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EX-23.1 - CONSENT OF PRICEWATERHOUSECOOPERS LLP - IMPINJ INCdex231.htm
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As filed with the Securities and Exchange Commission on June 16, 2011

Registration No. 333-173667

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Amendment No. 2

to

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

IMPINJ, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   3679   91-2041398
(State or other jurisdiction of incorporation or organization)   (Primary Standard Industrial Classification Code Number)  

(I.R.S. Employer

Identification Number)

 

701 North 34th Street, Suite 300

Seattle, Washington 98103

(206) 517-5300

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

William T. Colleran, Ph.D.

President and Chief Executive Officer

701 North 34th Street, Suite 300

Seattle, Washington 98103

(206) 517-5300

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

Copies to:

Patrick J. Schultheis

Michael Nordtvedt

Wilson Sonsini Goodrich & Rosati,
Professional Corporation

701 Fifth Avenue, Suite 5100

Seattle, Washington 98104-7036

(206) 883-2500

 

Martin A. Wellington

Davis Polk & Wardwell LLP

1600 El Camino Real

Menlo Park, California 94025

(650) 752-2000

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer   ¨      Accelerated filer    ¨
Non-accelerated filer   x   (Do not check if a smaller reporting company)    Smaller reporting company    ¨

 

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission acting pursuant to said Section 8(a), may determine.

 

 


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The information in this prospectus is not complete and may be changed. We and the selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we and the selling stockholders are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

Issued June 16, 2011

 

                     Shares

LOGO

COMMON STOCK

 

 

 

Impinj, Inc. is offering                  shares of its common stock and the selling stockholders are offering                  shares of common stock. We will not receive any proceeds from the sale of shares by the selling stockholders. This is our initial public offering and no public market exists for our shares. We anticipate that the initial public offering price will be between $             and $             per share.

 

 

 

We intend to apply for listing of our common stock on              under the symbol “    ”.

 

 

 

Investing in the common stock involves risks. See “Risk Factors” beginning on page 11.

 

 

 

PRICE $             A SHARE

 

 

 

      

Price to

Public

    

Underwriting
Discounts and
Commissions

    

Proceeds to
Company

    

Proceeds to
Selling
Stockholders

Per Share

     $               $               $               $         

Total

     $                          $                          $                          $                    

 

Impinj and the selling stockholders have granted the underwriters the right to purchase up to an additional shares of common stock to cover over-allotments.

 

The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The underwriters expect to deliver the shares to purchasers on                     , 2011.

 

 

 

MORGAN STANLEY   J.P. MORGAN

 

 

 

NEEDHAM & COMPANY, LLC
PACIFIC CREST SECURITIES
RAYMOND JAMES

 

                    , 2011


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TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

Risk Factors

     11   

Special Note Regarding Forward-Looking Statements and Industry Data

     35   

Use of Proceeds

     37   

Dividend Policy

     38   

Capitalization

     39   

Dilution

     41   

Selected Financial Data

     44   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     46   

Business

     73   

Management

     90   

Executive Compensation

     98   
 

 

We, the selling stockholders and the underwriters have not authorized anyone to provide any information other than that contained in this prospectus or in any free writing prospectus prepared by or on behalf of us or to which we have referred you. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. We, the selling stockholders and the underwriters are not making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

 

Until                     , 2011, all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

 

This summary highlights selected information contained elsewhere in this prospectus and is qualified in its entirety by the more detailed information and financial statements included elsewhere in this prospectus. It does not contain all of the information that may be important to you and your investment decision. You should carefully read this entire prospectus, including the matters set forth under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes.

 

IMPINJ, INC.

 

Overview

 

Impinj is the leading provider of UHF RFID solutions for identifying, locating and authenticating items. We believe our technology platform, known as GrandPrix, is the most comprehensive and widely adopted in our industry. GrandPrix’s key elements are Monza tag ICs, Indy reader ICs and Speedway readers and subsystems. RFID systems built on GrandPrix deliver real-time information about tagged items, thereby enabling applications and analytics designed to improve business decisions and enhance consumer experience. Leading retail, apparel, pharmaceutical, food and beverage, technology and logistics companies as well as government agencies rely on our GrandPrix platform. We are the technology leader in our industry, with 90 issued and allowed U.S. patents and 77 pending U.S. patent applications as of April 15, 2011. We have sold over two billion Monza tag ICs since its introduction in 2005, including 940 million in 2010 alone.

 

We focus exclusively on ultra-high frequency, or UHF, radio-frequency identification, or RFID, solutions. UHF RFID enables writing individualized information to and reading information from tagged items without line of sight and at longer range, higher speed, lower cost and with more automation than any competing technology. We embrace the global industry standard for UHF RFID, called UHF Gen2, which we extend through our leadership in the standards-setting process and enhance with our proprietary technologies and deep domain expertise. UHF Gen2 is the fastest growing segment of the RFID market. UHF Gen2 systems are well suited for high-volume, item-level applications that require low-cost consumable tags, such as retail inventory management, pharmaceutical authentication and airline baggage tracking. VDC Research Group, or VDC, projects the number of UHF Gen2 tag ICs shipped will grow from 1.6 billion in 2010 to 41.0 billion in 2015, a compound annual growth rate, or CAGR, of 92.2%.

 

From 2009 to 2010 unit sales of our Monza UHF Gen2 tag ICs increased by 279%. We believe that Impinj leads the market in UHF Gen2 tag ICs, reader ICs and stationary readers with estimated 60%, 86% and 25% share, respectively. We estimate that Impinj enables more than 70% of the UHF Gen2 reader market when we combine the share of our Speedway reader with that of other readers based on our Indy reader ICs. We believe that our market leadership position and the benefits and efficiencies end users derive from UHF Gen2 systems are driving our rapid growth. For 2009, 2010 and the three months ended March 31, 2011, our revenue was $20.8 million, $31.8 million and $12.3 million, respectively, and our net losses from continuing operations were $9.9 million, $11.4 million and $1.8 million, respectively.

 

LOGO   LOGO

 

 

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We sell to a broad and well-established ecosystem of more than 450 inlay manufacturers, reader original equipment manufacturers, or OEMs, distributors, system integrators, value-added resellers, or VARs, and other technology companies, as well as to end users. Our ecosystem relies on the elements of our GrandPrix platform to deliver UHF Gen2 solutions to end users in wide-ranging markets, such as Walmart and Banana Republic for apparel inventory management, Coca-Cola for product authentication in next-generation beverage dispensers and LS Industrial Systems for tracking and authenticating pharmaceuticals, which are the largest consumers by volume of our IC products for such applications.

 

We believe current applications of UHF Gen2 represent a small portion of the potential for this technology. We envision a future when a broad array of everyday items is linked to networked information systems, thereby enabling significantly improved visibility, understanding and analysis of those items’ location and attributes. This global network of connected objects is often referred to as the “Internet of Things.” We believe that UHF Gen2 technology, powered by Impinj, is helping to make that vision a reality.

 

We use third-party foundries and subcontractors to produce our ICs and contract manufacturers to assemble our readers and subsystems. This capital-efficient operating model is designed to scale efficiently as our volume grows, allowing us to focus our resources on developing new products and solutions while continuing to build our reputation as the UHF Gen2 leader.

 

The RFID Industry

 

RFID technology has been employed for decades. Legacy RFID technologies, such as those that operate in the low frequency, or LF, and high frequency, or HF, bands have been employed for years in specialized applications such as animal tagging and in security applications such as access cards. More recently, the market for UHF systems has grown rapidly as companies deploy enterprise-wide UHF RFID systems to realize the benefits and efficiencies those systems deliver.

 

UHF Gen2 RFID

 

The development of the UHF Gen2 standard was, and continues to be, driven by end-user requirements. A critical end-user requirement is that UHF Gen2 be the single worldwide standard for retail RFID. In contrast, technology providers have typically driven specifications for other RFID standards, often leading to competing standards that end users are reluctant to adopt. GS1 EPCglobal, a nonprofit industry association, created the UHF Gen2 standard and a corresponding electronic product code, or EPC, numbering system to assign unique numbers to UHF Gen2-tagged items. GS1 EPCglobal also created other standards and guidelines related to data storing, data sharing, reader operations and tag applications. As of March 31, 2011, GS1 EPCglobal had over 950 end-user members, including many of the world’s leading retail, apparel, logistics and pharmaceutical companies. UHF Gen2 systems generally have lower power requirements, demonstrate superior performance and may be deployed at lower cost compared to LF and HF technologies. These attributes, coupled with the single industry standard, make UHF Gen2 systems well suited for item-level, high-volume applications. These applications generally require ongoing purchases of consumable tags that uniquely identify items.

