Impinj Inc (PI) 2021 Q4 法說會逐字稿

Good day, and welcome to the Impinj Fourth Quarter and Full Year 2021 Earnings Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Andy Cobb, Vice President and Strategic Finance. Please go ahead, sir.

Thank you, Chuck. Good afternoon, and thank you all for joining us to discuss Impinj's Fourth Quarter and Full Year 2021 Results. On today's call, Chris Diorio, Impinj's Co-Founder and CEO, will provide a brief overview of our market opportunity and performance. Cary Baker, Impinj's CFO, will follow with a detailed review of our fourth quarter and full year 2021 financial results and first quarter 2022 outlook. We will then open the call for questions. Jeff Dossett, Impinj's CRO, will join us in the Q&A session. You can find management's prepared remarks plus trended financial data on the Investor Relations section of the company's website.

We will make statements in this call about future expectations and financial performance that are based on our outlook as of today. Any such statements are forward-looking under the Private Securities Litigation Reform Act of 1995. While we believe we have a reasonable basis for making these forward-looking statements, our actual results could differ materially because any statements we make today are subject to risks and uncertainties. We describe these risks and uncertainties in the annual and quarterly reports we file with the SEC. We do not undertake and expressly disclaim any obligation to update or alter our forward-looking statements, except as required by applicable law.

On today's call, all financial metrics, except for revenue or where we explicitly state otherwise, are non-GAAP. Balance sheet and cash flow metrics are on a GAAP basis. Please refer to our earnings release for a reconciliation of our non-GAAP financial metrics to the most comparable GAAP metrics.

Before turning to our results and outlook, note that we will participate in the Morgan Stanley Technology, Media and Telecom Conference on March 9 and the 34th Annual ROTH Conference on March 15. We look forward to connecting with many of you at those events.

I will now turn the call over to Chris.

Thank you, Andy, and thank you all for joining the call. Impinj capped 2021 with record fourth quarter and full year revenue and bookings despite the disruptive impact of COVID-19 and wafer supply shortfalls on our supply chain. We ended the year with 3 consecutive quarters of double-digit revenue growth as well as record bookings in 3 out of 4 quarters, culminating with record backlog entering 2022.

Our results were driven by strong Impinj execution and enterprises accelerating their investments in supply chain visibility, omnichannel performance and operational efficiencies. We delivered our 60 billionth endpoint IC, another milestone on our journey to connect every item in our everyday world. If not for the wafer supply shortfalls, we would have delivered even more. Despite that constraint, we orchestrated a strong quarter and a strong year, and that strength continues into 2022.

Fourth quarter endpoint IC revenue exceeded our expectations with record bookings despite us instituting cost pass-throughs starting in October. Retail demand remains strong, with retailers large and small turning to RAIN RFID to improve both in-store and supply chain inventory visibility and to accelerate omnichannel fulfillment. We also saw a growing adoption from mainstream supply chain and logistics providers, with the key adoption drivers being productivity gains, shipment tracking accuracy and capacity expansion.

Full year endpoint IC revenues set an annual record with year-over-year percentage growth at its highest pace since 2016. Looking forward, we see bellwether enterprises broadening their use cases and driving our endpoint IC demand.

Like for the second and third quarters, fourth quarter endpoint IC demand exceeded shipments by more than 50%. And with our inlay partners periodically lines down and both their and our inventory levels measured in mere days, we continue to believe they would increase their bookings if we had more supply. Unfortunately, as of today, we don't. Our first half 2022 wafer supply remains relatively unchanged, with 200 and 300 millimeter wafer supply commitments that should allow us to equal or exceed fourth quarter 2021 shipment levels through mid-2022.

But those shipment levels fall far short of our rapidly growing demand. And although our foundry partner continues to prioritize us for upside wafers, with both we and they hopeful for relief in the process nodes we use, to date that relief has not come, at least not sized to our need. Regardless, we continue expanding our 300 millimeter post-processing capacity to stay ahead of our opportunity even after successfully quintupling that capacity in 2021. We will be ready when the wafers finally do come.

Fourth quarter systems revenue also exceeded our expectations. Reader IC revenue was a bright spot, continuing its recovery from the first half 2021 supply shortfall. We still expect supply of our prior generation Indy reader ICs to catch up to demand in first quarter of 2022 and supply of our new E-family reader ICs to catch up to growing demand in second half 2022. We have high expectations for the latter, now with more than 100 design wins.

Fourth quarter reader and gateway supply was better than we expected, contributing to our strong systems performance. That said, we continue navigating difficult component shortfalls that increase schedule variability and costs while we wait for key components to complete our product builds. We currently do not see supply normalizing or necessarily even improving in the first or second quarters. Like for fourth quarter, we entered first quarter with significant reader backlog that we must fulfill in a constrained supply environment even as demand remains strong.

On the project front, follow-on orders for our RAIN loss prevention product for the visionary European retailer contributed nicely to fourth quarter revenue. The customer is happy with the product performance and what it means for their store of the future, and we hope will deploy more broadly.

A second large North American supply chain and logistics customer continued deploying, contributing modest fourth quarter revenue. And a broadening of partner-led revenue in both retail and supply chain and logistics, our 2 target markets, was a bright spot in our fourth quarter. We are very pleased to see growing leverage from these partner-led deals.

