Welcome to the Impinj fourth 1/4 and full year 2021 earnings conference call and webcast. All participants will be in a Listen-O nly Mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions.
To ask a question, you may press star then one on your Touch-Tone phone, and to withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Andy Cobb, Vice President, Strategic Finance. Please go ahead, sir.
Thank you, Chuck. Good afternoon, and thank you all for joining us to discuss Impinj's fourth 1/4 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 1/4 and full year 2021 financial results, and first 1/4 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, 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 & 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. Thank you all for joining the call. Impinj capped 2021 with record fourth 1/4 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, Omni-Channel fulfillment, 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 1/4 and a strong year, and that strength continues into 2022.
Fourth 1/4 endpoint IC revenue exceeded our expectations with record bookings despite us instituting cost passthrough starting in October. Retail demand remained strong, with retailers large and small turning to RAIN RFID to improve both in-store and supply chain inventory visibility and to accelerate Omni-Channel fulfillment.
We also saw 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 had 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 1/3 quarters, fourth 1/4 endpoint IC demand exceeded shipments by more than 50%.
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 1/2 2022 wafer supply remains relatively unchanged, with 200- and 300-millimeter wafer supply commitments that should allow us to equal or exceed fourth 1/4 2021 shipment levels through mid-2022.
Those shipment levels fall far short of our rapidly growing demand. 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 1/4 systems revenue also exceeded our expectations. Reader IC revenue was a bright spot, continuing its recovery from the first 1/2 2021 supply shortfall.
We still expect supply of our prior generation Indy reader ICs to catch up to demand in first 1/4 2022, and supply of our new E family reader ICs to catch up to growing demand in second 1/2 2022. We have high expectations for the latter, now with more than 100 design wins. Fourth 1/4 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 1/4, we entered first 1/4 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 1/4 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.
The second large North American supply chain and logistics customer continued deploying, contributing modest fourth 1/4 revenue and a broadening of partner-led revenue in both retail and supply chain and logistics, our two target markets. That was a bright spot in our fourth 1/4. 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've championed a vision of digital twins for physical items and what it means for the Internet of Things, power of RAIN item visibility in every person's hand, available information about every connected item, a 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 two 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 three years, Hussein championed the development of the Impinj platform, delivering groundbreaking endpoint ICs, reader ICs, readers, and gateways. 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 Neera Rao, who just joined our board. Neera was previously CFO at Monolithic Power Systems, and she brings significant executive and board-level experience to Impinj.
Steve, thank you. Neera, 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.
To each and every Impinj team member, I'd like to give my heartfelt thank you. In closing 2021 with 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-mm post-processing capacity, and accelerating our M700 series ramp.
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 1/4 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 1/4.
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 1/4 revenue was $52.6 million, up 16% sequentially compared with $45.2 million in 1/3 1/4 2021, and up 44% year over year from $36.4 million in fourth 1/4 2020. Fourth 1/4 Endpoint IC revenue was $38.4 million, up 20% sequentially compared with $32 million in 1/3 1/4 2021, and up 35% year over year from $28.5 million in fourth 1/4 2020.
Quarter-over-1/4, 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 1/4 2022 Endpoint IC revenue to decline slightly sequentially, driven by a smaller percentage of specialty industrial ICs.
Q4 systems revenue was $14.2 million, up 7% sequentially compared with $13.2 million in Q3 2021, and up 79% Year-Over-Year from $7.9 million in Q4 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 Q1 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 Omni-Channel 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 1/4 gross margin was 58.2%, compared with 53.3% in 1/3 1/4 2021 and 50.4% in fourth 1/4 2020.
The 1/4-over-1/4 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 1/4.