 

We believe that apparel retailers are adopting UHF Gen2 systems because of demonstrable benefits and efficiencies. For example, UHF Gen2 systems can identify every tagged garment in a stack in a fraction of a second, enabling daily store-floor inventorying, even while customers remain in the store. Item-level, real-time inventory visibility allows retailers to reduce out-of-stocks and overstocks, carry less inventory, better meet consumers’ needs and make better business decisions. University of Arkansas studies demonstrate that RFID item tagging significantly improves store-floor inventory accuracy.

 

We believe demand for UHF Gen2 systems will grow both by further penetration into existing applications such as apparel tagging and by expansion into myriad other high-volume tagging applications. In consumer

 

 

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retail, UHF Gen2 growth prospects include tagging of consumer electronics, cosmetics and jewelry. A number of governments have mandated UHF Gen2-based tagging of automobiles, pharmaceuticals and liquor. Manufacturing logistics, postal applications and food safety exhibit great promise. These examples represent just some of the applications that we believe will contribute to sustained market growth.

 

Unlike other semiconductor-based products, we believe the consumable nature of UHF Gen2 tags will drive sustained volume growth. Furthermore, we expect that a number of trends, including ubiquitous connectivity, internet-enabled commerce and the need to identify, authenticate and track items in increasingly complex business environments will accelerate broader adoption of UHF Gen2 systems. VDC projects the number of UHF Gen2 tag ICs shipped will grow from 1.6 billion in 2010 to 41.0 billion in 2015, a CAGR of 92.2%.

 

Our GrandPrix Platform

 

We believe that Impinj has the only UHF RFID technology platform, industry-leading product performance and leading market share in each of our tag IC, reader IC and reader product lines. Our GrandPrix platform tightly integrates numerous elements, including Monza tag ICs, reference tag antenna designs, reader antennas, Indy reader ICs, Speedway readers and subsystems, OEM reader reference designs, software-development kits, or SDKs, application-programming interfaces, or APIs, application software and services. Our ecosystem partners develop GrandPrix-based UHF Gen2 systems and deploy them at leading retail, apparel, pharmaceutical, food and beverage, technology and logistics enterprises. GrandPrix provides superior performance, proprietary system enhancements and a comprehensive development environment. Our integrated GrandPrix platform offers numerous benefits to our ecosystem partners and end users, including:

 

   

Superior performance. We believe that each of our products, individually, has best-in-class performance, and when integrated together delivers the best system performance in the industry. We base our belief both on field experience and on industry data, such as the January 2011 ABI Research passive UHF tag Vendor Matrix IC ranking that placed us first in both innovation and implementation.

 

   

Proprietary system enhancements. We use our deep domain expertise to solve the most difficult challenges in UHF Gen2 and embed our proprietary solutions into GrandPrix. For example, traditional UHF tags are not readable when the tag antenna is aligned end-on to the reader antenna. To solve this problem we developed our patent-pending True3D technology that enables orientation-insensitive tags.

 

   

Comprehensive development environment. We strive to empower our ecosystem partners to develop complete systems for end users and to further their preference for our GrandPrix platform. For our Speedway and Indy products we offer development environments, easy-to-use APIs, SDKs, software drivers and libraries, upgrade agents, sample application code and application software.

 

 

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Our Competitive Strengths

 

We are the leading provider of UHF Gen2 solutions and believe we can maintain this position by leveraging our competitive strengths, including:

 

   

Our market and technology leadership. Our exclusive focus on the high-growth UHF Gen2 market and our resulting deep domain knowledge and systems engineering expertise has allowed us to become the market leader. Impinj leads the market in UHF Gen2 tag ICs, reader ICs and stationary readers with estimated 60%, 86% and 25% share, respectively, based on VDC data. We believe our exclusive focus on the UHF Gen2 market allows us to be more nimble, innovation-focused and better able to identify and capture opportunities.

 

LOGO

 

   

Our platform approach. We believe that Impinj is the only company that provides an integrated UHF Gen2 product suite. When our ecosystem partners deploy GrandPrix-based systems as an integrated whole, end users benefit from system performance and ease-of-use that we believe cannot be equaled by “mix and match” implementations. In addition, the knowledge we gain from developing one component of a UHF Gen2 system often allows us to optimize other components while improving our domain expertise, which makes us an attractive partner in the critical “design-in” phase of end users’ vendor selection processes.

 

   

Our intellectual property portfolio. We own a strong intellectual property portfolio with 90 issued and allowed U.S. patents and 77 U.S. patent applications as of April 15, 2011. These patents cover UHF Gen2 system design, tag ICs, reader ICs, readers, software, firmware and antenna designs.

 

   

Our standards leadership. We have taken leadership roles in establishing RFID standards at worldwide governing bodies, including GS1 EPCglobal. Our active role in driving standardization of RFID technology has enabled us to maintain our leadership in UHF Gen2 products and to promote the adoption of our technical innovations in the marketplace.

 

   

Our broad and well-established ecosystem. We sell to an ecosystem of more than 450 inlay manufacturers, reader OEMs, distributors, system integrators, VARs and other technology companies. In addition, end users seek us out for our domain knowledge and systems engineering expertise to develop applications that are tailored to their needs. We leverage this understanding of end users’ needs to secure design wins with inlay manufacturers, reader OEMs and end users.

 

   

Our capital-efficient operating model. We use third-party foundries and assembly subcontractors to produce our ICs, and we use contract manufacturers to assemble our readers and subsystems. This capital-efficient operating model is designed to scale efficiently as our volume grows, allowing us to focus our resources on developing new products and new solutions, while continuing to build our reputation as the UHF Gen2 leader.

 

 

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Our Strategy

 

We strive to accelerate UHF Gen2 market adoption and extend our GrandPrix platform’s leadership while growing revenue profitably. Key elements of our strategy are to:

 

   

Deliver the most innovative UHF Gen2 solutions. We will continue to innovate to extend our significant UHF Gen2 technology leadership. Given the multi-year lifecycle of UHF Gen2 deployments, we believe that design wins earned today will engender continued customer preference for systems that employ our products in the future.

 

   

Embrace and extend the UHF Gen2 standard. We intend to continue our active leadership role within GS1 EPCglobal because we believe this role enables us to extend the UHF Gen2 standard and influence its future direction. We believe that the insights we gain through our involvement in the standards-setting process allow us to deliver first-to-market, standards-compliant products with the potential for broad market acceptance.

 

   

Commercialize new use cases. We intend to continue to actively engage customers and end users to identify key market needs and to develop or enable application-specific solutions that address large market opportunities.

 

   

Expand and enable our implementation and go-to-market partnerships. We intend to continue to broaden and deepen our relationships with inlay manufacturers, reader OEMs, distributors, VARs, system integrators, software providers and other technology companies, as well as with end users. By leveraging these relationships we expect to continue to identify, target and deliver complete solutions to end users in existing and new markets and applications.

 

Risks Associated with Our Business

 

Our business and our ability to execute our strategy are subject to many risks that you should be aware of before you decide to buy our common stock. These risks are discussed more fully in “Risk Factors” beginning on page 11 and include, among others:

 

   

The adoption rate for UHF Gen2 technology has been slower than anticipated or forecasted by both us and industry sources. If the market for UHF Gen2 products does not continue to develop, or develops more slowly than we expect, our business will suffer.

 

   

Our market is very competitive, and if we are unsuccessful developing new products and enhancements, our customers or end users do not select our UHF Gen2 products to be designed into their products or systems or we fail to compete successfully, our business and operating results will suffer.

 

   

The UHF Gen2 market has been characterized by significant price erosion. If such erosion continues and we are unable to offset any reductions in our average selling prices by increasing our sales volumes or introducing new products with higher margins, our revenue and gross margins will suffer.

 

   

We rely on a limited number of third parties to manufacture, assemble and test our products, particularly our sole-source supplier of Monza wafers, and we do not have any long-term supply contracts. If the supply of our products is disrupted, fulfilling our customer orders may be adversely affected and our reputation, revenue and growth prospects could be impaired.

 

   

We rely on third party inlay manufacturers, reader OEMs, distributors, VARs and system integrators to sell our products, and we have experienced significant customer concentration in certain of our product lines. If we are unable to maintain our relationships with our channel partners or develop relationships with new channel partners, our business, financial condition and operating results could be harmed.

 

 

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Corporate Information

 

We were incorporated in Delaware in April 2000. Our principal executive office is located at 701 North 34th Street, Suite 300, Seattle, Washington 98103. Our telephone number is (206) 517-5300. Our website address is www.impinj.com. Information contained in, or that can be accessed through, our website is not a part of, and is not incorporated into, this prospectus.

