended factory shutdowns, particularly in some Asian countries, which created unusual order patterns, and subsequently slowed Toggle MRAM demand, particularly from our industrial customers. We continue to see an impact as reflected in reduced demand from some customers and distributors. While we are working closely with our manufacturing partners and suppliers to support demand for our products, the full impact on our demand from customers remains unknown. Management is thus planning for a broad range of possible demand outcomes in an effort to ensure the success of our business under a variety of end market conditions.
The emergence of potential new variants of COVID-19, and the prevalence of cases of infection globally adds additional uncertainty and could result in further impacts to our business and operations, including those discussed above and in “Risk Factors” in Part II, Item 1A of this report.
Recently, the United States Government declared that it was no longer treating COVID-19 as a pandemic. Since our business is dependent on a global supply chain, we expect to continue to navigate the impact of COVID-19, particularly in some Asian countries. We will continue to monitor the situation and take additional actions as warranted. These actions may include further altering our operations in order to protect the best interests of our employees, customers and suppliers, and to comply with government requirements, while also planning and executing our business to best support our customers, suppliers, and partners.
The ultimate extent of the impact of the COVID-19 pandemic on our business, results of operations and financial condition will depend on future developments, which are highly uncertain, continuously evolving and cannot be predicted, including, but not limited to, the duration and spread of the COVID-19 outbreak, its severity, the emergence and severity of its variants, the actions to contain the virus or treat its impact, such as the availability and efficacy of vaccines (particularly with respect to emerging strains of the virus) and potential hesitancy to use them, general economic factors, such as increased inflation, supply chain restraints, labor supply issues, and how quickly and to what extent normal economic and operating conditions can resume. Accordingly, our current results and financial condition discussed herein may not be indicative of future operating results and trends. See “Risk Factors” in Part II, Item 1A of this report for additional risks we face due to the COVID-19 pandemic.
Results of Operations
Below are factors we want to highlight for understanding our 2022 annual results and year over year comparison with proper historical perspective:
● 2022 represented a year of broad semiconductor supply chain challenges driven by factors including the COVID-19 pandemic and international trade conflicts, which significantly impacted our results.
● Our relationships with our foundry partners and assembly and test partners contributed significantly to our ability to secure more capacity and support the growth of product revenue in 2022 compared to 2021.
● Our manufacturing efficiency and yields improved throughout 2022 resulting in significantly higher product margins compared to 2021.
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The following table sets forth our results of operations for the periods indicated:
Year Ended December 31,
December 31,
December 31,
2022
2021
2022
2021
(In thousands)
(As a percentage of revenue)
Product sales
$
55,032
$
43,931
92
%
80
%
Licensing, royalty, patent, and other revenue
4,953
11,215
8
20
Total revenue
59,985
55,146
100
100
Cost of product sales
25,112
21,045
42
38
Cost of licensing, royalty, patent, and other revenue
928
1,029
2
2
Total cost of sales
26,040
22,074
43
40
Gross profit
33,945
33,072
57
60
Operating expenses:
Research and development
11,108
12,628
19
23
General and administrative
11,741
10,949
20
20
Sales and marketing
4,869
4,460
8
8
Total operating expenses
27,718
28,037
47
51
Income from operations
6,227
5,035
10
9
Interest expense
(274)
(547)
—
(1)
Other income (expense), net
190
(141)
—
—
Net income before income taxes
6,143
4,347
10
8
Income tax expense
(14)
(4)
—
—
Net income and comprehensive income
$
6,129
$
4,343
10
%
8
%
Comparison of the Years Ended December 31, 2022 and 2021
Revenue
We generated 85% and 66% of our revenue from products sold through distributors for the years ended December 31, 2022 and 2021, respectively.
