EVERSPIN TECHNOLOGIES, INC. 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 inthe 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 (loss) reported in accordance with GAAP. The following table presents a reconciliation of net income (loss), the most directly comparable GAAP measure, to Adjusted EBITDA for the periods indicated: Year Ended December 31, 2021 2020 Adjusted EBITDA reconciliation: Net income (loss)$ 4,343 $ (8,512) Depreciation and amortization 1,455 1,982 Stock-based compensation expense 3,227 3,968 Interest expense 547 665 Income tax expense 4 260 Adjusted EBITDA$ 9,576 $ (1,637) 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 2021 were 40, 37, 40, and 64, respectively, compared to 37, 43, 52, and 43 in each successive quarter of 2020, 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, that are
more contagious than previous strains have emerged. The spread of these new
strains have caused many government authorities and businesses to reimplement
the aforementioned measures to try to reduce the spread that had become less
prevalent. The COVID-19 pandemic and its variants have negatively
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impacted the global economy, disrupted global supply chains and workforce participation, and initially created significant volatility and disruption of financial markets.
Overall, our business remains operational in the midst of the pandemic. However, as a result of the ongoing COVID-19 outbreak and the 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. Further, in an effort to protect the health and safety of our employees, we transitioned most of our office and support employees and contractors to working from home; suspended all non-essential business travel; and implemented social distancing guidelines for our employees and contractors who must work in our manufacturing and laboratory locations. Consequently, the remote working environment we have implemented for our employees has adversely impacted manufacturing operations given delays in data gathering, analysis and inefficiencies of teams solving technical problems via remote-only means, which has impacted, and continues to impact, our cost of sales. The emergence of different variants of COVID-19 and the prevalence of breakthrough cases of infection among fully vaccinated people 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. 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 and 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 2021 annual results and year over year comparison with proper historical perspective:
2021 represented a year of broad semiconductor market demand challenges driven
? by factors that included challenges from the COVID-19 pandemic and
international trade conflicts, which had a significant impact on our results;
? Our manufacturing yields improved throughout 2021 resulting in significantly
higher product margins compared to 2020.
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The following table sets forth our results of operations for the periods
indicated:
Year Ended December 31,
2021 2020 2021 2020
(In thousands) (As a percentage of revenue)
Product sales $ 43,931 $ 39,848 80 % 95 %
Licensing, royalty, patent, and
other revenue 11,215 2,183 20 5
Total revenue 55,146 42,031 100 100
Cost of product sales 21,045 23,746 38 56
Cost of licensing, royalty, patent,
and other revenue 1,029 196 2 -
Total cost of sales 22,074 23,942 40 57
Gross profit 33,072 18,089 60 43
Operating expenses:
Research and development 12,628 10,896 23 26
General and administrative 10,949 10,773 20 26
Sales and marketing 4,460 3,983 8 9
Total operating expenses 28,037 25,652 51 61
Income (loss) from operations 5,035 (7,563) 9 (18)
Interest expense (547) (665) (1) (2)
Other expense, net (141) (24) - -
Net income (loss) before income
taxes 4,347 (8,252) 8 (20)
Income tax expense (4) (260) - (1)
Net income (loss) and comprehensive
income (loss) $ 4,343 $ (8,512) 8 % (21) %
Comparison of the Years Ended
Revenue
We generated 66% and 62% of our revenue from products sold through distributors
for the years ended
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 ; andEurope ,Middle East andAfrica (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, 2021 2020 APAC$ 32,327 $ 29,480 North America 15,813 9,253 EMEA 7,006 3,298 Total revenue$ 55,146 $ 42,031 33 Table of Contents Year Ended December 31, Change 2021 2020 Amount % (Dollars in thousands) Product sales$ 43,931 $ 39,848 $ 4,083 10.2 % Licensing, royalty, patent, and other revenue 11,215 2,183 9,032 413.7 % Total revenue$ 55,146 $ 42,031 $ 13,115 31.2 % Total revenue increased by$13.1 million , or 31.2%, from$42.0 million during the year endedDecember 31, 2020 , to$55.1 million during the year endedDecember 31, 2021 . Product sales increased by$4.1 million or 10.2%, from$39.8 million to$43.9 million . The increase was primarily driven by a higher volume of Toggle MRAM product sales. 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 increased by$9.0 million , from$2.2 million during the year endedDecember 31, 2020 to$11.2 million during the year endedDecember 31, 2021 . The increase 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 combined with$3.7 million 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 endedDecember 31, 2021 .