The fourth 1/4 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 1/4 operating expense was $25.3 million, compared with $24.4 million in 1/3 1/4 2021 and $21.5 million in fourth 1/4 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 1/4 adjusted EBITDA was a profit of $5.3 million, compared with a loss of $400,000 in 1/3 1/4 2021 and a loss of $3.1 million in fourth 1/4 2020. 2021 adjusted EBITDA was a profit of $9.1 million, compared with a loss of $11.5 million in 2020. Fourth 1/4 GAAP net loss was $20 million. Fourth 1/4 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 1/4 with cash equivalents, and investments of $207.6 million, compared with $113.3 million in 1/3 1/4 2021 and $106.1 million in fourth 1/4 2020.
In fourth 1/4 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 1/4, with the increase primarily from systems. Fourth 1/4 net cash used in operating activities was $3.9 million. Property and equipment purchases totaled $2.1 million. Free cash flow was -$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 -$9.8 million. Before I turn to our first 1/4 guidance, I want to highlight items unique to fourth 1/4 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 benefit from selling fully reserved inventory and M700 volume nearly doubling, drove our record fourth 1/4 gross margin.
We expect a slightly less favorable mix of industrial and specialty endpoint ICs in first 1/4, driving margins down sequentially. In second 1/4 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 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 1/4 of 2022 guidance. Third, we delivered business model leverage in an environment where revenue was supply constrained, setting adjusted EBITDA records in fourth 1/4 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 1/4 revenues 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 1/4 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 1/4 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?
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your Touch-Tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. As a courtesy to others, we ask that you please limit yourself to one question and one Follow-Up.
If you have additional questions, please Re-Queue, and we will take as many questions as time allows. At this time, we'll pause momentarily to assemble our roster. The first question, excuse me, will come from Toshiya Hari with Goldman Sachs. Please go ahead.
Hi, guys. Congratulations on a very strong year, and thank you for taking the question. I guess to start off, I had two questions. Chris, I was hoping you could elaborate a little bit more on, you know, how you're thinking about supply in 2022.
You know, based on your comments, it's pretty clear you're gonna be supply gated for at least the first 1/2 and potentially the second 1/2 as well. As we think about, you know, how to model 2022 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. I'm gonna 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 and coming at least relative to the outsized magnitude of our demand.
I do wanna make that point that our demand is large, our opportunity is growing rapidly, and with that record backlog entering 2022, the strength of demand we're seeing, we and our foundry partner are working closely together to deliver into that opportunity. To date, we don't have the supply that allows us to meet that opportunity for the year.
We continue working with them. They have prioritized us for upside. We will work hand in hand with them to try to deliver into our opportunity and kind of capture everything that we see in front of us. Did I answer your question adequately, Toshiya?
Yes, on the systems side, Chris, were there any other
Oh, yes.
... dynamics at play?
Yeah. On the systems side, as I mentioned in the prepared remarks, 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. 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 our supply to catch up to demand in first 1/4, in this 1/4. 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 1/2 of the year.
Overall, even also on the system 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 are 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. We're doing our best from an operational side, an operational perspective, and with our foundry partner and with our other suppliers out in the market to meet that demand.
Got it. Then I guess, Chris, based on those comments, would it be fair to assume sort of a low $50 million revenue number for 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?
Yeah. Hi, Toshiya This is Cary. Thanks for the question. I think I'll take that one from Chris. Yes, we've obviously guided, you know, a midpoint of $51 million in Q1. As I look through into Q2, 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 Q1 and into Q2, or mid-2022.
There will be a little bit of an impact from a reducing mix of industrial and specialty projects. That drove high revenue, high gross margin in Q4. That mix will tail off a little bit in Q1, and then it'll normalize in Q2. From the systems side, you know, Chris really highlighted it.
We're navigating an ever-changing list of components, component shortfalls. We do our best to solve those, and then the next 1/4, we're out solving another list of challenging projects. I think that kind of sets us up for fairly consistent performance on the systems. Obviously, however, you know, any time we're talking about our systems revenue line, you know, 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.
Tushar, I guess I'm just gonna add that, the environment we're in, we are supply limited, not demand limited. So demand far outstrips our supply. To the extent we can get outside supply, you know, we will deliver into that demand. If supply remains constrained, then we'll be tight. It's just.