 

Unless the context indicates otherwise, as used in this prospectus, the terms “Impinj,” “we,” “us” and “our” refer to Impinj, Inc. We use Impinj®, the Impinj logo, the Powered by Impinj® shield logo, GrandPrix, Monza®, Indy®, Speedway®, the checkered flag logo and other marks as trademarks in the United States and other countries. This prospectus contains references to our trademarks and service marks and to those belonging to other entities. Solely for convenience, trademarks and trade names referred to in this prospectus, including logos, artwork and other visual displays, may appear without the ® or ™ symbols, but such references are not intended to indicate in any way that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensor to these trademarks and trade names. We do not intend our use or display of other entities’ trade names, trademarks or service marks to imply a relationship with, or endorsement or sponsorship of us by, any other entity.

 

 

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THE OFFERING

 

Common stock offered by us

                        shares

Common stock offered by the selling stockholders

  

                     shares

Total

                        shares

Common stock outstanding after this offering

  

                     shares

Over-allotment option

  

                     shares

Risk factors

   See “Risk Factors” beginning on page 11 and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our common stock.

Use of proceeds

   We expect to use approximately $25 million of the net proceeds from this offering to repay indebtedness (including approximately $8.2 million for the repayment of indebtedness held by our affiliates) and the remaining              of the net proceeds for general corporate purposes. We will not receive any of the proceeds from the sale of common stock by the selling stockholders. See “Use of Proceeds.”

Proposed              symbol

  

 

The number of shares of our common stock outstanding immediately after this offering is based on 132,776,294 shares of our common stock outstanding as of March 31, 2011. This number excludes, as of March 31, 2011:

 

   

21,914,388 shares of common stock issuable upon the exercise of outstanding options with a weighted average exercise price of $0.11 per share;

 

   

1,004,155 shares of common stock reserved for future issuance under our 2010 Equity Incentive Plan as of March 31, 2011; provided, however, that immediately upon the signing of the underwriting agreement for this offering, our 2010 Equity Incentive Plan will terminate so that no further awards may be granted under our 2010 Equity Incentive Plan;

 

   

an aggregate of up to              shares of common stock reserved for future issuance under our 2011 Equity Incentive Plan and 2011 Employee Stock Purchase Plan, each of which will become effective immediately upon the signing of the underwriting agreement for this offering;

 

   

an aggregate of 2,797,112 shares of Series E convertible preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying our subordinated convertible promissory notes (which notes will be repaid using a portion of the net proceeds of the offering contemplated by this prospectus);

 

   

an aggregate of 890,721 shares of Series E convertible preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying warrants with an exercise price of $2.286 per share (which warrants will be exercised automatically on a net exercise basis in connection with the offering contemplated by this prospectus if the initial per share price to public exceeds the exercise price of the warrants); and

 

 

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an aggregate of 260,280 shares of our Series E preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying warrants with an exercise price of $2.286 per share and an aggregate of 300,000 shares of our common stock underlying warrants with an exercise price of $0.21 per share.

 

Except as otherwise indicated, all information in this prospectus assumes:

 

   

the conversion of all our outstanding shares of convertible preferred stock into 97,465,284 shares of common stock immediately prior to the closing of this offering;

 

   

the filing of our amended and restated certificate of incorporation, which will occur immediately prior to the closing of this offering; and

 

   

no exercise of the underwriters’ over-allotment option.

 

In addition, we may choose to effect a reverse stock split prior to the effectiveness of this offering. This prospectus does not reflect the effects of this reverse stock split.

 

 

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SUMMARY FINANCIAL DATA

 

We have derived the following summary of our statements of operations data for the years ended December 31, 2008, 2009 and 2010 from our audited financial statements appearing elsewhere in this prospectus. We derived the unaudited statements of operations data for the three months ended March 31, 2010 and 2011 and the balance sheet data as of March 31, 2011 from our unaudited interim financial statements included elsewhere in this prospectus. In the opinion of management, the unaudited financial statements reflect all adjustments, which include only normal recurring adjustments necessary to a fair statement of our results of operations and financial position. Our historical results are not necessarily indicative of the results that may be expected in the future. The summary of our financial data set forth below should be read together with our financial statements and the related notes to those statements, as well as the sections captioned “Selected Financial Data” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the “Unaudited Pro Forma Condensed Financial Statements” appearing elsewhere in this prospectus.

 

     Year Ended
December 31,
    Three Months Ended
March 31,
 
     2008     2009     2010     2010     2011  
           (Unaudited)  
     (In thousands, except per share amounts)  

Revenue:

          

Product revenue

   $ 15,457      $ 10,305      $ 29,221      $ 4,640      $ 11,397   

Development, service and licensing revenue

     9,586        10,511        2,576        500        868   
                                        

Total revenue

     25,043        20,816        31,797        5,140        12,265   

Costs of revenue:

          

Cost of product revenue

     10,791        6,782        17,008        2,455        6,325   

Cost of development, service and licensing revenue

     2,006        2,219        603        111        472   
                                        

Total cost of revenue

     12,797        9,001        17,611        2,566        6,797   
                                        

Gross profit

     12,246        11,815        14,186        2,574        5,468   

Operating expenses:

          

Research development

     12,257        9,492        10,662        2,389        2,781   

Selling and marketing

     7,375        7,320        8,256        1,957        2,375   

General and administrative

     6,711        5,271        5,525        1,241        1,594   
                                        

Total operating expenses

     26,343        22,083        24,503        5,587        6,750   
                                        

Loss from operations

     (14,097     (10,268     (10,317     (3,013     (1,282

Interest income (expense) and other, net

     316        67        (978     (55     (495
                                        

Net loss before income tax (expense) benefit

     (13,781     (10,201     (11,295     (3,068     (1,777

Income tax (expense) benefit

     644        50        (90     (19     (24
                                        

Loss from continuing operations

     (13,137     (10,151     (11,385     (3,087     (1,801

Income from discontinued operations, net of tax

     1,275        291                        
                                        

Net loss

   $ (11,862   $ (9,860   $ (11,385   $ (3,087   $ (1,801
                                        

Net loss attributable to common stockholders

   $ (19,481   $ (18,419   $ (19,943   $ (5,227   $ (3,838
                                        

Basic and diluted loss per common share:

          
          

Loss from continuing operations

   $ (0.68   $ (0.56   $ (0.58   $ (0.15   $ (0.11

Income from discontinued operations

     0.04        0.01                        
                                        

Net loss

   $ (0.64   $ (0.55   $ (0.58   $ (0.15   $ (0.11
                                        

Weighted-average number of shares used in per share amounts (in thousands):

     30,509        33,527        34,127        33,723        34,824   
                                        

Pro forma net loss per share, basic and diluted

       $ (0.08     $ (0.01
                      

Pro forma weighted average shares outstanding, basic and diluted(1)

         131,592          132,289   
                      

 

 

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     As of March 31, 2011  
     Actual     Pro Forma
As Adjusted(2)
 
     (Unaudited)  
     (In thousands)  

Balance Sheet Data:

    

Cash, cash equivalents and short-term marketable securities

   $ 12,052      $                

Working capital

     18,779     

Total assets

     43,121     

Total long-term debt

     18,438     

Redeemable convertible preferred stock

     160,197     

Accumulated deficit

     (155,830  

Total stockholders’ deficit

     (155,810  

 

(1)   Assumes the conversion of all outstanding shares of convertible preferred stock outstanding as of March 31, 2011 into common stock.
(2)   Reflects, on a pro forma basis, the automatic conversion described in footnote (1) and, on an as adjusted basis, the sale by us of             shares of common stock offered by this prospectus at an assumed initial price to public of $             per share, the midpoint of the range set forth on the cover of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses, and the application of such proceeds as described in the section captioned “Use of Proceeds.” Each $1.00 increase (decrease) in the assumed initial price to public of $             per share, would increase (decrease) each of cash and cash equivalents, working capital, total assets and total stockholders’ deficit by approximately $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase (decrease) of             in the number of shares offered by us would increase (decrease) each of cash and cash equivalents, working capital, total assets and total stockholders’ deficit by approximately $             million, assuming that the assumed initial price to public remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will adjust based on the actual initial price to public and other terms of this offering determined at pricing.

 

 

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RISK FACTORS

 

Investing in our common stock involves a high degree of risk. Before making an investment decision, you should carefully consider the risks and uncertainties described below, which we believe are the material risks of our business and this offering. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. Our business, financial condition, operating results or growth prospects could be harmed by any of these risks. In that event, the trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. In assessing these risks, you should also refer to all of the other information contained in this prospectus, including our financial statements and related notes.

 

Risks Related to Our Business and Industry

 

Market acceptance of UHF Gen2 solutions is uncertain. If the market for UHF Gen2 solutions does not continue to develop, or develops more slowly than we expect, our business will suffer.