We maintain a direct selling relationship, for strategic purposes, with several key customer accounts. We have organized our sales team and representatives into three primary regions: Asia-Pacific (APAC); North America; and Europe, Middle East and Africa (EMEA). We recognize revenue by geography based on the region in which our products are sold, and not to where the end products in which they are assembled are shipped. Our revenue by region for the periods indicated was as follows (in thousands):
Year Ended December 31,
2022
2021
APAC
$
35,631
$
32,327
North America
14,533
15,813
EMEA
9,821
7,006
Total revenue
$
59,985
$
55,146
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Year Ended December 31,
Change
2022
2021
Amount
%
(Dollars in thousands)
Product sales
$
55,032
$
43,931
$
11,101
25.3
%
Licensing, royalty, patent, and other revenue
4,953
11,215
(6,262)
(55.8)
%
Total revenue
$
59,985
$
55,146
$
4,839
8.8
%
Total revenue increased by $4.9 million, or 8.8%, from $55.1 million during the year ended December 31, 2021, to $60.0 million during the year ended December 31, 2022. Product sales increased by $11.1 million or 25.3%, from $43.9 million to $55.0 million. The increase was primarily driven by a higher volume of toggle units produced and sold, along with average sales price increases to offset supplier increases.
Licensing, royalty, patent, and other revenue is a highly variable revenue item characterized by a small number of transactions annually with revenue based on size and terms of each transaction. Licensing, royalty, patent, and other revenue decreased by $6.3 million, from $11.2 million during the year ended December 31, 2021 to $5.0 million during the year ended December 31, 2022. The decrease was primarily due to the intellectual property monetization deal to sell five patents to a customer for a total contract value of $5.3 million in 2021, along with a decrease in license revenues from a contractual agreement with a customer for the development of a RAD-Hard product, consisting of a technology license, a design license agreement and development contract entered into during the year ended December 31, 2021. There were no patent sales during the year ended December 31, 2022.
Cost of Sales and Gross Margin
Year Ended December 31,
Change
2022
2021
Amount
%
(Dollars in thousands)
Cost of sales
$
25,112
$
21,045
$
4,067
19.3
%
Cost of licensing, royalty, patent, and other revenue
928
1,029
(101)
(9.8)
%
Total cost of sales
$
26,040
$
22,074
$
3,966
18.0
%
Gross margin
56.6
%
60.0
%
*
*
Cost of product sales increased by $4.1 million, or 19.3%, from $21.0 million during the year ended December 31, 2021, to $25.1 million during the year ended December 31, 2022. The increase was due to an increase in product sales and price increases from suppliers, partially offset by increased yields on toggle products.
Cost of licensing, royalty, patent, and other revenue decreased by $0.1 million, or 9.8%, from $1.0 million during the year ended December 31, 2021, to $0.9 million during the year ended December 31, 2022. The decrease was due primarily to a decline in licensing costs.
Our gross margin decreased from 60.0% during the year ended December 31, 2021, to 56.6% during the year ended December 31, 2022. Our gross margin decreased due to price increases from suppliers and lower licensing, royalty, patent, and other revenue.
Operating Expenses
Our operating expenses consist of research and development, general and administrative and sales and marketing expenses. Personnel-related expenses, including salaries, benefits, bonuses, and stock-based compensation, are among the most significant component of each of our operating expense categories.
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Year Ended
December 31,
Change
2022
2021
Amount
%
(Dollars in thousands)
Research and development
$
11,108
$
12,628
$
(1,520)
(12.0)
%
Research and development as a % of revenue
19
%
23
%
Research and Development Expenses. Research and development expenses decreased by $1.5 million, or 12.0%, from $12.6 million during the year ended December 31, 2021, to $11.1 million during the year ended December 31, 2022. The decrease was primarily due to higher expenses in 2021 relating to the development of our 28 nm product that started production in 2022.
Year Ended
December 31,
Change
2022
2021
Amount
%
(Dollars in thousands)
General and administrative
$
11,741
$
10,949
$
792
7.2
%
General and administrative as a % of revenue
20
%
20
%
General and Administrative Expenses. General and administrative expenses increased by $0.8 million, or 7.2%, from $10.9 million during the year ended December 31, 2021, to $11.7 million during the year ended December 31, 2022. The increase was primarily due to increases in expenses related to profit sharing and professional service fees.
Year Ended
December 31,
Change
2022
2021
Amount
%
(Dollars in thousands)
Sales and marketing
$
4,869
$
4,460
$
409
9.2
%
Sales and marketing as a % of revenue
8
%
8
%
Sales and Marketing Expenses. Sales and marketing expenses increased by $0.4 million, or 9.2%, from $4.5 million during the year ended December 31, 2021, to $4.9 million during the year ended December 31, 2022. The increase was primarily due to an increase in variable compensation costs.