You know, we only guide one 1/4 at a time, and it's especially difficult right now for us to talk beyond the current 1/4 we're in and 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, incredible execution by our team, and it requires visibility to, you know, kind of where the supply in the market's gonna go. We'll keep talking about supply. If supply improves, things, you know, we'll deliver it.
Got it. Sorry, as my second question, just on gross margins, I guess this one's probably for you, Cary. You know, great job in Q4. You talked about a slight decline in Q1 and then further normalization and mix in Q2. If you can kind of speak to how you're thinking about, you know, some of the swing factors, if you will, the M700, you know, cost inflation.
You know, you talked about passing through some of the cost increases to your customers starting in October. 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. Thank you.
Thanks, Toshiya. That's a great question and one filled with a lot of nuance. You know, 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 Q2 of 2020. In that 1/4, Q2 of 2020, we delivered 51.4% gross margin, and we had a negative impact of 220 basis points from an E&O Write-Off.
In that 1/4, Q2 of 2020, 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 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 2020. It's also worth noting that 4Q benefited from the reverse of those E&O Write-Offs from 2020, where we sold some of that fully reserved inventory and benefited by 130 basis points.
Normalize those two factors out, and you can start to understand what the benefit of the M700 is. As I look into 1Q of 2022, I expect a weakening mix of industrial specialty SKUs, but still stronger than normal.
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 2021. 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.
Thank you.
The next question will come from Mike Walkley with Canaccord Genuity. Please go ahead.
Great. Thanks for taking my questions, and congrats on the strong 2021 execution despite the challenging year. I guess, the-
Thank you.
... the first question, Chris, is just on a high level, you know, with the tight labor market and all the efficiencies, you know, 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?
Yeah. Thank you, Mike, for the question. I guess I'm gonna start my answer to the question by saying we are 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, you know, with the AmerisourceBergen announcement in pharmaceuticals and healthcare.
We as a company are significantly focused on retail just because it was 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 next industry crossing the chasm, I'm not really gonna 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, you know, food, of course, is 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
The key point I wanna make is that if you look 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, you know, 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. Fundamentally, I don't see any other technology today or on the horizon that does that. Our future is incredibly bright. We'll focus on our two target verticals for now, and as we make more progress, we'll open up to a 1/3. The 1/3s are definitely out there.
Great. Thanks. I guess my Follow-Up question, just how is the large project pipeline and is the industry shortage of RAIN, I see, 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. To build on what Chris has commented on, the diversification of that demand both geographically and across different industry sectors is exciting.
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 leading industry-leading enterprises. 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. I think we and our partners are seeing continued growth in demand and a need to thoughtfully plan supply meeting that growing demand.
Makes a lot of sense. That's helpful. Thanks, for taking my questions. I'll jump back in the queue.
Thank you, Mike.
Thanks, Mike.
The next question will come from Harsh Kumar with Piper Sandler. Please go ahead.
Yeah. Hey, guys. First of all, congratulations, Hussein, and, you know, great job getting Steve and Neera. We know Steve Sanghi from Microchip covering that company, and both of these guys, you know, both of them are amazing gets as board members.
The first question, Cary, I wanna go back to Toshiya's question earlier and try and, for lack of a better word, pin you down a little bit on what the margins can be normalized in two Qs. So I think what you told us is 130 basis points is reserved inventory that was written off, and maybe, you know, I'm assuming you got maybe 100 basis points of mix.
Is it fair for us to think that we take 58% and we sort of take off 250 basis points, 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?
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. Of the 58.2% that we reported for Q4, you're absolutely right, 130 basis points were related to 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 2020, 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 2020.
This 1/4, I think that benefit is even strong for the specialty and industrial mix. That's how I would back out to what I think of as a normalized gross margin. In that normalized gross margin is our M700 doubling from Q3.