 

The market for UHF Gen2 solutions is relatively new and, to a large extent, unproven. Whether UHF Gen2 solutions will achieve and sustain high demand and market acceptance is uncertain. The adoption rate for UHF Gen2 technology has been slower than anticipated or forecasted by both us and industry sources. For example, beginning in the early 2000s, when retailers, such as Wal-Mart Stores, Inc., or Walmart, piloted UHF Gen2 for pallet- and case-level tagging to improve the efficiency of their supply chains, their initiatives failed to gain significant traction. Near-term growth of UHF Gen2 item-tagging solutions depends on large organizations with market influence, such as Walmart and Banana Republic, a division of Gap Inc., continuing to adopt and deploy UHF Gen2 item-tagging solutions. The growth of the market for UHF Gen2 solutions will depend upon further adoption within the retail industry, as well as adoption in other industries and by government agencies. If these market-leading early adopters fail to realize demonstrable benefits and efficiencies through expanded adoption of UHF Gen2 solutions or otherwise elect to abandon UHF Gen2 solutions for any reason, overall market acceptance of these solutions will be materially and adversely affected. Any widespread delay, slowdown or failure by organizations implementing UHF Gen2 solutions could materially and adversely affect our business, operating results, financial condition and prospects.

 

End users and our prospective customers may not be familiar with our solutions or UHF Gen2 solutions in general, or may use other products and technologies to identify, authenticate, track and prevent loss of their assets. Additionally, even if our prospective customers are familiar with RFID technology and our solutions, a negative perception of, or experience with, RFID technology or of a competitor’s RFID products may deter them from adopting UHF Gen2 technology or our solutions. Businesses, government agencies and other organizations may need education on the benefits of using UHF Gen2 solutions in their operations. These educational efforts may not be successful, and organizations may decide that the costs of adopting UHF Gen2 solutions outweigh the benefits. In addition, increased market adoption of UHF Gen2 solutions is likely to depend in part upon the continued decline in selling prices for UHF Gen2 products and infrastructure, particularly UHF Gen2 tags. Failure of organizations to adopt UHF Gen2 solutions for any reason could hurt the development of the UHF Gen2 market and, consequently, impair our business and prospects.

 

We have a history of losses, and we expect to incur additional losses in the future. We cannot be certain that we will achieve or sustain profitability.

 

We have never been profitable, and we expect to continue to incur additional losses in the future. We incurred net losses of $11.9 million, $9.9 million, $11.4 million and $1.8 million in 2008, 2009, 2010 and the three months ended March 31, 2011, respectively. As of March 31, 2011, we had an accumulated deficit of $155.8 million. Our ability to achieve or sustain profitability is based on numerous factors, many of which are out of our control, including the continued widespread adoption of UHF Gen2 solutions, our market share and margins. We may never be able to generate sufficient revenue or sell a sufficient volume of UHF Gen2 products to achieve or sustain profitability.

 

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Our market is very competitive. If we fail to compete successfully, our business and operating results will suffer.

 

We face significant competition in the UHF Gen2 industry from both established and emerging players. We believe our principal competitors are NXP B.V., or NXP, and Alien Technology Corporation, or Alien, in the market for tag ICs; austriamicrosystems AG and Phychips Inc. in reader ICs; and Motorola Solutions, Inc., or Motorola, Alien, Federal Signal Corporation, Intermec Technologies Corporation, or Intermec, and Trimble Navigation Limited, or Trimble, in UHF Gen2 readers. In addition, our customers, including inlay manufacturers, reader OEMs and distributors, may decide to enter our market and compete with us rather than purchase our products, which would not only reduce our customer base but also increase competition in the market, adversely affecting our operating results, business and prospects. Companies in adjacent markets or newly formed companies may decide to enter the UHF Gen2 market.

 

Because the market for UHF Gen2 solutions is new and evolving, winning key end-user and customer accounts early in the development of the market will be critical to growing our business. Competition for key potential customers is intense. Additionally, end users that use competing products and technologies may face high switching costs, which may affect our and our channel partners’ ability to successfully convert them to our products. Failure to obtain orders from key customers and end users, for competitive reasons or otherwise, would materially adversely affect our operating results, business and prospects.

 

Some of our competitors have longer operating histories and significantly greater financial, research and development, marketing and other resources than us. As a result, some of these competitors are able to devote greater resources to the development, promotion, sale and support of their products. These competitors may also have the ability to provide discounted pricing on their products to gain market share. In addition, consolidation in the UHF Gen2 industry could intensify the competitive pressures that we face. Many of our existing and potential competitors may be better positioned than we are to acquire other companies, technologies or products.

 

Some of our customers have policies for maintaining diverse supplier bases. Many of these customers desire to enhance competition and maintain multiple providers of UHF Gen2 products and thus do not have an interest in purchasing exclusively from one supplier or promoting a particular brand. Our ability to increase order sizes from these customers and maintain or increase our market share is constrained by these policies. In addition, any decline in quality or availability of our products or any increase in the number of suppliers that such a customer uses may decrease demand for our products and adversely affect our operating results, business and prospects.

 

Our ability to compete successfully depends on numerous factors, including our ability to:

 

   

maintain our market leadership position and the strength of our brand in UHF Gen2;

 

   

provide an integrated suite of UHF Gen2 products;

 

   

remain an active leader in the standards-setting process and promote relevant standards;

 

   

maintain and expand our relationships with channel partners;

 

   

secure products in large volume in a cost-effective and timely manner from our suppliers;

 

   

develop innovative, differentiated, high-performance solutions relative to our competitors’ solutions; and

 

   

protect our intellectual property.

 

We cannot assure you that our solutions will continue to compete favorably or that we will be successful in the face of increasing competition from new products and enhancements introduced by our existing competitors or new companies entering our market. In addition, we cannot assure you that our competitors do not have or will not develop processes or product designs that currently or in the future will enable them to produce competitive products at lower costs than ours. Any failure to compete successfully would materially adversely affect our business, prospects, operating results and financial condition.

 

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We rely on a limited number of providers to manufacture, assemble and test our products, and if we fail to obtain quality products in a timely and cost effective matter, our operating results and growth prospects would be adversely affected.

 

We do not own or operate manufacturing facilities. Currently, all of our Monza wafers are manufactured by Taiwan Semiconductor Manufacturing Company, Limited, or TSMC; all of our Indy wafers are manufactured by Tower Semiconductors Ltd., or TowerJazz; and all of our Speedway readers are manufactured by Plexus Corp., or Plexus. We also use contractors for assembly and testing. We do not control our suppliers’ ability or willingness to meet our supply requirements.

 

Currently, we do not have long term supply contracts with TSMC, TowerJazz or Plexus, and our suppliers are not required to supply us products for any specific period or in any specific quantity. Suppliers can allocate production capacity to other companies’ products and reduce deliveries to us on short notice. Our suppliers may have long-term agreements with others or allocate capacity to other companies for strategic reasons, which could impair our ability to secure sufficient supply of products for sale.

 

We place orders for products with some of our suppliers approximately four to five months prior to the anticipated delivery date, with order volumes based on our forecasts of customer demand. Accordingly, if we inaccurately forecast demand for our products, we may be unable to obtain adequate and cost-effective foundry or assembly capacity to meet our customers’ delivery requirements, or we may accumulate excessive inventory.

 

Manufacturing capacity may not be available when needed or at reasonable prices. For example, in the last three quarters of 2010 we experienced significant shortages in the delivery of Monza wafers from TSMC relative to our submitted purchase orders given high industry demand for foundry capacity. Such shortages adversely affected our ability to meet our obligations to our customers and, in some cases, caused customers to cancel orders, qualify alternative sources of supply or purchase from our competitors. In addition, in response to the recent shortage or future shortages, our customers may overbuy our products, which may artificially inflate sales in near-term periods while leading to sales declines in future periods as our customers burn through accumulated inventory.

 

If our suppliers fail to deliver products at reasonable prices or satisfactory quality levels, our ability to bring products to market and our reputation could suffer. For example, if supplier capacity diminishes, including from a catastrophic loss of facilities or otherwise, we could have difficulty fulfilling our orders, our revenue could decline and our growth prospects could be impaired. We anticipate requiring 9 to 12 months to transition our foundry or assembly services to new providers. Such a transition would likely require a qualification process by our customers or end users, which could also adversely affect our ability to sell our solutions and operating results.

 

Average selling prices of our products could decrease substantially, which could have a material adverse effect on our revenue and gross margins.

 

The UHF Gen2 market has been characterized by significant price erosion. We may experience substantial fluctuations in future operating results due to the decline of our average selling prices, or ASPs. The ASP of our UHF Gen2 products has decreased as the market for UHF Gen2 solutions has developed. From time to time, we have reduced the selling price of our products due to competitive pricing pressures, to encourage adoption, to address macroeconomic conditions and for other reasons. We expect that we may have to do so again in the future. If we are unable to offset any reductions in our ASPs by increasing our sales volumes or introducing new products with higher margins, our revenue and gross margins will suffer. Our customers may be slow to migrate to new, higher margin products. Some competitors have significantly greater resources than we have and may be better able to absorb the negative impact on operating results as a result of such trends.