Cost of Sales and Gross Margin
Year Ended December 31, Change
2021 2020 Amount %
(Dollars in thousands)
Cost of sales $ 21,045 $ 23,746 $ (2,701) (11.4) %
Cost of licensing, royalty, patent,
and other revenue 1,029 196 833 425.0 %
Total cost of sales $ 22,074 $ 23,942 $ (1,868) (7.8) %
Gross margin 60.0 % 43.0 % * *
Cost of product sales decreased by $2.7 million , or 11.4%, from $23.7 million
during the year ended December 31, 2020 , to $21.0 million during the year ended
December 31, 2021 . The decrease primarily reflects improved toggle manufacturing
yields during the year ended December 31, 2021 , and a reduction due to a $1.9
million reserve charge for excess and obsolete inventory for the year ended
December 31, 2020 .
Cost of licensing, royalty, patent, and other revenue increased by $0.8 million ,
or 425.0%, from $0.2 million during the year ended December 31, 2020 , to $1.0
million during the year ended December 31, 2021 . The increase was due primarily
to increases in foundry and licensing activities.
Our gross margin increased from 43.0% during the year ended December 31, 2020 to
60.0% during the year ended December 31, 2021 . Our product margins increased as
a result of improvements of manufacturing yields throughout 2021, along with an
increase in licensing, royalty, patent, and other revenue, which typically have
higher margins than our product sales. We continually look for alternative uses
for previously reserved inventory and in certain instances we may receive
discounted wafers based on product yields, which could impact individual product
margin.
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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Research and Development Expenses. Our research and development expenses consist
primarily of personnel-related expenses for the design and development of our
products and technologies, development wafers required to validate and
characterize our technology, and expenses associated with our joint development
activities. Research and development expenses also include consulting services,
circuit design costs, materials and laboratory supplies, fabrication and new
packaging technology, and an allocation of related facilities and equipment
costs. We are also incurring costs associated with our new 28nm product
development. We recognize research and development expenses as they are
incurred.
Year Ended
December 31, Change
2021 2020 Amount %
(Dollars in thousands)
Research and development $ 12,628 $ 10,896 $ 1,732 15.9 %
Research and development as a % of revenue 23 % 26 %
Research and development expenses increased by
Year Ended
December 31, Change
2021 2020 Amount %
(Dollars in thousands)
General and administrative $ 10,949 $ 10,773 $ 176 1.6 %
General and administrative as a % of revenue 20 % 26 %
General and Administrative Expenses. General and administrative expenses
increased by $0.2 million , or 1.6%, from $10.8 million during the year ended
December 31, 2020 , to $10.9 million during the year ended December 31, 2021 . The
increase was primarily due to increases in expenses related to profit sharing
and professional service fees.
Year Ended
December 31, Change
2021 2020 Amount %
(Dollars in thousands)
Sales and marketing $ 4,460 $ 3,983 $ 477 12.0 %
Sales and marketing as a % of revenue 8 % 9 %
Sales and Marketing Expenses. Sales and marketing expenses increased by $0.5
million , or 12.0%, from $4.0 million during the year ended December 31, 2020 , to
$4.5 million during the year ended December 31, 2021 . The increase was primarily
due to an increase in variable compensation costs.
Interest Expense
Year Ended December 31, Change
2021 2020 Amount %
(Dollars in thousands)
Interest expense $ 547 $ 665 $ (118) (17.7) %
Interest expense decreased by $0.1 million , or 17.7%, from $0.7 million during
the year ended December 31, 2020 , to $0.5 million during the year ended
December 31, 2021 . The decrease was due to lower outstanding balances under the
credit facility during the year resulting in less interest incurred.
Other Expense, Net
Year Ended December 31, Change
2021 2020 Amount %
(Dollars in thousands)
Other expense, net $ (141) $ (24) $ (117) 487.5 %
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Other expense, net increased by $117,000 , or 487.5%, from $24,000 during
the year ended December 31, 2020 to $141,000 during the year ended December 31,
2021 . The increase was primarily due to a decrease in interest income earned on
our cash balances during the year from the lower interest rate environment,
along with increases in non-income-based tax charges.
Liquidity and Capital Resources
As ofDecember 31, 2021 , and as ofMarch 9, 2022 we believe that our existing cash and cash equivalents, coupled with the amount available under our credit facility and our anticipated growth and sales levels, will be sufficient to meet our anticipated cash requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including 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. We have generated significant losses since our inception and had an accumulated deficit of$152.8 million as ofDecember 31, 2021 . We have historically financed our operations primarily through the sale of our common stock in our initial public offering (IPO) and follow-on public offering, sales of our common stock under our at-the-market sales agreement, sales of our redeemable convertible preferred stock, debt financing and the sale of our products. As ofDecember 31, 2021 , we had$21.4 million of cash and cash equivalents, compared to$14.6 million as ofDecember 31, 2020 . For the year endedDecember 31, 2021 , we also generated cash flows from operations of$9.4 million . InAugust 2019 , we entered into an open market sale agreement (2019 Sales Agreement) withJefferies, LLC (Jefferies) for the offer and sale of shares of our common stock having an aggregate offering of up to$25.0 million from time to time through Jefferies, acting as sales agent. The issuance and sale of these shares by us pursuant to the 2019 Sales Agreement were deemed an "at-the-market" (ATM) offering under the Securities Act. Under the 2019 Sales Agreement, we agreed to pay Jefferies a commission of up to 3% of the gross proceeds of any sales made pursuant to the 2019 Sales Agreement. During the year endedDecember 31, 2020 , we received net proceeds of$2.1 million after deducting commissions and expenses payable by us, from the sale of 468,427 shares of common stock pursuant to the 2019 Sales Agreement. We suspended sales under the 2019 Sales Agreement inMarch 2020 and terminated the ATM program inNovember 2020 .