Beyond our strong results, 2021 was a fantastic year for RAIN. I am perhaps most excited by AmerisourceBergen launching its RFID tagging service. To my knowledge, their launch marks the first time a major corporation is sharing information about their RAIN-tagged items with people, you and me, unconstrained. I think back to the many years I have championed a vision of digital twins for physical items and what it means for the Internet of Things, the power of RAIN item visibility in every person's hand, available information about every connected item, the massive inflection opportunity, and I can see it materializing. I am absolutely thrilled.

2021 was marked by other big stories as well. For example, the CEO of the world's largest package delivery company announced a plan to add RAIN tags to all their packages to drive efficiencies and eliminate 20 million manual scans a day. An Accenture report stated that 93% of North American retailers are piloting or deploying RAIN. And we know that few of those retailers are fully deployed, signaling huge opportunities ahead. Despite COVID-19 and the operational challenges and the stress we all feel, I do believe someday we will look back and say 2021 was a big year for Impinj and for the RAIN market overall.

On the organizational side, we made 2 major announcements last week. First, I would like to congratulate Hussein Mecklai on his promotion from Executive Vice President of Engineering to Chief Operating Officer, with engineering and operations now reporting to him. For the past 3 years, Hussein championed the development of the Impinj platform, delivering groundbreaking endpoint ICs, reader ICs, readers and gateways. And most recently, he spearheaded growing our operations capacity across our product lines. Congratulations, Hussein.

Second, I'd like to thank current director Steve Sanghi, who has agreed to serve as Impinj's next Board Chair, effective at our upcoming general meeting. Steve's experience as Microchip's long-term CEO and current Executive Chair brings an extraordinary level of knowledge and insight to Impinj. Also, I'd like to welcome Meera Rao, who just joined our Board. Meera was previously CFO at Monolithic Power Systems, and she brings significant executive and Board-level experience to Impinj. Steve, thank you. And Meera, welcome.

Finally, long-term Board members Peter van Oppen and Theresa Wise, have decided not to stand for reelection this year. We will continue benefiting from their guidance for the remainder of their terms. I want to express my heartfelt appreciation to both Peter and Theresa for their support and guidance to me personally as well as for their many contributions to Impinj over the years. I will miss them on our Board, and I wish them both the very best.

Before I close, I'd like to thank every member of the Impinj team for their incredible effort every day of 2021. Your spirit and dedication in the face of COVID-19, the unparalleled supply chain disruptions and inadequate product supply amazes me. Our record results are a testament to your grace under pressure. So to each and every Impinj team member, I'd like to give my heartfelt thank you.

In closing, 2021 was a solid year driving our bold vision. We delivered record bookings, revenue and adjusted EBITDA while launching key new products, investing in our team, building our 300 millimeter post-processing capacity and accelerating our M700 series brand. As we continue working side-by-side with our ecosystem partners to navigate both growing demand and ongoing supply-chain disruption, I remain confident in our market position and energized by the opportunities ahead.

I will now turn the call over to Cary for our detailed financial review and first quarter outlook. Cary?

Thank you, Chris, and good afternoon, everyone. I want to start by taking a moment to reflect on 2021. On the surface, it was a fantastic year for Impinj. We delivered record revenue, adjusted EBITDA and bookings with revenue and profitability significantly exceeding our expectations. We saw strong bookings momentum throughout the year, capped by a record fourth quarter.

Below the surface, however, our team wrestled with COVID-19, supply-chain challenges and wafer shortfalls constraining our ability to fully capitalize on record demand. I can only imagine how much stronger 2021 would have been with more supply.

Today, more than ever, I am energized by our massive opportunity. And with the strength of our team, I am optimistic we will capitalize on our record backlog when the supply constraints ease.

Fourth quarter revenue was $52.6 million, up 16% sequentially compared with $45.2 million in third quarter 2021 and up 44% year-over-year from $36.4 million in fourth quarter 2020. Fourth quarter endpoint IC revenue was $38.4 million, up 20% sequentially compared with $32 million in third quarter 2021 and up 35% year-over-year from $28.5 million in fourth quarter 2020.

Quarter-over-quarter endpoint IC revenue growth significantly outpaced typical seasonal declines. Our specialty and industrial product mix proved richer than our original assumptions, driving revenue above our expectations. Looking forward, we expect first quarter 2022 endpoint IC revenue to decline slightly sequentially, driven by a smaller percentage of specialty/industrial ICs.

Fourth quarter systems revenue was $14.2 million, up 7% sequentially, compared with $13.2 million in third quarter 2021 and up 79% year-over-year from $7.9 million in fourth quarter 2020. Systems revenue exceeded our expectations due to our contract manufacturer delivering readers earlier than we expected. On a quarter-over-quarter basis, reader IC and gateway revenue increased, while reader revenue declined. On a year-over-year basis, reader IC, reader and gateway revenue all increased.

We expect first quarter 2022 systems revenue to follow seasonal trends, declining slightly sequentially.

2021 revenue was $190.3 million, up 37% year-over-year compared with $138.9 million in 2020. Endpoint IC revenue grew 36% year-over-year, driven by strength in omnichannel fulfillment, new deployments, expansion of existing deployments and COVID-19 recovery. Systems revenue grew 39% year-over-year, driven by loss prevention and broad-based demand for readers and gateways.

Fourth quarter gross margin was 58.2%, compared with 53.3% in third quarter 2021 and 50.4% in fourth quarter 2020. The quarter-over-quarter increase was driven by underlying product margins, partially offset by a smaller contribution from sales of fully reserved inventory. The year-over-year increase was driven by underlying product margins and product mix.