 

The rapid innovation occurring in the UHF Gen2 market can drive intense pricing pressure, particularly on products containing older technology. Relatively short life cycles for certain products cause them to be replaced by more technologically advanced substitutes on a regular basis. In turn, when demand for older technology

 

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declines, ASPs may drop, in some cases precipitously. To profitably sell these products, we must improve technology or processes to reduce our production costs in line with the lower selling prices. If we and our third party suppliers and manufacturers cannot advance process technologies or improve efficiencies to a degree sufficient to maintain required margins, we may not be able to sell these products profitably. Should our cost reductions fail to keep pace with reductions in market prices, our business, financial condition and operating results could be materially adversely affected.

 

Changes in our product mix could cause our overall gross margin to decline, adversely affecting our operating results and financial condition.

 

Our gross margin is highly dependent on product mix. A shift in sales mix away from our higher margin products could adversely affect our gross margins, and there can be no assurance that we will be able to maintain our historical gross margins. A majority of our revenue is generated by sales of our Monza ICs, which has lower gross margins than our Indy reader ICs and Speedway readers, and we expect Monza IC revenue to increase as a percentage of total revenue over time. If Monza IC revenue continues to grow relative to our other products and services, our company-wide gross margin will decline. Additionally, increased competition and the existence of product alternatives, weaker than expected demand and other factors may lead to further price erosion, lower revenue and lower margins for us in the future, adversely affecting our operating results and financial condition.

 

If we are unsuccessful developing and introducing new products and enhancements, our operating results and competitive position will be harmed.

 

To keep pace with technological developments, satisfy increasingly sophisticated end-user requirements and achieve market acceptance, we plan to introduce new UHF Gen2 solutions. We commit significant resources to developing new products, improving performance and reliability and reducing costs. In the future, we may not succeed in developing the underlying technologies or processes necessary to create new or enhanced products or in licensing or otherwise acquiring these technologies from third parties. We may also fail to anticipate or meet market requirements for new features and functionality. We may be unable to develop commercially viable products using new or enhanced technologies, such as smaller silicon process geometries for ICs or new materials or designs for antennas. The success of a new or enhanced product depends on accurate forecasts of long-term market demand and future technological developments, as well as on a variety of specific implementation factors, including:

 

   

timely and efficient completion of process design;

 

   

timely and efficient implementation of manufacturing, assembly and testing procedures;

 

   

product performance;

 

   

product certification;

 

   

the quality and reliability of the product; and

 

   

effective marketing, sales and service.

 

To the extent that we fail to introduce new or enhanced solutions that meet the needs of our customers in a timely fashion, we will lose market share and our revenue and financial condition could be materially adversely affected.

 

Fluctuations in our quarterly and annual operating results may adversely affect our business, prospects and stock price.

 

You must consider our business and prospects in light of the risks and difficulties we encounter in the new, uncertain and rapidly evolving market for UHF Gen2 solutions. Because this market is new and evolving, predicting its future growth rate and size is difficult. In the past, both we and other industry participants have overestimated UHF Gen2 market size and growth rates. The rapidly evolving nature of the markets in which we sell our products, as well as other factors that are beyond our control, reduce our ability to accurately evaluate

 

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our future prospects and forecast quarterly or annual performance. To date, we have had limited success in accurately predicting future sales of our UHF Gen2 products. We expect that our visibility into future sales of our products, including both sales volumes and prices, will continue to be limited for the foreseeable future and could result in fluctuations in our quarterly and annual operating results that we are unable to predict as well as failure to achieve our expected operating results.

 

Numerous other factors, many of which are outside our control, may cause or contribute to significant fluctuations in our quarterly and annual revenue and operating results. These fluctuations may make financial planning and forecasting difficult. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively affect our business and prospects. Factors that may contribute to fluctuations in our operating results and revenue include:

 

   

variations in the adoption rate of UHF Gen2 technology and any delays in UHF Gen2 deployments by industry leaders;

 

   

fluctuations in demand for our solutions, particularly by large inlay manufacturers and other significant customers on which we rely for a substantial portion of our revenue;

 

   

fluctuations in supply for our solutions;

 

   

variations in the quality of our products and return rates;

 

   

declines in average selling prices for our products;

 

   

delays in timing of product shipments and work performed under development contracts;

 

   

variations in the introduction or enhancement of products, services and technologies by us and our competitors and market acceptance of these new or enhanced products, services and technologies;

 

   

unanticipated excess or obsolete inventory as a result of introduction of new products, quality issues or otherwise;

 

   

changes in the amount and timing of our operating costs, including those related to the expansion of our business, operations and infrastructure;

 

   

changes in business cycles or seasonal fluctuations that may affect the markets in which we sell our products;

 

   

adverse outcomes of litigation, intellectual property disputes or governmental proceedings;

 

   

changes in industry standards or specifications, or changes in government regulations, relating to UHF Gen2;

 

   

late, delayed or cancelled payments from our customers; and

 

   

unanticipated impairment of long-lived assets and goodwill.

 

One or more of the foregoing or other factors may cause our operating expenses in one period to be disproportionately higher or lower or may cause our revenue and operating results to fluctuate significantly. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance.

 

We generate most of our revenue from our Monza ICs, and a decline in sales of these products could adversely affect our operating results and financial condition.

 

We derive, and expect to continue to derive, a majority of our product revenue from our Monza tag ICs, and we expect this trend to continue. In addition, the continued adoption of our Monza ICs drives in part our ability to generate revenue from our other products. As a result, we are particularly vulnerable to fluctuations in demand for our Monza ICs, and if demand for them declines significantly, our business and operating results will be adversely affected.

 

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Our reliance on third-party inlay manufacturers, reader OEMs, distributors, VARs and system integrators to sell our products could adversely affect our business and operating results.

 

We rely significantly on third-party inlay manufacturers, reader OEMs and distributors to distribute our products to end users. Substantially all of our Monza ICs and a substantial majority of our Indy ICs are sold through inlay manufacturers and distributors, respectively. In 2010, sales to Avery Dennison Corporation, or Avery Dennison, and UPM-Kymmene Corporation, or UPM, accounted for 42% and 29% of our Monza IC revenue, respectively, and sales to our top two Indy reader IC customers accounted for 34% and 17%, respectively, of our reader IC revenue. Although our strategy is to diversify our customer base by pursuing increased orders from mid-size buyers and expanding sales to other customers, we cannot give any assurance that we will be successful in doing so. Even if we are successful in obtaining and retaining new customers, our existing customers or other inlay manufacturers, reader OEMs and distributors may continue to account for a substantial portion of our sales in the future. Changes in markets, customers or products, or negative developments in general economic and financial conditions and the lack of availability of credit, may adversely affect the ability of these inlay manufacturers, reader OEMs and distributors to bring our products to market. Additionally, if they are unable to sell an adequate amount of our products in a given quarter to end users or if they decide to decrease their inventories of our products for any reason, our revenue may decline.

 

For strategic or other reasons, our inlay manufacturers, reader OEMs and distributors may choose to prioritize the sale of our competitors’ products over our products. Our future performance will depend, in part, on our ability to attract additional inlay manufacturers, reader OEMs and distributors who will be able to market and support our products effectively, especially in markets in which we have not previously sold our products. If we cannot retain our current inlay manufacturers, reader OEMs and distributors or establish new relationships, our business, financial condition and operating results could be harmed. In addition, our competitors’ strategic relationships with or acquisitions of these inlay manufacturers, reader OEMs or distributors could disrupt our relationships with them. Any such disruption in the distribution of our products could impair or delay sales of our products to end users and increase our costs of distribution, which could adversely affect our sales or operating results.

 

Our revenue also depends on the ability of system integrators to successfully market, sell, install and provide technical support for systems in which our products are integrated or to sell our products on a stand-alone basis. Our revenue may decline if the efforts of these system integrators fail. Further, the faulty or negligent implementation and installation of our products by system integrators may harm our reputation. Moreover, because we are often at least one step removed from the end users of our products, we may be unable to rectify damage to our reputation caused by system integrators, distributors or VARs who have direct contact with end users. If our system integrators, distributors or VARs are unable to sell an adequate amount of our products in a given quarter to manufacturers and end users or if they decide to decrease their inventories of our products for any reason, our sales to these channel partners and our revenue may decline.

 

If some channel partners decide to purchase more of our products than are required to satisfy end user demand in any particular period, inventories at these channel partners would grow in that period. These channel partners likely would reduce future orders until inventory levels realign with end customer demand, which could adversely affect our product revenue in a subsequent period. Distributors may also return our products, subject to time and quantity limitations. Our reserve estimates for products stocked by our distributors are based principally on reports provided to us by our distributors, typically on a monthly basis. To date, we believe that this data typically has been accurate but is often late and subject to errors in our distributors’ accounting systems. To the extent that this resale and channel inventory data is inaccurate or not received in a timely manner, we may not be able to make reserve estimates for future periods accurately or at all.