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,
2021 2020
(In thousands)
Cash provided by (used in) operating activities
(1,030) (320)
Cash (used in) provided by financing activities (1,519) 3,355
Cash Flows From Operating Activities
During the year endedDecember 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. 36 Table of Contents
During the year endedDecember 31, 2020 , cash used in operating activities was$2.9 million , which primarily consisted of a net loss of$8.5 million , adjusted by non-cash charges of$6.3 million and a change of$0.7 million in our net operating assets and liabilities. The non-cash charges primarily consisted of stock-based compensation of$4.0 million , depreciation and amortization of$2.0 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$1.8 million in accounts receivable due to increased sales volume and timing of cash receipts for outstanding balances, an increase of$2.1 million in inventory to meet demand of future sales and growing backlog, a decrease of$0.8 million in accounts payable due to the timing of payments, and a decrease of$0.3 million in accrued liabilities primarily due to timing of payments on inventory purchases.
Cash Flows From Investing Activities
Cash used in investing activities during the years endedDecember 31, 2021 and 2020 was$1.1 million and$0.3 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 endedDecember 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. During the year endedDecember 31, 2020 , cash provided by financing activities was$3.4 million , which primarily consisted of$2.1 million in net proceeds from the sale of our common stock through our ATM program under the 2019 Sales Agreement, and$1.3 million in proceeds from stock option exercises and purchases of shares under our employee stock purchase plan.
Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.
Credit Facilities
InMay 2017 , we executed a Loan and Security Agreement (2017 Credit Facility) withSilicon Valley Bank (SVB) for a$12.0 million term loan, which we subsequently amended inJanuary 2019 andJune 2019 . InAugust 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. InJuly 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 theWall Street Journal (WSJ) prime rate plus 1.5%, per annum, subject to a floor of 4.75%. Currently,$4.0 million remains available under the Line of Credit, subject to borrowing base availability. As ofDecember 31, 2021 , the effective interest rate under the Line of Credit was 10.18% and the outstanding balance was$1.0 million . The Line of Credit was set to mature onAugust 5, 2021 . The second amendment entered into onJuly 28, 2021 extended the maturity date of the Line of Credit toAugust 5, 2022 . 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, 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 ofDecember 31, 2021 , the effective interest rate under the 2019 Term Loan was 7.85% and the outstanding balance was$4.0 million . The 2019 Term Loan matures onJune 1, 2023 . 37
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In conjunction with entering into the 2019 Credit Facility, onAugust 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 onJuly 6, 2023 . Additionally, in conjunction with entering into the first amendment to the 2019 Credit Facility, onJuly 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 onJuly 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. OnJuly 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 the Company's 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 atDecember 31, 2021 . 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 ofDecember 31, 2021 , we do not believe that it is probable that the clause will be triggered within the next 12 months.
For additional information about the 2019 Credit Facility, see Note 6 to our financial statements in Part II, Item 8 of this report.
Critical Accounting Policies and Significant Judgements and Estimates
Our financial statements have been prepared in accordance withU.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.
We incur incremental costs of obtaining contracts and expense such costs as incurred because the life of the underlying contract for product sales is typically less than one year and incremental costs to obtain contracts for licenses, royalties and patent sales are not significant.
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
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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. We sell a majority of our products to our distributors at a uniform list price. However, distributors may resell our products to end customers at a very broad range of individually negotiated price points. 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 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 the Company's 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 statement of operations.
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 milestones 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 endedDecember 31, 2021 for the development of a RAD-Hard product, consisting of a technology license, a design license agreement and development contract. 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
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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.
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.
Other Revenue
For certain revenue streams, we recognize revenue based on the pattern of transfer of the services. We use the input method of measuring costs incurred to date compared to total estimated costs to be incurred under the contract as this method most faithfully depicts its performance. We record an unbilled receivable (within accounts receivable, net) for the portion of the work that has been completed but not invoiced at the end of each reporting period. At the inception of each agreement that includes milestone payments, we evaluate whether the milestones are considered probable of being reached and estimate the amount to be included in the transaction price by using the most likely amount method. If it is probable that a significant reversal of cumulative revenue would not occur, the associated milestone value is included in the transaction price. At the end of each subsequent reporting period, we re-evaluate the probability or achievement of each such milestone and any related constraint, and if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect revenues and earnings in the period of adjustment.
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 to our financial statements 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.
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