Beyond the margin-rich industrial and specialty products, the M700 series became our volume runner, providing a gross margin tailwind in the fourth quarter. The fourth quarter 2021 benefit from selling fully reserved inventory was 130 basis points. Full year 2021 gross margin set an annual record at 54.2% compared with 49% in 2020, with the increase due primarily to lower E&O charges, sales of fully reserved inventory and higher underlying product margins. The 2021 benefit from selling fully reserved inventory was 150 basis points.

Total fourth quarter operating expense was $25.3 million compared with $24.4 million in the third quarter of 2021 and $21.5 million in fourth quarter 2020. Research and development expense was $12.3 million, sales and marketing expense was $6.8 million, general and administrative expense was $6.2 million. 2021 operating expense totaled $94.1 million compared with $79.6 million in 2020.

Fourth quarter adjusted EBITDA was a profit of $5.3 million compared with a loss of $400,000 in the third quarter 2021 and a loss of $3.1 million in the fourth quarter 2020. 2021 adjusted EBITDA was a profit of $9.1 million compared with a loss of $11.5 million in 2020.

Fourth quarter GAAP net loss was $20 million. Fourth quarter non-GAAP net profit was $4.3 million or $0.16 per share using a weighted average diluted share count of 26.8 million shares. 2021 GAAP net loss was $51.3 million. 2021 non-GAAP net profit was $6.4 million or $0.25 per share using a weighted average diluted share count of 25.9 million shares.

Turning to the balance sheet. We ended the fourth quarter with cash, cash equivalents and investments of $207.6 million compared with $113.3 million in third quarter 2021 and $106.1 million in fourth quarter 2020. In fourth quarter 2021, we issued 1.125% convertible notes due November 2027, generating $287.5 million in gross proceeds and $94.2 million in net proceeds after fees and retiring almost 90% of our 2% convertible notes due December 2026. Inventory totaled $22 million, up $3.5 million from the prior quarter, with the increase primarily from systems.

Fourth quarter net cash used in operating activities was $3.9 million. Property and equipment purchases totaled $2.1 million. Free cash flow was negative $6 million. For the full year, net cash provided by operating activities was $6.5 million, property and equipment purchases totaled $16.2 million, free cash flow was negative $9.8 million.

Before I turn to our first quarter guidance, I want to highlight items unique to fourth quarter and give an update on a few of our strategic initiatives. First, a margin-rich mix of industrial and specialty endpoint ICs, combined with the benefits from selling fully reserved inventory and M700 volume nearly doubling, drove our record fourth quarter gross margin. We expect a slightly less favorable mix of industrial and specialty endpoint ICs in first quarter, driving margins down sequentially. In second quarter 2022, we expect that mix to normalize.

Second, back in 2019, to conserve cash, we pivoted our incentive compensation to 100% stock. Since then we've strengthened our balance sheet and in 2021 delivered record adjusted EBITDA. In 2022, we will pivot our incentive compensation back to a mix of cash and stock. We have reflected the increase in operating expense in our first quarter 2022 guidance.

Third, we delivered business model leverage in an environment where revenue was supply constrained, setting adjusted EBITDA records in fourth quarter and full year 2021. Even as we continue investing in our business in 2022, we remain focused on delivering adjusted EBITDA breakeven or better.

Finally, we expect first and second quarter revenue to be supply constrained, with those constraints likely continuing throughout 2022. From today's vantage point, demand far outstrips our supply. Turning to our outlook. We expect first quarter revenue to be between $50 million and $52 million, a 13% year-over-year increase at the midpoint of the range compared with $45.2 million in first quarter 2021. We expect an adjusted EBITDA profit between $100,000 and $1.6 million. On the bottom line, we expect non-GAAP net income between a loss of $1.1 million and a profit of $400,000, reflecting non-GAAP earnings per share between a loss of $0.05 and a profit of $0.01 on a weighted average diluted share count between 24.9 million and 27.2 million shares.

In closing, I want to thank our Impinj team, our customers, our suppliers and you, our investors, for your ongoing support. I will now turn the call to the operator to open the question-and-answer session. Chuck?

(Operator Instructions) And the first question will come from Toshiya Hari with Goldman Sachs.

Congratulations on a very strong year. I guess to start off, I had 2 questions. Chris, I was hoping you could elaborate a little bit more on how you're thinking about supply in '22. Based on your comments, it's pretty clear you're going to be supply gated for at least the first half and potentially the second half as well. But as we think about how to model '22 on a sequential basis, both for the endpoint IC business as well as the systems business, how should we think about the cadence at which you sort of gain additional supply throughout the year?

Okay. Thank you, Toshiya, and thanks for your comments. So I'm going to preface the comments about supply by saying that our demand entering 2022 is very strong. We have, as I said in the prepared remarks, visibility to our wafer supply that allows us to maintain constant or slightly increasing endpoint IC volumes in the first and second quarters of this year. We are working closely with our foundry partner to get upside wafers.

The process nodes we are in are very tight. They're, for example, shared by automotive and others. And to date that supply has been short in coming, at least relative to the outsized magnitude of our demand. And I do want to make that point that our demand is large. Our opportunity is growing rapidly. And with that record backlog entering 2022 and the strength in demand we're seeing, we and our foundry partner are working closely together to deliver into that opportunity. But to date, we don't have the supply that allows us to meet that opportunity for the year.

So we continue working with them. They have prioritized us for upside. We will work hand-in-hand with them to try and deliver into our opportunity and kind of capture everything that we see in front of us. Did I answer your question adequately, Toshiya?