 

Many of our channel partners provide us with customer referrals and cooperate with us in marketing our products; however, our relationships with them may be terminated at any time. If we fail to successfully manage our relationships with our channel partners, our ability to sell our products into new industries and to increase our penetration into existing industries may be impaired and our business would be harmed.

 

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We will lose market share and may not be successful if end users or customers do not select our products to be designed into their products and systems.

 

End users often undertake extensive pilot programs or qualification processes prior to placing orders for large quantities of UHF Gen2 products, in particular for UHF Gen2 reader products, because these products must function as part of a larger system or network or meet certain other specifications. We spend significant time and resources to have our solutions selected by a potential end user or customer, which is known as a “design-in.” In the case of UHF Gen2 reader products, such “design-ins” mean that the reader products have been selected to be designed into the end user’s system and, in the case of a UHF Gen2 tag, may mean the tag has met certain unique performance criteria established by the end user or customer. If we fail to develop new products that adequately or competitively address the needs of potential end users, they may not select our products to be designed into their systems, which would adversely affect our business, prospects and operating results.

 

Our products must meet exacting technical and quality specifications. Defects, errors in or interoperability issues with our products or the failure of our products to operate as expected could affect our reputation, result in significant costs to us and impair our ability to sell our products.

 

Our products may contain defects, errors or not operate as expected, which could materially and adversely affect our reputation, result in significant costs to us and impair our ability to sell our products in the future. Our customers have demanding specifications for quality, performance and reliability that our tag and reader products must meet. Our products are highly technical and designed to be deployed in large and complex systems, networks and other settings under a wide variety of conditions. Customers and end users may discover errors, defects or incompatibilities in our products only after they have been fully deployed. For example, harsh environments and radio-frequency interference may negatively affect the performance of our UHF Gen2 readers. In addition, users of our UHF Gen2 products may experience compatibility or interoperability issues between our products and their enterprise software systems or networks, or between our products and other UHF Gen2 products they use.

 

We may also experience quality problems with our products that are combined with or incorporated into products from other vendors, such as tags produced by our inlay manufacturers, or that are assembled by subcontractors. We may have difficulty identifying and correcting the source of problems when third parties are combining, incorporating or assembling our products.

 

If we are unable to fix errors or other problems, we could experience:

 

   

loss of customers or customer orders;

 

   

lost or delayed market acceptance and sales of our products;

 

   

loss of market share;

 

   

damage to our brand and reputation;

 

   

impaired ability to attract new customers or achieve market acceptance;

 

   

diversion of development resources;

 

   

increased service and warranty costs;

 

   

replacement costs;

 

   

legal actions by our customers; and

 

   

increased insurance costs.

 

While our agreements typically contain provisions and disclaimers that purport to limit our liability for damages resulting from defects in our products, such limitations and disclaimers may not be enforced by a court or other tribunal or otherwise effectively protect us from claims. We may be required to indemnify our customers

 

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against liabilities arising from defects in our products or their solutions which incorporate our products. These liabilities may also include costs incurred by our customers or end users to correct the problems or replace our products.

 

The costs incurred correcting product defects or errors may be substantial and could adversely affect our operating results. While we test our products for defects or errors prior to product release, defects or errors are occasionally identified by our customers. Such defects or errors have occurred in the past and may occur in the future. For example, in the fourth quarter of 2010, we adopted new tag IC post-processing techniques to enhance the number of Monza ICs we could supply. Despite our qualification testing, the new techniques increased our defect rate, and our product returns increased. To the extent product failures are material, they could adversely affect our business, operating results, customer relationships, reputation and prospects.

 

In addition, our new products, features and enhancements must comply with the UHF Gen2 standard. Compatibility issues could disrupt our customers’ operations, hurt our customer relations and materially adverse our business and prospects.

 

If we are unable to protect our intellectual property, our business could be adversely affected.

 

Our success depends in part upon our ability to protect our intellectual property. We rely on a variety of intellectual property rights, including patents in the United States and copyrights, trademarks and trade secrets in the United States and foreign countries for this protection. Because most RFID products are used in or imported into the United States, we do not have patents or pending patent applications in any foreign country. By seeking patent protection only in the United States, our ability to assert our intellectual property rights outside the United States will be limited. We have registered trademarks and domain names in selected foreign countries where we believe filing for such protection is appropriate. Regardless, some of our products and technologies may not be covered or covered adequately by any patent, patent application, trademark, copyright, trade secret or domain name.

 

We cannot guarantee that:

 

   

any of our present or future patents or patent claims will not lapse or be invalidated, circumvented, challenged or abandoned;

 

   

our intellectual property rights will provide competitive advantages to us;

 

   

our ability to assert our intellectual property rights against potential competitors or to settle current or future disputes will not be limited by our agreements with third parties;

 

   

any of our pending or future patent applications will be issued or have the coverage originally sought;

 

   

our intellectual property rights will be enforced in jurisdictions where competition may be intense or where legal protection may be weak;

 

   

any of the trademarks, copyrights, trade secrets or other intellectual property rights that we presently employ in our business will not lapse or be invalidated, circumvented, challenged or abandoned; or

 

   

we will not lose the ability to assert our intellectual property rights against, or to license our technology to, others and collect royalties or other payments.

 

In addition, our competitors or others may design around our patents or protected technologies. Effective intellectual property protection may be unavailable or more limited in one or more relevant jurisdictions relative to those protections available in the United States. If we pursue litigation to assert our intellectual property rights, an adverse decision in any legal action could limit our ability to assert our intellectual property rights, limit the value of our technology or otherwise negatively impact our business, financial condition and operating results.

 

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Monitoring unauthorized use of our intellectual property is difficult and costly. Unauthorized use of our intellectual property may have occurred or may occur in the future. Although we have taken steps to minimize the risk of unauthorized use, any failures to identify unauthorized use or otherwise adequately protect our intellectual property could adversely affect our business. Moreover, any litigation, could be time consuming, and we could be forced to incur significant costs and divert our attention and the efforts of our employees, which could, in turn, result in lower revenue and higher expenses.

 

We also rely on customary contractual protections with our customers, suppliers, distributors, employees and consultants, and we implement security measures to protect our trade secrets. We cannot assure you that these contractual protections and security measures will not be breached, that we will have adequate remedies for any such breach, that third parties will not discover our proprietary information independently or through legal means or that our suppliers, employees or consultants will not assert rights to our intellectual property.

 

Finally, our use of overseas manufacturers may involve particular risks. The intellectual property protection in countries where our third-party contractors operate is weaker than in the United States. If the steps we have taken and the protection provided by law do not adequately safeguard our intellectual property rights, we could suffer losses in profits due to the sales of competing products which exploit our intellectual property rights.

 

Our licensing of UHF Gen2-related intellectual property from others may be subject to requirements or limitations that could adversely affect our business and prospects.

 

We have intellectual property license agreements that give us access to certain patents and intellectual property of others. We have not licensed our patents or intellectual property to others except as necessary for our customers to practice their business using our products and as required pursuant to agreements we have entered into in connection with our participation in the development of GS1 EPCglobal specifications and International Standards Organization, or ISO, standards, as described below. We may choose to license our patents or intellectual property to others in the future. We cannot guarantee that any patents and technology that we provide in such future licenses will not be used to compete against us.

 

We may face claims of intellectual property infringement, which could be time consuming, costly to defend or settle and result in the loss of significant rights.

 

Our industry is characterized by companies that hold large numbers of patents and other intellectual property rights and that may vigorously pursue, protect and enforce their intellectual property rights. For example, two companies that manufacture and sell UHF Gen2 products, Intermec and Alien, have been engaged in patent litigation (to which we are not a party), when Alien sought declaratory judgment of non-infringement of certain Intermec RFID patents. We have in the past and may in the future receive invitations to license patent and other intellectual property rights to technologies that are important to our business. We may also receive assertions against us, our customers or distributors, claiming that we infringe patent or other intellectual property rights. Claims that our products, processes, technology or other aspects of our business infringe third-party intellectual property rights, regardless of their merit or resolution, could be costly to defend or settle and could divert the efforts and attention of our management and technical personnel. If we decline to accept an offer, the offering party may allege that we infringe such patents, which could result in litigation.