Okay. Very helpful and takes care of a lot of questions I'm sure that investors had. Chris, maybe I'll ask you a question. You know, 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, you know, from talking to you guys when Delta did the implementation.
The large airline company did their implementation, it took them, call it 3.5-4 years. Where do you think we are in that cycle when, you know, you get one of these wins and you're able to talk about it?
Harsh, correct me if I'm wrong, but I think you got two questions. One is just kind of the supply and the impact of supply. The second one is our ability to talk about specific deployments.
Yes. On supply chain side. You're right. Thanks, Chris.
On supply chain side specifically. You know, as I think we've kind of pointed out, at least from the vantage point we have today, 2022 is gonna 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 the criticality of our ask for supply.
As we get supply, you know, I'm optimistic we get more, but you know, you can't count on it until it comes. As we get supply, we'll be able to deliver into that demand. We will continue trying to get there.
You know, 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, and very strong demand coming from, you know, a whole bunch of verticals, and of course, there's limited supply out there in environment.
We will continue talking about supply. We'll, you know, give you and our investors an update on the next call and keep you appraised to the situation as we see it, but just know demand's very strong. In terms of supply chain 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, you know, and 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 gonna 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, like, that I can answer your question any more detailed than that, you know, till we actually start talking about actual deployments.
Totally understood, Chris. Thank you, and congratulations.
Thank you, Harsh.
Thanks, Harsh.
The next question will come from Troy Jensen with Lake Street Capital Markets. Please go ahead.
Hey. Congrats, gentlemen. Maybe two quick questions here for Cary. You mentioned cost passthroughs. I was wondering if you could kind of quantify that. Also, was there any 10% customers in Q4?
From a cost passthrough, in last October, as a response to our cost or our COGS increasing, we began the process of passing through those costs on to our customer. We did it in a way to maintain the integrity of our margin model. Think of that as preserving everything that was in place in our margin model prior to it.
Not only the kind of 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 passthrough philosophy. 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. Maybe just a quick Follow-Up or maybe one for Chris here. You know, other industries that I 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. Just curious to know kind of your confidence that, you know, this massive bookings that you guys have had throughout the year really reflects the demand versus customers just trying to, you know, get more of the current capacity coming online.
Yeah. Thanks, Troy. You know, there's always a risk of double ordering in the two-step distribution model that we've got, but our team is pretty seasoned on it now. Our purchase orders are Non-cancelable. You know, we have contact directly with a lot of end users, so our visibility into both our partners' inventory levels, our end users' respective 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. Yeah, it's real.
All right. Well, good luck to everyone. Keep up the good work.
Thank you.
Thanks, Troy.
The next question will come from Derek Soderberg with Colliers Securities. Please go ahead.
Hey, guys. Thanks for taking my questions. Cary, just going back to gross margins again. You know, I know it's gonna take some time to sort of fully realize the, you know, benefit of the M700. I guess, you know, when can we expect the M700 to achieve this, you know, this sort of Long-Term target gross margin that you guys have set internally? You know, which inning are you guys in around achieving that, you know, gross margin benefit fully? You know, how long is it gonna take to sort of get to that target?
Yeah. 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 tick-tock strategy, and there's gonna be more innovation that the team's working on to both increase productivity, add new features to it or capabilities to it, as well as drive costs out.
As I'm looking at the M700 today, in Q3, we reached the crossover point. Think of that as during late in the 1/4, we began shipping more M700 product or our 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 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.
You know, as I look forward to next year, I mean the overarching comment is, you know, supply is gonna have an impact on our M700 mix. We're 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. That's helpful. Chris, you know, high level, you guys talked about accelerating demand. You know, in the past you've talked about where that demand is in relation to supply. Was wondering if you could update on that.
You know, besides that, you know, I'm wondering if once this wafer supply does come online, you know, given the dynamics of the M700, you know, performance size and, you know, coming off a larger wafer, you know, do you expect to gain market share from your largest competitor? I mean, is that sort of your thinking there?