Yes. And on the systems side, Chris, were there any other dynamics at play?

Yes. On the systems side, as I mentioned in the prepared remarks, on -- for example, for our readers specifically, we do have supply shortfalls in some critical components. We're kitting ahead in order to basically have our kits built as those components come in. And we do see supply constraints in first and second quarters. We are optimistic that those constraints will alleviate in the latter part of the year, but it's still too early to tell.

Our Indy reader ICs, we expect to catch up to -- our supply to catch up to demand in the first quarter, this quarter. Our E-family, the new reader ICs for which we have more than 100 design wins, we expect supply to catch up to growing demand in the second half of the year. So overall, also on the systems side just like the endpoint IC side, strong demand, really strong demand, growing opportunities out in the market, driven by enterprises kind of reinventing themselves: omnichannel fulfillment broadening their use cases, supply chain and logistics increasing their operational efficiencies and driving capacity improvements.

All those enterprises are driving rapid demand growth and causing us to strain to meet the needs of the market. And we're doing our best from an operational side, operational perspective, and with our foundry partner and with our other suppliers out in the market, to meet that demand.

Got it. And then I guess, Chris, based on those comments, would it be fair to assume sort of a low $50 million revenue number, obviously for Q1 given your guidance, but also for Q2, and then a potential step change to the upside in Q3 and Q4? At a high level, is that kind of the right way to think about the year?

Yes. Toshiya, this is Cary. Thanks for the question. I think I'll take that one from Chris. So yes, we've obviously guided midpoint of $51 million in first quarter. And as I look through into second quarter, the endpoint IC situation hasn't changed that much. Yes, we've continued to receive modest upside wafers, but we're still in the pocket of shipping kind of 4Q level units through 1Q and into 2Q or mid-2022.

There will be a little bit of an impact from a reducing mix of industrial and specialty projects. So that drove high revenue, high gross margin in Q4. That mix will tail off a little bit in Q1 and then it will normalize in Q2.

From the systems side, Chris really highlighted it. We're navigating an ever-changing list of component shortfalls, and we do our best to solve those. And then the next quarter we're out solving another list of challenging projects. So that -- I think that kind of sets us up for fairly consistent performance on the systems. Obviously, however, any time we're talking about our systems revenue line, the timing and sizes of large projects can play a factor in it. But we'll keep you up to speed on how that's progressing.

And Toshiya, I guess I'm just going to add that our -- the environment we're in, we are supply limited, not demand limited. So the demand far outstrips our supply. So to the extent we can get upside supply, we will deliver into that demand. If supply remains constrained, then we'll be tight. So it's just -- we only guide 1 quarter at a time, and it's especially difficult right now for us to talk beyond the current -- the quarter we're in, in what we're guiding because we are strictly supply constrained.

Demand is very significant right now, and we're doing our best across the company and in every way we can to deliver into that supply. But it requires a lot of things. It requires support from our partners, requires incredible execution by our team, and it requires visibility, kind of where the supply in the market is going to go. So we'll keep talking about supply. If supply improves, things -- we'll deliver it.

Got it. And then, sorry, as my second question, just on gross margins. I guess this one's probably for you, Cary. Great job in Q4. You talked about a slight decline in Q1 and then further normalization in mix in Q2. If you can kind of speak to how you're thinking about some of the swing factors, if you will, the M700, cost inflation? You talked about passing through some of the cost increases to your customers starting in October. But if you can walk us through the puts and takes and how we should think about normal gross margins for your business going forward, that would be great.

Thanks, Toshiya. That's a great question and one filled with a lot of nuance. So Q4 gross margins were obviously very strong. The driver of that strength was a particularly strong mix of industrial and specialty products. This is the second time in my tenure that we've seen a similar strong mix of industrial and specialty SKUs. The last time was about 18 months ago in 2Q of '20. And in that quarter, 2Q of '20, we delivered 51.4% gross margin. And we had also benefited by about 220 basis points from fully reserve -- sale of full -- excuse me, we had a negative impact of 220 basis points from an E&O write-off. So in that quarter, Q2 of '20, we had about a 53.5% normal gross margin.

All of that lift above our then typical 50% average is really attributed to the strong mix of specialty and industrial SKUs. As I look at Q4 results, that mix was even a little bit stronger than it was 18 months ago in 2Q of '20. It is worth -- it's also worth noting that 4Q benefited from the reversal of those E&O write-offs from 2020, where we sold some of that fully reserved inventory and benefited by 130 basis points. So normalize those 2 factors out, and you can start to understand what the benefit of the M700 is.

As I look into 1Q of '22 I expect a weakening mix of industrial specialty SKUs but still stronger than normal. So we'll get a little bit of a lift in 1Q from that, but nowhere near the size of the lift we got in 4Q '21. And then by the time we get into Q2, I expect us to be at kind of our normalized run rate with our strong mix of M700 supporting it.

The next question will come from Mike Walkley with Canaccord Genuity.

Great. And congrats on the strong 2021 execution despite the challenging year.

Thank you.

I guess the first question, Chris, just on a high level, with the tight labor market and all the efficiencies, so many industries could benefit from adopting RAIN. What do you see as potential for some new industries that are interesting long term and could potentially cross the chasm, as you put it, in terms of broad adoption, like we've seen with retail and now the logistics markets?