 

In addition, many of our customer and distributor agreements require us to indemnify and defend our customers or distributors from third-party infringement claims and pay damages in the case of adverse rulings. Moreover, we may not know whether we are infringing a third party’s rights, due to the large number of patents related to UHF Gen2 or to other systemic factors. For instance, patent applications in the United States are maintained in confidence for up to 18 months after their filing or, in some cases, for the entire time prior to issuance as a patent. Thus, we would not be able to account for such rights before publication. Competitors may also have filed patent applications or received patents and may obtain additional patents and proprietary rights that block or compete with our patents. Claims of this sort could harm our relationships with our customers or distributors and might deter future customers from doing business with us. We do not know whether we will

 

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prevail in any such future proceedings given the complex technical issues and inherent uncertainties in intellectual property litigation. If any pending or future proceedings result in an adverse outcome, we could be required to:

 

   

cease the manufacture, use or sale of the infringing products, processes or technology;

 

   

pay substantial damages for infringement;

 

   

expend significant resources to develop non-infringing products, processes or technology;

 

   

license technology from the third party claiming infringement, which license may not be available on commercially reasonable terms, or at all;

 

   

cross-license our technology to a competitor to resolve an infringement claim, which could weaken our ability to compete with that competitor; or

 

   

pay substantial damages to our customers or end users to discontinue their use of or to replace infringing technology sold to them with non-infringing technology.

 

Any of the foregoing results could have a material adverse effect on our business, financial condition and operating results.

 

We have limited visibility regarding the length of the sales cycles for our products.

 

Based on the limited sales history for our UHF Gen2 products, we have limited visibility into the length of the sales cycle for our products, and from time to time sales cycles have been longer than initially anticipated. Numerous factors can contribute to the length of the sales cycle, including technical evaluations of our products by our customers and end users and our efforts to educate customers and end users on the uses and benefits of UHF Gen2 technology. The length and uncertain timing of the sales cycle can lead to delayed product orders. In anticipation of product orders, we may incur substantial costs before the sales cycle is complete and before we receive any customer orders or payments. If a sale is not completed or is cancelled or delayed, we may incur substantial expenses, which would hinder our ability to achieve or maintain profitability or otherwise negatively affect our financial results.

 

We are subject to order and shipment uncertainties. Inaccuracies in our estimates of customer demand and product mix could negatively affect our inventory levels, sales and operating results.

 

We derive revenue primarily from customer purchase orders rather than long-term purchase commitments. To ensure availability of our products, in some cases we start manufacturing based on forecasts provided by customers in advance of receiving purchase orders from them. Our customers can cancel purchase orders or defer the shipments of our products under certain circumstances with little or no advance notice to us. Some of our products are manufactured according to our estimates of customer demand, which requires us to make demand forecast assumptions for every customer, and which may introduce significant variability into our aggregate estimate. We typically sell to channel partners rather than to end users, and we consequently have limited visibility into future end-user demand, which could adversely affect our revenue forecasts and operating margins. Moreover, because the market for UHF Gen2 solutions is relatively new, many of our customers have difficulty accurately forecasting their product requirements and estimating the timing of their new product introductions, which ultimately affects their demand for our products. Additionally, we sometimes receive soft commitments for larger order sizes which do not materialize.

 

Historically, because of this limited visibility, our estimates of customer demand have been inaccurate. Some of these inaccuracies have been material, leading to excess inventory with associated costs or product shortages with its concomitant reduction in revenue and gross margin. These forecasting inaccuracies may occur in the future, and their adverse impact could grow if we are unsuccessful in selling more products to some customers. Excess inventory levels and increased obsolescence could result in unexpected expenses or increases in our reserves that could adversely affect our business, operating results and financial condition. If we were to

 

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underestimate customer demand or if sufficient manufacturing capacity were unavailable, we could miss revenue opportunities, potentially lose market share and damage our customer relationships. For example, we were unable to meet customer demand for our products in 2010 as a result of supply constraints and thus lost revenue opportunities. In response, we have purchased excess inventory, which may expose us to the risk of inventory write-downs due to excess and obsolescence of inventory that we are unable to sell on a timely basis. In the fourth quarter of 2010, we wrote off $592,000 in obsolete inventory, primarily our Speedway Classic reader. Any significant future cancellations or deferrals of product orders or the return of previously sold products due to manufacturing defects could materially and adversely impact our profit margins, increase our write offs due to product obsolescence and restrict our ability to fund our operations.

 

Our sales and marketing efforts may be unsuccessful in maintaining and expanding existing sales channels, developing new sales channels and increasing the sales of our products.

 

To grow our business, we must add new customers for our UHF Gen2 solutions in addition to retaining and increasing sales to our current customers. Our ability to attract new customers will depend in part on the success of our sales and marketing efforts. There can be no guarantee that we will be successful in developing or implementing our sales and marketing strategy. If suitable sales channels do not develop, we may not be able to sell certain of our products in significant volumes and our operating results, business and prospects may be harmed.

 

We may be unable to successfully expand our international operations.

 

We currently generate approximately 40% of our revenue outside of the Americas. We anticipate growing our business in part by continuing to expand our international operations. Our international operations involve a variety of risks, including:

 

   

unexpected changes in regulatory requirements, taxes, trade laws, tariffs, export quotas, custom duties or other trade restrictions;

 

   

more stringent regulations relating to data privacy and the unauthorized use of, or access to, commercial and personal information, particularly in Europe;

 

   

lack of established standards or regulations with which our UHF Gen2 products must comply;

 

   

greater difficulty in supporting and localizing our products;

 

   

different or unique competitive pressures as a result of, among other things, the presence of local businesses and other market players;

 

   

challenges inherent in efficiently managing an increased number of employees over large geographic distances, including the need to implement appropriate systems, policies, benefits and compliance programs;

 

   

limited or unfavorable intellectual property protection;

 

   

changes in foreign currency exchange rates;

 

   

changes in a specific country’s or region’s political, regulatory, legal or economic conditions;

 

   

international political conflicts;

 

   

differing regulations with regard to maintaining operations, products and public information;

 

   

differing labor regulations, especially where labor laws are generally more advantageous to employees than in the United States; and

 

   

restrictions on repatriation of earnings.

 

We have limited experience in marketing, selling and supporting our products and services abroad. We may not be able to increase or maintain international market demand for our products. In addition, regulations or

 

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standards adopted by other countries may require us to redesign our existing products or develop new products for those countries. For example, foreign governments may impose regulations or standards with which our current UHF Gen2 products do not comply, or may require operation in frequency bands in which our products do not operate. Furthermore, if we are unable to expand international operations in a timely and cost-effective manner in response to increased overseas demand, we could miss sales opportunities and our revenue would decline, adversely affecting our operating results, business and prospects. If we invest substantial time and resources to expand our international operations and are unable to do so successfully and in a timely manner, our business, prospects and operating results will suffer.

 

If we do not successfully attract and complete custom engineering projects with strategic end users and others, adoption of our products could be delayed, and our market position could be compromised.

 

To encourage the widespread market adoption of our products and of UHF Gen2 technology in general and to extend the reach and capabilities of our products, we sometimes perform non-recurring engineering, or NRE, product, tool or software developments for strategic end users and others. We compete with other companies to win these engagements and, in the future, may not be able to compete successfully. Some developments grant time-bounded exclusivity to the customer who paid for the NRE, which may limit our ability to capitalize on the knowledge and experience we gain in connection with such engagements. If we accept such NRE-based development yet do not successfully complete the project, our relationship with the customer could deteriorate, and we may lose business and the opportunity to expand the market for our products. Because some NRE-based developments take a year or more to complete, our time to product revenue can be long. Additionally, the customer may choose to cancel or delay the development mid-way through the process, again causing a loss of potential revenue. If a competitor develops and markets a similar product yet we are unable to compete in the general market due to the time-bounded exclusivity with our customers, then we could lose business, market share and revenue opportunities.

 

Acquisitions could result in operating difficulties, dilution and other harmful consequences.

 

We have made, and may continue to make, acquisitions of companies, products, services and technologies to expand our product offerings and capabilities, customer base and business. For example, in July 2008, we acquired certain assets of Intel Corporation’s UHF RFID reader IC business. We have only acquired this one business. We have evaluated, and expect to continue to evaluate, a wide array of potential strategic transactions, and occasionally we may engage in discussions regarding potential acquisitions. Any of these transactions could be material to our financial condition and operating results. In addition, the process of integrating an acquired company, business or technology may create unforeseen operating difficulties and expenditures. Acquisition-related risks include:

 

   

diversion of management time and focus from operating our business to acquisition integration challenges;

 

   

difficulties integrating the products into our strategy and product plan;

 

   

the possibility that customers may seek a new supplier to replace us because of an acquisition;

 

   

inability to retain employees from the businesses we acquire;

 

   

challenges associated with integrating employees from the acquired company into our organization;

 

   

difficulties integrating each company’s accounting, management information, human resource and other administrative systems to permit effective management;

 

   

potential requirements for remediating controls, procedures and policies appropriate for a public company in acquired businesses that prior to the acquisition lacked these controls, procedures and policies;

 

   

potential liability for past or present environmental, hazardous substance, or contamination concerns associated with the acquired business or its predecessors;

 

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possible write-offs or impairment charges resulting from acquisitions; and

 

   

unanticipated or unknown liabilities relating to acquired businesses.