Interest Expense
Year Ended December 31,
Change
2022
2021
Amount
%
(Dollars in thousands)
Interest expense
$
274
$
547
$
(273)
(49.9)
%
Interest expense decreased by $0.3 million, or 49.9%, from $0.5 million during the year ended December 31, 2021, to $0.3 million during the year ended December 31, 2022. The decrease was due to lower outstanding balances under the credit facility during the year resulting in less interest incurred.
Other Income (Expense), Net
Year Ended December 31,
Change
2022
2021
Amount
%
(Dollars in thousands)
Other income (expense), net
$
190
$
(141)
$
331
(234.8)
%
Other income (expense), net changed by $0.3 million, or 234.8%, from $0.1 million of expense during the year ended December 31, 2021 to $0.2 million of income during the year ended December 31, 2022. The increase was primarily due to interest income earned on the money market cash account.
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Liquidity and Capital Resources
As of December 31, 2022, we had $26.8 million of cash and cash equivalents, compared to $21.4 million as of December 31, 2021. We believe our cash and cash equivalents, coupled with the amount available under our credit facility and our anticipated growth and sales levels are sufficient to meet our anticipated capital requirements in the next 12 months. Our future capital requirements will depend on many factors, including, among other things, our growth rate, the timing and extent of our spending to support research and development activities, the timing and cost of establishing additional sales and marketing capabilities, and the introduction of new products.
Additionally, see “Credit Facilities” below for information regarding our debt financing.
Cash Flows
The following table summarizes our cash flows for the periods indicated (in thousands):
Year Ended
December 31,
2022
2021
(In thousands)
Cash provided by operating activities
$
9,493
$
9,359
Cash used in investing activities
(2,586)
(1,030)
Cash used in financing activities
(1,521)
(1,519)
Cash Flows From Operating Activities
During the year ended December 31, 2022, cash provided by operating activities was $9.5 million, which primarily consisted of net income of $6.1 million, adjusted by non-cash charges of $5.3 million and a decrease of $1.9 million in our net operating assets and liabilities. The non-cash charges primarily consisted of stock-based compensation of $4.4 million, depreciation and amortization of $1.0 million, and non-cash interest expense of $0.1 million, offset by a gain on disposal of property and equipment of $0.2 million. The change in our net operating assets and liabilities was primarily due to an increase of $2.5 million in accounts receivable due to an increased sales volume and timing of cash receipts for outstanding balances and a $0.3 million increase in inventory. These were offset by an increase of $0.6 million in accounts payable due to timing of invoice due dates and a $0.2 million increase in lease liabilities.
During the year ended December 31, 2021, cash provided by operating activities was $9.4 million, which primarily consisted of net income of $4.3 million, adjusted by non-cash charges of $5.0 million and a change of $4,000 in our net operating assets and liabilities. The non-cash charges primarily consisted of stock-based compensation of $3.2 million, depreciation and amortization of $1.5 million, and non-cash interest expense of $0.3 million. The change in our net operating assets and liabilities was primarily due to an increase of $1.7 million of accrued liabilities and an increase in deferred revenue of $0.8 million related to timing of RAD-Hard licensing revenue recognition. These were offset by a decrease of $0.7 million in inventory, an increase of $0.5 million in prepaid expenses and other current assets, an increase of $0.6 million in accounts receivable due to increased sales volume and timing of cash receipts for outstanding balances, a decrease of $0.6 million in accounts payable due to the increased cash flow and increased efforts on timely payments, a decrease of $0.2 million in lease liabilities, and an increase of $11,000 in other assets.
Cash Flows From Investing Activities
Cash used in investing activities during the years ended December 31, 2022 and 2021 was $2.6 million and $1.0 million, respectively, which consisted of capital expenditures primarily for the purchase of manufacturing equipment and purchased software.
Cash Flows From Financing Activities
During the year ended December 31, 2022, cash used in financing activities was $1.5 million, which primarily consisted of $2.4 million in payments on long-term debt offset by $0.9 million in proceeds from stock option exercises and purchases of shares under our employee stock purchase plan.