Yes. Thank you, Mike, for the question. I guess I'm going to start my answer to the question by saying, you're seeing broad-based adoption in very many verticals. We're seeing it in, of course, retail and supply chain logistics. We're seeing opportunities in automotive. We're seeing opportunities in food. We're seeing industrial and manufacturing, electronics. I mean just very broad-based adoption, and with the AmerisourceBergen announcement, in pharmaceuticals and health care.

We, as a company, are significantly focused on retail because they're the early adopter and there's so much opportunity there, and supply chain and logistics with some of our very significant design wins. That doesn't mean that we're ignoring those other opportunities in other spaces, but we are significantly counting on our partners to deliver against them.

As I think about the tight labor market and where we could see further significant adoption, and the next industry crossing the chasm, I'm not really going to be able to hazard a guess right now because there's so much movement happening in so many verticals. You hear some of our partners talking about significant opportunities in food, and food, of course, it's a huge opportunity. And you hear others, for example, talking about automotive. And if aviation comes back, there's still the aviation opportunity.

I think the key point I want to make is that, if you look about at what RAIN really does, it allows companies to track every item they manufacture, transport and sell; gives them visibility to where those items are as a function of time, to increase their efficiencies, reduce their operational costs, reduce mistakes, track items better, deliver more efficiently. It really allows enterprises to transform how they run their businesses. And fundamentally, I don't see any other technology today or on the horizon that does that. So our future is incredibly bright. We'll focus on our target verticals for now. And as we make more progress, we'll open up to a third. The thirds are definitely out there.

Great. And I guess my follow-up question, just how is the large project pipeline? And is the industry shortage of RAIN ICs, is that causing a pause in terms of timing of large product rollout because they're worried about getting the endpoints eventually? Or is the pipeline still strong just given all the use cases you just laid out?

Mike, this is Jeff. I'll take that one. First of all, in terms of the pipeline, I think as reflected in our prepared remarks and Chris's earlier answers, the demand environment is strong. Our pipeline is strong. And to build on what Chris has commented on, the diversification of that demand, both geographically and across different industry sectors, is exciting. And it includes a range of size of projects, of course. But the component which is large project is growing, and it reflects the digital transformation projects and initiatives of lead -- industry-leading enterprises. And so the pipeline is strong.

Now to the second part of your question, which relates to how is the supply environment impacting end customer projects. We work in close collaboration with our partners and end customers in the planning of either the expansion of existing projects or the introduction of new projects, with a view of trying to ensure we optimize the timing and pace of those expansions or new projects according to the supply visibility. So I think we and our partners are seeing continued growth in demand and a need to thoughtfully plan supply, meeting that growing demand.

The next question will come from Harsh Kumar with Piper Sandler.

First of all, congratulations Hussein, and great job getting Steve and Meera. We know Steve Sanghi from Microchip, covering that company, and both of these guys -- both of them are amazing gets as Board members.

But the first question, Cary, I want to go back to the -- to Toshiya's question earlier and trying, for lack of a better word, pin you down a little bit on what the margins can be normalized in 2Q. So I think what you told us is 130 bps is reserved inventory that was written off. And maybe you -- I'm assuming you got maybe 100 bps of mix. So is it fair for us to think that we take 58%, and we sort of take off 250 bps, and that would be a good number for us to think about for margins going forward and the benefits you're getting in -- starting, call it, 2Q, 3Q and onwards?

So Harsh, this is Cary. Thanks for the question, and I appreciate the opportunity to follow up, because gross margin is incredibly nuanced in Q4, less so in Q1, but will still be nuanced in Q1. So of the 58.2% that we reported for Q4, you're absolutely right. 130 basis points were related to the sale of fully reserved items. That won't repeat again in Q2. So take that off.

The piece where I think a little bit under is on the mix benefit from the specialty and industrial SKUs. When I was pointing back to Q2 of '20, the last time we had that strong mix, we were able to back into the strength of that mix being about 350 basis points in Q2 of '20. This quarter, I think that benefit is even stronger for the specialty and industrial mix. So that's how I would back out to what I think of as a normalized gross margin. And in that normalized gross margin is our M700 doubling from Q3.

Okay. Very helpful and takes care a lot of questions I'm sure that investors had. And Chris, maybe I'll ask you a question. On the last call, you touched upon the supply chain guys, on this call you touched upon a little bit more. You're increasingly talking about this topic. I know that from talking to you guys, when Delta did the implementation, the airline guys that -- the large airline company did the implementation, it took them, call it, 3.5 to 4 years. Where do you think we are in that cycle when you get one of these wins and you're able to talk about it?

So Harsh, correct me if I'm wrong, but I think you got 2 questions. One is just kind of the supply and the impact of supply. And the second one is our ability to talk about specific deployments.

Yes. On supply chain side. Correct.

On the supply chain side specifically. Yes. So as I think we've kind of pointed out, at least from the vantage point we have today, 2022 is going to be significantly supply-chain dominated. Our demand is very strong. If we get more supply, and we are working, as I said before, we're working really closely with our partners to kind of -- to really highlight our need, the opportunity in the market and criticality for our ask for supply. So as we get supply -- and I'm optimistic we get more, but you can't count on it until it comes -- as we get supply, we'll be able to deliver into that demand. And we will continue trying to get there for you and all of our investors.

We don't have visibility to it today, primarily because the nodes that we operate in for our endpoint ICs are still significantly impacted by very strong demand, the very strong demand coming from a bunch of verticals. And of course, there's limited supply out there in the environment. So we will be -- we will continue talking about supply. We'll give you and our investors an update on the next call, and keep you appraised of the situation as we see it. But just know demand is very strong.