Yeah. Thanks, Derek. As I said in our prepared remarks, yet again, in fourth 1/4 demand exceeded supply by more than 50%. You know, 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 they're driving, the end customer needs, especially around Omni-Channel fulfillment, and some of the other use cases I mentioned, we truly believe that demand is real, that we're seeing a significant pull for the products we deliver.
I'm gonna say it's actually for our platform, 'cause what we're delivering now more and more is platform solutions built on the entirety of our platform. Our endpoint ICs, our reader ICs, 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, you know, in terms of the share opportunity, we have an opportunity to gain share. We also have an opportunity potentially for it to go the other way. It really depends on who gets the supply first, so our primary competitor. We are doing everything we can to try and get that supply first.
I can't predict which way it's gonna go, but we're gonna do everything in our power to get supply as quickly as we can and to work with our foundry partner to win this huge opportunity. They know they see the opportunity, they know it as well, so they're doing what they can to support us. As I said before, they are very tightly constrained.
Got it. Thanks, guys.
Great. Thank you, Derek.
The next question will come from Jim Ricchiuti with Needham & Company. Please go ahead.
Hi. Thank you. 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 1/4, just you know 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.
Hey, 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. You know, as a broader statement, as it relates to attrition, you know, we performed pretty well given the macro factors that were at 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. 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 that your foundry partner came back, I think, in Q4 with additional wafers supplied. I'm wondering, you know, do the UPS comments and other high-profile reports, like the ones we've seen relating to Walmart, and maybe, you know, use cases that are accelerating that we're not aware of, doesn't that, you know, help further your cause?
A simple answer, Jim: Yes. I mean, it's that our foundry partner is prioritizing us for upside. We share information with our foundry partner. They do their own diligence. They see it as well. Yet they look internally, and they see how tight they are. They see also demand, like I mentioned, from automotive and other industries and the process nodes we use. They've come back and told us that we are prioritized for upside, and they're gonna help us as they can. They've also explained to us the constraints that they're facing. You know, some of these. You know, 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 and 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.
Quite frankly, we're gonna get it, if either the market situation improves, other industries slow down a little bit, or the foundry's able to, you know, for example, increase their output. It's not. They're in a tough situation as well. I think you just have to take it at face value. They prioritize us for supply.
The opportunity out there in the market's real. We will continue trying to get that supply if we are able to.
Got it. Thanks a lot.
Okay. Thank you, Jim.
The next question will come from Mark Lipacis with Jefferies. Please go ahead.
Hi. Thanks for taking my question. 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, you know, there is a risk that if your competition comes up with supply earlier, that you could lose that, you know, that demand could fall off. I guess I wanted to make sure I understood.
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, you know, kind of a first come, first serve, like if somebody produces the capacity, then there is certainly a real risk that the backlog that you have kinda disappears? I had a Follow-Up. I Thank you.
Okay. Great. Mark, this is Chris, and I really appreciate the question. It will be helpful to clarify there. When I speak to platform wins, in those platform wins we're recovering, a full platform. In general, we are optimizing the performance of the system to use our entire platform. As we get supply, we're actually prioritizing delivering into those platform wins.
Not all of the wins we have in the market are platform wins. If you think about the retail space going back where it's just handheld-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. You should think of the market as being essentially having two elements for us.
One is use cases that can use both our and our competitors' endpoint ICs, and 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. Where we'll be fighting for share and where we'll be looking for upside wafers is in the less differentiated opportunities out in the market, which gets to my point. If our competitor comes up with share first, they'll take a greater portion of those undifferentiated opportunities.
Got-gotcha.
That makes sense?
That's very clear. Thank you. 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, you know, 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? Thank you.
Thanks for the question, Mark. I think, as I look at the OpEx impact from making this shift back to a mix of cash and stock for incentive compensation, I think that impact is about $700K-$800K per 1/4 in new OpEx that wasn't there last 1/4, 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. I guess, like, just say all things being equal, do you have a full 1/4 of this new incentive compensation plan or will we have, you know, we only have a partial 1/4 this 1/4 and then a full 1/4 next 1/4? Thanks.