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During the year ended December 31, 2021, cash used in financing activities was $1.5 million, which primarily consisted of $3.4 million in payments on long-term debt offset by $1.9 million in proceeds from stock option exercises and purchases of shares under our employee stock purchase plan.
Credit Facilities
In May 2017, we executed a Loan and Security Agreement (2017 Credit Facility) with Silicon Valley Bank (SVB) for a $12.0 million term loan, which we subsequently amended in January 2019 and June 2019. In August 2019, we executed an Amended and Restated Loan and Security Agreement (2019 Credit Facility), which amended and restated the 2017 Credit Facility, providing for a formula revolving line of credit (Line of Credit) and a term loan (2019 Term Loan) with SVB to refinance in full the outstanding principal balance of $8.0 million under the 2017 Credit Facility.
In July 2020, we executed the first amendment to the 2019 Credit Facility with SVB. The amendment, among other things, extended the initial 12-month interest-only period for the term loan to a 16-month interest-only period and lowered the floor interest rate. The floor interest rates for 2019 Term Loan and the Line of Credit Facility were reduced from 4.75% and 6.75% to 3.75% and 4.75%, respectively.
The amended Line of Credit allows for a maximum draw of $5.0 million, subject to a formula borrowing base, has a two-year term and bears interest at a floating rate equal to the Wall Street Journal (WSJ) prime rate plus 1.5%, per annum, subject to a floor of 4.75%. As of December 31, 2022, the interest rate was 9.00%. The Line of Credit required a commitment fee of 1.6% of the maximum availability of the Line of Credit, which was paid in August 2019 upon closing, and was accounted for as a debt discount. The Line of Credit also provides for a termination fee equal to 1% of the maximum availability under the Line of Credit, which is due in case of a termination of the Line of Credit prior to the scheduled maturity date, and an unused facility fee equal to 0.125% per annum of the average unused portion of the Line of Credit, which is expensed as incurred. Currently, $4.0 million remains available under the Line of Credit, subject to borrowing base availability. As of December 31, 2022, the effective interest rate under the Line of Credit was 9.36% and the outstanding balance was $1.0 million. The Line of Credit was set to mature on August 5, 2022. The third amendment entered into on July 22, 2022, extended the maturity date of the Line of Credit to August 5, 2023.
The amended 2019 Term Loan provides for a $6.0 million term loan. The amended 2019 Term Loan has a term of 46 months, and a 16-month interest-only period followed by 30 months of equal principal payments of $200,000 per month, plus accrued interest. The 2019 Term Loan bears interest at a floating rate equal to the WSJ prime rate minus 0.75%, subject to a floor of 3.75%. As of December 31, 2022, the interest rate was 6.75%. A final payment of 7% of the original principal amount of the 2019 Term Loan must be made when the 2019 Term Loan is prepaid or repaid, whether at maturity or as a result of a prepayment or acceleration or otherwise. The additional payment, which is accounted for as a debt discount, is being accreted using the effective interest method. The 2019 Term Loan has a prepayment fee equal to 2% of the total commitment, which is due only if the 2019 Term Loan is prepaid prior to the scheduled maturity date for any reason. As of December 31, 2022, the effective interest rate under the 2019 Term Loan was 6.94% and the outstanding balance was $1.6 million. The 2019 Term Loan matures on June 1, 2023.
In conjunction with entering into the 2019 Credit Facility, on August 5, 2019, we and SVB amended and restated the warrant issued to SVB in connection with the first amendment to the 2017 Credit Facility, which was a warrant to purchase 9,375 shares of our common stock at an exercise price of $8.91 per share, to add an option by SVB to put the warrant back to us for $50,000 upon expiration or a liquidity event, to be prorated if SVB exercises a portion of the warrant. The warrant expires on July 6, 2023. The warrant is classified as a liability and recorded at fair value within other liabilities in our balance sheet. Due to the put right, the warrant is subject to fair value remeasurement at each subsequent reporting date until the exercise or expiration of the warrant. Any resulting change in the fair value of the warrant will be recorded as other (expense) income, net in our statements of income and comprehensive income. The other (expense) income recognized for the years ended 2022 and 2021 related to the change in fair value of the warrant has been minimal and immaterial to the financial statements.