In terms of supply chain and logistics as a vertical, some of the -- we believe or what we feel is that some of the recent announcements you have seen, you and others have seen, when one we cited just in the prepared remarks about world's largest supply chain and logistics company highlighting putting RAIN tags on all their packages and saving 20 million manual scans a day, it's those kind of announcements that can really galvanize an industry and pull an industry across the chasm.

I'm not going to say we're there yet, but the excitement that we feel from some of these announcements, some of these projects, some of which have taken years to kind of build and grow, I feel very good about the supply chain and logistics vertical. Which is why we've talked about it for a while and why we keep investing in helping our end customers deploy in that vertical, and why we keep focusing very significantly on it. I don't know that I can answer your question in any more detail than that until we actually start talking about actual deployments.

Totally understood. Chris, congratulations.

Thank you, Harsh.

Thanks, Harsh.

The next question will come from Troy Jensen with Lake Street Capital.

Maybe 2 quick questions here for Cary. You mentioned cost pass-throughs, so I was wondering if you could kind of quantify that. And then also, was there any 10% customers in Q4?

Yes. So from a cost pass-through, so in October -- last October, and as a response to our cost or our COGS increasing, we began the process of passing through those costs on to our customers. We did it in a way to maintain the integrity of our margin model. So think of that as preserving everything that was in place in our margin model prior to it. So not only the kind of the 50% corporate average gross margin that we had, but also the ambitions of M700 driving margin accretion to the business. All of those tenets of that margin model were maintained in our cost pass-through philosophy. And then in terms of 10% customers on an annual basis, that will be included in our 10-K which will be filed early next week.

Okay. Understood. And maybe just a quick follow-up, or maybe one for Chris here. Other industries that I've followed, when new product cycles start or when capacity gets tight, customers can double order to try to get more allocation of what you're currently getting. So just curious to know kind of your confidence that this massive bookings that you guys have had throughout the year really reflects the demand versus customers just trying to get more of the current capacity coming out of that?

Yes. Thanks, Troy. So there's always a risk of double ordering in the 2-step distribution model that we've got. But our team is pretty seasoned on it now. Our purchase orders are not cancelable. And we have contact directly with a lot of the end users. So our visibility into both our partners' inventory levels, our end users' effectively inventory levels and their need, and the fact that our direct partners are frequently lines down, gives us good confidence that the demand we're seeing is true demand. Yes, it's real.

The next question will come from Derek Soderberg with Colliers.

Cary, just going back to gross margins again. I know it's going to take some time to sort of fully realize the benefit of the M700. I guess, when can we expect the M700 to achieve this sort of long-term target gross model that you guys have set internally? Which inning are you guys in around achieving that gross margin benefit fully? How long is it going to take to get to that target?

Yes. Thanks, Derek. It's a good question. First off, think of M700 as a platform. And the chip that we're selling today is the first chip in our TikTok strategy. And there's going to be more innovation that the team is working on to both increase productivity, add new features to it or capabilities to it, as well as drive cost out.

So as I'm looking at the M700 today, in Q3 we reach the crossover point. Think of that as during late in the quarter we begin shipping more M700 product, the 300 millimeter products, than we did our prior generation Monza R6 and R6-P on 200 millimeter.

In Q4, M700 became the volume runner. In Q4, the volume nearly doubled relative to Q3. We're getting at a very strong mix in Q4 of the M700 as a percentage of our sales. And you're seeing that benefit in our strong gross margin. Yes, gross margin benefited from industrial/specialty SKUs. We've assigned that impact. Yes, we benefited from the sale of fully reserved inventory. But underlying both of those are continued increase in gross margin directly driven by the M700.

And as I look forward to next year, I mean the overarching comment is supply is going to have an impact on our M700 mix. We are ready and waiting for any wafer we can get, whether that be 200 or 300 millimeter products. And we will -- whatever one we get, we'll turn it into product and sell it to our customers.

Got it. Got it. That's helpful. And then, Chris, high level, you guys talked about accelerating demand. In the past, you've talked about where that demand is in relation to supply. I was wondering if you could update on that. And besides that, I'm wondering if once this wafer supply does come online, given the dynamics of the M700, performance, size and coming off the larger wafer, you got -- do you expect to gain market share from your largest competitor? I mean is that sort of your thinking there?

Yes. Thanks, Derek. So as I said in our prepared remarks, yet again, in fourth quarter, demand exceeded supply more than 50%. And so that's just reiterating again the points I've been making about the strong demand environment.

And as I just answered the question from Troy in terms of how we feel about the demand, how real is it? Is it double booking or is it real demand? As we look into both our partners and our end customers, the opportunities that are driving the end customer needs, especially around omnichannel fulfillment and on some of the other use cases and engines, we truly believe that that demand is real, that we're seeing just a significant pull for the products we deliver. And I'm going to say it's actually for our platform.

Because what we're delivering now more and more is platform solutions. Solutions built on the entirety of our platform. Our endpoint ICs, our readers ICs or readers and gateways delivering a complete solution that, with our partner, allows us to deliver a whole product to the market.

As we look forward in terms of the share opportunity, we have an opportunity to gain share. We also have an opportunity, potentially, to go -- for it to go the other way. It really depends on who gets the supply first, us or our primary competitor. We are doing everything we can to try and get that supply first.