Yeah, and
I'd appreciate it if that base compensation was around, yeah.
Okay. I understand your question. Think of it as $700-$800K per 1/4. That $700K reflects a full impact in Q1 and, you know, assuming we'd have a similar full impact in Q2. Obviously, there are performance attainment and accelerators of the bonus, so if we start over-performing, our estimate for that accrual will increase, but we will be able to tell you when that happens.
Gotcha. Thank you.
Thanks, Mark.
Thanks, Mark.
The next question will come from Scott Searle with Roth Capital Partners. Please go ahead.
Hey, good afternoon. Thanks for taking my questions. Hey, Cary, just quickly, I wanted to clarify on the gross margin comments. In the current 1/4, there is no benefit from inventory that was previously written off. The comment about the 300 basis point plus benefit included both specialty and M700, is that correct?
Let me correct you on both of those. There was 130 basis points benefit from selling fully reserved inventory, not expected to repeat. I highlighted, you know, using the last time we had a strong industrial specialty mix, which was 2Q of 2020, that impact was about 350 basis points to the 1/4. The impact to Q4 was larger than that. This was a stronger, even stronger industrial specialty mix in Q4. 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 five quarters now and really heavily in the last two quarters. We reached the crossover point in Q3, and it became the volume runner in Q4. 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. Given the price increases that have gone through, are they expected to be permanent through the year, or do you have a give back at some point?
Let me answer the last one first. We made the decision to pass through cost when we received cost increases on our part. 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. I just don't see that happening right now. I expect elevated costs throughout 2022.
This is Chris. Just given the short wafer supply and the needs in the market and, you know, I personally will be surprised if the foundries actually drop their wafer pricing. There'd be
Yeah
Actually some material change on the market then, you know, that would be disruptive, kind of in much broader ways. Cary?
Chris, and then.
A-And-
I'm sorry, go ahead.
Go ahead.
No, no, please go ahead.
No, I was gonna ask then to follow up on just the outlook in terms of supply-demand coming back into balance. You know, you're under shipping 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 1/4?
I know it's a moving target that you'd 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, you know, 1/3 1/4, fourth 1/4 of this year, or is it sometime in 2023?
Unfortunately, Scott, I don't. I can't really answer the question in terms of the detail. That's sort of like, you know, how much upside supply are we gonna get, and is it on the table? I wanna say two things in kind of indirect or sort of in, I won't say direct. It's 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, you know, they have another set of constraints. They're working with us, and if supply comes free, we've been prioritized to get some upside. If supply doesn't come free, you know, we're not gonna get the upside 'cause it didn't come free. It's really that simple of an environment.
They know the need. I have hope for the future, but as I said, in the prepared remarks, you know, in terms of upside supply as of today, we don't have it.
Gotcha.
Longer term.
Chris
I just wanna 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. 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.
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. We're focusing on that kind of topic for the next year, many years without, you know, because it's so critically important. Go ahead.
I cut you off.
Oh, no, not at all. Chris, just following up on that point, and I guess coupling it with Mike's question earlier, you know, some new verticals are starting to come into play more through some of your partners, particularly things when you mention end markets like food. Has the pandemic, you know, changed the price points for adoption here?
Particularly, I think in the past, you talked about self-checkout, food, you know, 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 three years out or five years out? Or has it moved everything forward by a couple of years? Thanks.
Yeah. I'm gonna 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 Omni-Channel fulfillment and amplified the value in driving efficiencies, and to increase capacity. You can think of supply chain and logistics. 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 at, you know, across the different verticals. 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 two short years. You know, 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.
That's perfect. Very helpful. Thanks so much, and nice job on the 1/4.
Okay. Thank you.
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 1/4. Bye-bye.
The conference has now concluded. Thank you for attending today's presentation.