Additionally, in conjunction with entering into the first amendment to the 2019 Credit Facility, on July 15, 2020, we issued an additional warrant to SVB to purchase 21,500 shares of our common stock at an exercise price of $0.01 per share, which was to expire on July 15, 2025. The warrant was classified as equity and was recorded as a debt discount that was amortized to interest expense using the effective interest method. The fair value of the warrant was $152,000 on the date of issuance using the Black-Scholes option-pricing model.
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On July 22, 2021, SVB elected to exercise the warrant associated with the first amendment to the 2019 Credit Facility, which resulted in a net cashless exercise of the warrant and the issuance of 21,463 shares of our common stock.
Collateral for the 2019 Credit Facility includes all of our assets except for intellectual property. We are required to comply with certain covenants under the 2019 Credit Facility, including requirements to maintain a minimum cash balance and availability under the Line of Credit, and restrictions on certain actions without the consent of the lender, such as limitations on our ability to engage in mergers or acquisitions, sell assets, incur indebtedness, or grant liens or negative pledges on our assets, make loans or make other investments. Under these covenants, we are prohibited from paying cash dividends with respect to our capital stock. We were in compliance with all covenants at December 31, 2022. The 2019 Credit Facility contains a material adverse effect clause which provides that an event of default will occur if, among other triggers, an event occurs that could reasonably be expected to result in a material adverse effect on our business, operations, or condition, or on our ability to perform our obligations under the 2019 Term Loan. As of December 31, 2022, we do not believe that it is probable that the clause will be triggered within the next 12 months.
The amortization of the debt issuance costs and accretion of the debt discount is included in interest expense within the statement of income and comprehensive income and included in non-cash interest expense within the statements of cash flows.
For additional information about the 2019 Credit Facility, see Note 6 in the accompanying Notes to Financial Statements in Part II, Item 8 of this Form 10-K.
Critical Accounting Policies and Significant Judgements and Estimates
Our financial statements have been prepared in accordance with U.S. 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 revenue generated and expenses incurred during the reporting periods. We base our estimates on our 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. Actual results may differ from these estimates under different assumptions or conditions.
Revenue Recognition
We recognize revenue when a customer obtains control of the promised products or services, in an amount that reflects the consideration we expect to receive in exchange for those products or services. We recognize revenue net of allowances for returns and price concessions, and any taxes imposed on revenue transactions, which are subsequently remitted to governmental authorities.
Nature of Products and Services
We derive our revenue from the sale of MRAM-based products in discrete unit form, licenses of and royalties on our MRAM and magnetic sensor technology, the sale of backend foundry services, and design services to third parties. We recognize sales of products in discrete unit form at a point in time, revenue related to licensing agreements when we have delivered control of the technology, revenue related to royalty agreements in the period in which sales generated from products sold using our technology occurs, sales of backend foundry services over time, and design services to third parties either at a point in time or over time, depending on the nature of the services.
Product Revenue
For products sold in their discrete form, we either sell our products directly to OEMs, ODMs, contract manufacturers (CMs), or through a network of distributors, who in turn sell to those customers. For sales directly to OEMs, ODMs and CMs, we recognize revenue when the OEM, ODM or CM obtains control of the product, which occurs at a point in time, generally upon shipment to the customer.
From time to time, we may provide distributors with price adjustments subsequent to the delivery of product to them and such amounts are dependent on the end customer and product sales price. Price adjustments can be based on a
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variety of factors, including customer, product, quantity, geography, and competitive differentiation. Price protection rights grant distributors the right to a credit in the event of declines in the price of our products. Under these circumstances, we remit back to the distributor a portion of their original purchase price after the resale transaction is completed in the form of a credit against the distributors’ outstanding accounts receivable balance. The credits are on a per unit basis and are not given to the distributor until the distributor provides information regarding the sale to their end customer. We estimate these credits and record such estimates in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of an allowance for price adjustments for amounts due to distributors. We estimate credits to distributors based on the historical rate of credits provided to distributors relative to sales and evaluation of current market conditions. Revenue on shipments to distributors is recorded when control of the products has been transferred to the distributor.