I can't predict which way it's going to go, but we're going to do everything in our power to get supplies as quickly as we can and to work with our foundry partner to win this huge opportunity. And they know -- they see the opportunity. They know it as well. So they're doing what they can to support us, but as I said before, they are very tightly constrained.

The next question will come from Jim Ricchiuti with Needham & Company.

Just a couple of questions. I joined a little bit late, Cary, but I was wondering if you can comment on the sequential decline in G&A in the quarter. Just in light of everything we're hearing about wage inflation, I'm wondering how we think about that going forward. And then I have a follow-up.

Jim, thanks for the question. The sequential decline in G&A, it wasn't driven by attrition or anything like that. It was really in the non-wage line. It was more timing than anything else.

As a broader statement, as it relates to attrition, we performed pretty well given the macro factors that we had -- were in play in 2021. So we haven't seen it yet. We're obviously taking it very seriously and evaluating what we can and what we need to do for our employees. But so far, we've been able to navigate the challenges pretty well.

Okay. And just the follow-up question really relates to, I think, the comment, Chris, you might have made about being prioritized for upside. I mean I think that was true last year as well. And your foundry partner came back, I think, in Q4 with additional wafer supply. So I'm wondering what -- do the UPS comments and other high-profile reports, the ones we've seen relating to Walmart, and maybe use cases that are accelerating that we're not aware of, doesn't that help further your cause?

Simple answer, Jim, yes. I mean -- and so when I speak to the fact that we're prioritize -- that our foundry partners is prioritizing us for upside, we share information with our foundry partner. They do their own diligence. They see it as well. And yet they look internally and they see how tight they are. They see also demand, like I mentioned, from automotive and other industries in the process nodes we use. They come back and told us that we are prioritized for upside, and they're going to help us as they can. They've also explained to us the constraints that they're facing.

Some of these -- obviously, foundries have many different nodes. In some of the nodes, some capacity has started to free up, for example, some of the more advanced nodes. Some of the nodes, for example the ones we're in, remain tight, just due to very strong demand in other verticals that have very significant needs. It's my hope that with that prioritization that we're getting from our foundry partner and the significant verticals and statements that large companies are making, we will be able to get that supply.

But quite frankly, we're going to get it if either the market situation improves, other industries slow down a little bit, or the foundry is able to, for example, increase their output. It's not -- they're in a tough situation as well. So I think you just have to take it at face value. They prioritize us for supply. The opportunity out there in the market is real. We will continue trying to get that supply if we are able to.

The next question will come from Mark Lipacis with Jefferies.

I guess I had one for Chris and one for Cary. Chris. I just wanted to make sure I understood the statements. If you could reconcile -- I think you said that you had demand for the M700 platform products. But you also said that there is a risk that if your competition comes up with supply earlier, that you could you could -- that that demand could fall off. So I guess I wanted to make sure I understood.

So do you -- are you of the view that your customers are ordering specifically for endpoint ICs that are the M700 because they have a particular functionality that they need that maybe your competitor doesn't have, or is this more kind of a first come, first served? Like if somebody produces the capacity, then there is certainly a real [risk] that the backlog that you have kind of disappears. And then I had a follow-up.

Okay. Great. Mark, and this is Chris. I really appreciate the question. And it will be helpful to clarify there. When I speak to platform wins, in those platform wins, wins where we're delivering a full platform, in general we are optimizing the performance of the system to use our entire platform. And as we get supply, we're actually -- we're prioritizing delivering into those platform wins.

Not all of the wins we have in the market are platform wins. So if you think about the retail space going back, where it's just hand-held driven inventory counting, we're just in a competitive dynamic with our primary competitor out there in the market, and there is an ability to substitute.

So you should think of the market as being driven -- essentially having 2 elements for us: one is use cases that are -- that can use both our and our competitors' endpoint ICs, for which we compete directly against them head-to-head; another set of opportunities where we deliver our entire platform, and the system either has unique capabilities or performs better because we deliver our entire platform. Of course, when we have those platform wins, we are prioritizing delivering our endpoint ICs into those opportunities.

So where we'll be fighting for share, and where we'll be looking for upside wafers is in the less differentiated opportunity set in the market. Which gets to my point of, if our competitor comes up with share first, they'll take a greater portion of those undifferentiated opportunities. That make sense?

That's very clear. And then for Cary, I appreciate your comments about shifting the incentive portion of the compensation expense to more of a mix of stock-based comp and cash, if I heard correctly. Can you quantify that a little bit? How should we think about the OpEx through the year and like the mix of -- how should we think about stock-based compensation expense through the year, and then kind of the total aggregate line of stock-based comp and then regular operating expenses?

Yes. So thanks for the question, Mark. I think as I look at the OpEx impact from making the shift to -- back to a mix of cash and stock for incentive compensation, I think that that impact is about $700,000 to $800,000 per quarter in new OpEx that wasn't there last quarter, if you will. On the stock-based compensation, we have included that in our 1Q guide. It's a little bit hard to project for the full year. Yes, we will have fewer shares related to incentive compensation issued, but it really depends on what the stock price does.

Sure. Sure. Got it. But I guess -- so I guess the question would -- like just say all things being equal, would -- do you have a full quarter of this new compensation incentive compensation plan, or will we have -- we only have a partial quarter this quarter and then a full quarter next quarter -- I appreciate that stock-based compensation moves around, yes.