We estimate the amount of our product sales that may be returned by our customers and record this estimate as a reduction of revenue in the period the related product revenue is recognized. We estimate our product return liability by analyzing our historical returns, current economic trends and changes in customer demand and acceptance of products. We have received insignificant returns to date and believe that returns of our products will continue to be minimal.
Upon the transfer of control, generally at shipment, we record a trade receivable for the selling price as there is a legally enforceable obligation of the distributor to pay for the product delivered, an allowance is recorded for the estimated discount that will be provided to the distributor, and the net of these amounts is recorded as revenue on the statements of income and comprehensive income.
License Revenue
For licenses of technology, recognition of revenue is dependent upon whether we have delivered rights to the technology, and whether there are future performance obligations under the contract. In some instances, the license agreements call for future events or activities to occur in order for milestone amounts to become due from the customer. The terms of such agreements include payment to us of one or more of the following: non-refundable upfront fees; and royalties on net sales of licensed products. Historically, these license agreements have not included other future performance obligations once the license has been transferred to the customer.
We recognize revenue from non-refundable upfront payments when the license is transferred to the customer and we have no other performance obligations.
We also entered into a contractual agreement with a customer during the year ended December 31, 2021 for the development of a RAD-Hard product, consisting of a technology license, a design license agreement and development contract and a separate contractual agreement with a customer during the year ended December 31, 2022 for the development of a strategic radiation hardened field programmable gate array product, consisting of a technology license to provide design and development services under the contractual agreement. We applied a five-step approach in determining the amount and timing of revenue to be recognized: (1) identifying the contract with a customer; (2) identifying the performance obligations in the contract; (3) determining the transaction price; (4) allocating the transaction price to the performance obligations in the contract; and (5) recognizing revenue when the performance obligation is satisfied.
We concluded these contractual arrangements represent one arrangement and evaluated our promises to the customer and whether the performance obligations granted under the arrangement were distinct. The licenses provided to the customer are not transferable, are of limited value without the promised development services, and the customer cannot benefit from the license agreements without the specific obligated services in the development subcontract, as there is strong interdependency between the licenses and the development subcontract. Accordingly, we determined the licenses were not distinct within the context of the contract and combined the license with other performance obligations.
As a result, we are recognizing revenue related to the performance obligations over time using the input method based on costs incurred to date relative to the total expected costs of the contract over the performance obligation period.
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Patents
In an effort to monetize on our intellectual property, we may sell patents to customers. The performance obligations are satisfied at the point in time at which the customer obtains control of the patents.
Royalties
We recognize revenue from sales-based royalties from licenses of our technology at the later of when (1) the sale occurs or (2) the performance obligation to which some or all of the sales-based royalty has been allocated is satisfied (in whole or in part). We record an unbilled receivable (within accounts receivable, net) for the portion of sales-based royalties that have been earned, but not invoiced at the end of each reporting period. The unbilled accounts receivable is an estimate of consideration to which we expect to be entitled for uses of our intellectual property. Certain customers report on a lagged basis and actual information is not available timely. The estimates recorded are based on historical trends in the customer’s usage and current market conditions.
Inventory
We record inventories at the lower of cost, determined on a first-in, first-out basis or net realizable value. We write down inventory for estimated excess or obsolete inventory equal to the difference between cost and estimated net realizable value. Inventory write downs establish a new cost basis for inventory and charges are not subsequently reversed even if circumstances subsequently indicate that increased carrying amounts are recoverable. In estimating these reserves, our evaluation takes into consideration historical and expected future demand considering current market conditions and trends, the effect new products may have on the sale of existing products, technological obsolescence, and other factors. We record inventory write-downs for the valuation of inventory when required based on our analyses and any write-downs result in a new cost basis for the affected item.
Recent Accounting Pronouncements
See Note 2 in the accompanying Notes to Financial Statements in Part II, Item 8 of this Form 10-K for more information about recent accounting pronouncements, the timing of their adoption, and our assessment, to the extent we have made one yet, of their potential impact on our financial condition of results of operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not required for a smaller reporting company.
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