Okay. I understand your question. So think of it as $700,000 to $800,000 per quarter. So that $700,000 reflects a full impact in Q1 and assuming we'd have a similar full impact in Q2. Obviously, there are performance attainment and accelerators of the bonus, so if we start overperforming, our estimate for that accrual will increase. But we'll be able to tell you when that happens.

The next question will come from Scott Searle with ROTH Capital.

Cary, just quickly, I wanted to clarify on the gross margin comments. In the current quarter, there is no benefit from inventory that was previously written off. And then the comment about the 300 basis point plus benefit included both specialty and M700, is that correct?

So let me correct you on both of those. So there was a 130 basis point benefit from selling fully reserved inventory, not expected to repeat. And then the -- I highlighted using the last time we had a strong industrial/specialty mix, which was 2Q of '20, that impact was about 350 basis points to the quarter. The impact to Q4 was larger than that. This was a stronger -- even stronger industrial/specialty mix in Q4.

The remaining of that benefit, you can think of -- the remaining gross margin lift over our normal 50% is what you can think of as the cumulative impact or the current impact of the M700. We've been ramping up M700 as a percentage of our mix for 5 quarters now and really heavily in the last 2 quarters. It became -- we reached the crossover point in Q3, and it became the volume runner in Q4. And in Q4, we nearly doubled our volume of M700 chips.

Okay. Cary, just to follow up on those -- the gross margin outlook then for the rest of the year, is there an expectation in terms of what the mix will look like exiting this year? I know it's subject to a lot of factors, but a best guess at this point in time. And given the price increases that have gone through, are they expected to be permanent through the year? Or do you have a giveback at some point?

We -- so let me answer the last one first. We made the decision to pass through costs when we received cost increases on our parts. So that was the driving factor behind it. It's hard for me to speculate what we would do in the future, if the costing environment changed, how that would impact our pricing. But I just don't see that happening right now. I expect elevated costs throughout 2022.

Given the short -- this is Chris. Given the short wafer supply and the need that the market and -- I personally will be surprised if the foundries actually drop their wafer pricing. There would have to be some material change out in the market that would be disruptive kind of in much broader ways.

No, I was going to ask then, to follow up on just the outlook in terms of supply demand coming back into balance, you're undershipping by about 50% now on the endpoint IC front. As it stands today, Chris, do you have visibility through your wafer supplier that you would ever be able to get to a number that would satisfy the demand that you saw in the current quarter? I know it's a moving target, that you expect demand to continue to increase throughout the year. But as it stands today, that incremental $20 million or so, is that on the table to be able to service or have visibility to that at the current time, third quarter, fourth quarter of this year? Or is it sometime in 2023?

So unfortunately, Scott, I don't -- I can't really answer the question in terms of the details. Sort of like how much upside supply are we going to get, and is it on the table. I want to say 2 things, kind of in direct -- or I won't say direct, just kind of an indirect answer to your question. Number one is we've shared the information about the market opportunity with our foundry partner. They know what it is. And they have other set of constraints, and they're working with us. And if supply comes free, we've been prioritized to get some upside. If supply doesn't come free, we're not going to get the upside because it didn't come free. So it's really that simple of an environment. They know the need. And so I have hope for the future, but as I said in the prepared remarks, in terms of upside supply, as of today we don't have it.

Longer term, I just want to add one more thing. Just longer term, we've emphasized to our foundry partner the fact that our products need to be as available as paper. Because our end customers are using our products to track the items they manufacture, transport and sell. So longer term, we actually need to have good availability. We can't be in these supply environments, because it has such a great impact on supply chain and logistics across the globe.

So there's another way of thinking about things going forward is that the demand we have in the market actually, in order to get the end customers to deploy, we actually need to be able to deliver today and for the long term. It's -- we'll be focusing on that kind of topic for the next many years because it's so critically important. Go ahead. I cut you off.

No, no. But Chris, just following up on that point and I guess coupling it with Mike's question earlier, has the -- some new verticals are starting to come into play more through some of your partners, particularly things when you mentioned end markets like food. So has the pandemic changed the price points for adoption here? Particularly, I think in the past, you talked about self-checkout, food, the all-in cost of a tag being $0.015. Now is that a higher number that drives the adoption earlier, subject to available supply in the next couple of years? Or is it still looking at those kind of price points, whether it's 3 years out or 5 years out? Or has it moved everything forward by a couple of years?

Yes. I'm going to answer from my gut, which is that the pandemic has amplified the value of end-to-end supply chain visibility and amplified the value of omnichannel fulfillment and amplified the value in driving efficiencies and to increase capacity in supply chain and logistics. And with those amplified values, I find it difficult to believe that the prior price points still hold. The value is higher, the price points go up. I can't quantify how much those price points have gone up across the different verticals, but my gut says they have, just because the value of RAIN RFID is so much greater right now, and it's highlighted so much by the pandemic.

I mean if you just look at the Accenture report, roughly, the number of retailers who are adopting RAIN pre-pandemic/post-pandemic has doubled, rough numbers. It's 93% now of North American retailers are adopting or deploying RAIN RFID. That's a huge growth in just 2 short years. And we're seeing pull in some of the other verticals as well. That's about the best I can do to answer the question, Scott.

This concludes our question-and-answer session. I would like to turn the conference back over to Chris Diorio, Co-Founder and CEO, for any closing remarks. Please go ahead, sir.

Thank you, Chuck. I'd like to thank all of you for joining the call today. I hope you and your loved ones are and remain safe and well. Thank you very much, and we'll talk again next quarter. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.