 

Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different cultures and languages, currency risks and the particular economic, political and regulatory risks associated with specific countries. Also, the anticipated benefit of any acquisition may not materialize. Future acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses or write-offs of goodwill, any of which could harm our financial condition. Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on favorable terms or at all.

 

Our efforts to influence new standards could fail, which could adversely affect our ability to compete.

 

To encourage widespread market adoption of UHF RFID technology, we have participated in the development of industry standards, and we have designed our products to comply with these standards. GS1 EPCglobal is currently developing an enhanced version of UHF Gen2 based on end-user requirements, which we anticipate will be known as “UHF Gen2 Version 2” or simply “Gen2 V2.” The end-user requirements mandate that Gen2 V2 be backward compatible with the original Gen2. ISO has taken a set of steps that indicate that, like in the past, they will adopt and standardize Gen2 V2 as the next generation of 18000-6C (and which ISO has indicated that they will rename to 18000-63). In the future, we could lose our leadership position in GS1 EPCglobal or we could lose our project editorship position for UHF Gen2. Gen2 V2 could fail to be backward compatible with the original Gen2, GS1 EPCglobal could fail to ratify Gen2 V2, or ISO could choose to not adopt Gen2 V2. If Gen2 V2 diverges significantly from our or the market’s needs, or if it fails to materialize or to be standardized by ISO, then our products may likewise fail to keep pace with the market’s needs, our competitors’ products and end-user requirements, in which case end users could delay their UHF Gen2 adoption. Alternative or competing technologies could gain market share at the expense of UHF Gen2 and at the expense of our Gen2 products, and these competing technologies could use intellectual property that is either not royalty free or to which we do not have access.

 

Compliance with, and changes in, government spectrum regulations could adversely affect our ability to sell our products and impair our operating results.

 

Government spectrum regulations require that our UHF Gen2 readers and reader-based subsystems be certified in the jurisdiction where they are to be operated. Speedway Revolution readers are certified for use in over 40 countries worldwide, including the United States, Canada, Mexico, China, Japan, South Korea and each country in the European Union. If any of these products is found to be noncompliant despite having such certification, then we could be required to modify field-deployed readers to regain such certification and could spend significant resources as well as miss sales opportunities in the process. Our revenue would decline, adversely affecting our operating results, financial conditions, business and prospects. Additionally, government regulations may change, requiring us to redesign our products to the revised regulations or constraining our ability to implement new and desired features into our products, thereby causing us to incur significant expense or forego opportunities to improve on our products and potentially delaying our time-to-market, adversely affecting our operating results, financial conditions, business and prospects.

 

Alternative technologies or standards, or changes in existing technologies or standards, may adversely affect the growth of the market for UHF Gen2 solutions.

 

Significant developments in alternative technologies may affect our business in ways that we cannot anticipate. For instance, technology or market breakthroughs in legacy RFID systems, such as LF or HF systems, may adversely affect the growth of the UHF Gen2 market generally and demand for our products in particular. For example, near-field communications technology, which today addresses a different market than UHF Gen2, could, with breakthrough innovations, compete with UHF Gen2 in item tagging. Likewise, new technologies

 

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such as organic transistors may allow lower-cost UHF Gen2 ICs than our current silicon-based technology allows. An inability to innovate in new or enhanced technologies or processes, or to react to changes in existing technologies or in the market, or to compete with advances in legacy technologies, could materially delay our development of new and enhanced products and potentially result in product obsolescence, decreased revenue or a loss of market share.

 

Similarly, the introduction of new industry standards, or changes to existing industry standards, could make our products incompatible with the new or changed standards and could cause us to incur substantial development costs to adapt to these new or changed standards, particularly if they were to achieve, or be perceived as likely to achieve, greater penetration in the marketplace than UHF Gen2 or Gen2 V2. Moreover, the adoption or expected adoption of such new or changed standards could slow the sale of existing products even before products based on the new or changed standards become available. New industry standards or changes to existing standards could also limit our ability to implement new features in our products if those features do not meet the new or changed standards. The lost opportunities as well as the time and expense required for us to develop new products or change our existing products to comply with new or changed standards could be substantial, and there is no assurance that we could successfully develop products that comply with new or changed standards in doing so. If we are not successful in complying with any new or changed industry standards then we could lose market share, causing our business to suffer.

 

We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete in international markets.

 

We are subject to export control laws, regulations and requirements that limit which products we sell and where and to whom we sell our products. In some cases, it is possible that export licenses would be required from U.S. government agencies for some of our products in accordance with the Export Administration Regulations, the International Traffic in Arms Regulations or economic sanctions programs administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control. We may not be successful in obtaining the necessary export licenses in all instances. Any limitation on our ability to export or sell our products imposed by these laws would adversely affect our business, financial condition and results of operations. In addition, changes in our products or changes in export and import and economic sanctions laws and implementing regulations may create delays in the introduction of new products in international markets, prevent our customers from deploying our products internationally or, in some cases, prevent the export or import of our products to certain countries altogether. While we are not aware of any other current or proposed export or import regulations which would materially restrict our ability to sell our products, any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by these regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. In such event, our business and results of operations could be adversely affected.

 

Privacy and security concerns relating to UHF Gen2 technology could damage our reputation and deter current and potential customers from using our products. If we fail to develop products that meet privacy regulations or guidelines, customers may curtail using our products in certain applications, which would harm our business, operating results and financial condition.

 

From time to time, concerns have been and are expected to continue to be expressed about whether UHF Gen2 products can compromise consumer privacy or even facilitate theft. Typical fears include unauthorized parties collecting personal information, tracking consumers, stealing identities or causing other privacy-related issues. UHF Gen2 tags may be surreptitiously identified by unauthorized readers to track a consumer or otherwise gain access to information that a consumer considers private, even if the customer employs security measures such as shielding and encryption. Similarly, retailers may inadvertently or perhaps even intentionally scan consumers’ tags to gain information, such as shopping behavior, that may be illegal to collect or if not illegal, may be considered intrusive by consumers. Unauthorized readers could gain access to sensitive end-user information stored in the tags, again despite measures such as shielding and encryption designed to thwart such

 

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unauthorized access. For example, criminals seeking to divert or steal high-value pharmaceutical products could seek to identify these products by looking for tags with Electronic Product Codes, or EPCs, corresponding to these products. In addition, it may be possible to embed computer viruses or other malicious code into UHF Gen2 tags so that by reading the contents of a tag memory, the malicious code can be inserted into end-user systems. If a privacy or security breach occurs, our customers would be the likely target of regulatory actions or private lawsuits. However, in such cases, a customer might allege that our technology did not function as promised and may sue us for breach of contract, breach of warranty, negligence or another cause of action. Additionally, if our customers’ security measures are breached, even if through means beyond our control, our reputation could be damaged and our business and prospects could suffer. Moreover, concerns about security and privacy risks, even if unfounded, could damage our reputation and operating results and could delay the development of the overall UHF Gen2 industry.

 

Some regulatory jurisdictions expect Gen2 V2 to address consumer privacy concerns. If Gen2 V2 does not adequately address the concerns, or if regulators act independently, new laws could significantly impair the use of UHF Gen2 technology in certain applications, which in turn could affect our ability to sell our UHF Gen2 products into these applications and adversely affect our operating results, financial condition, business and prospects. Similarly, if we fail to implement new products that comply with the Gen2 V2 specification or any new regulations, or both, customers could choose to avoid our products which could adversely affect our operating results, financial conditions, business and prospects. Security breaches could expose us to litigation and possible liability. Even if our efforts meet any new standards or regulations, if our security measures are breached as a result of third-party action, employee error, criminal acts by an employee, malfeasance or otherwise, and, as a result, someone obtains unauthorized access to customer or end-user data, our reputation could be damaged, our business and prospects may suffer and we could incur significant liability.

 

Government regulations and guidelines relating to consumer privacy may have an adverse impact on the adoption of our products, require us to make design changes or constrain our ability to implement new and desired features for our products.

 

Public scrutiny of the manner and extent to which companies collect and use personal information, both in the United States and in many foreign countries, is at an all-time high. Our customers are subject to a number of foreign and domestic laws and regulations relating to the collection, storage, transmission and use of personal information about individuals, as well as additional laws and regulations that specifically address privacy and security issues related to the use of RFID technology. For example, some U.S. states have enacted statutes specifically governing the use of RFID. Four states have enacted laws stating that when an enhanced driver’s license or other state-issued identification card contains RFID technology, the RFID technology must include security controls to protect against the unauthorized disclosure of personal information. Three states have enacted laws that prohibit reading a person’s identification documents using RFID without that person’s knowledge or consent, except in certain circumstances. In addition, the European Commission, or EC, has issued voluntary guidance specifically designed to address privacy concerns about the use of RFID technology. The data security and privacy legislative and regulatory landscape in both the United States and the European Union, or EU, is rapidly evolving, and changes in such laws and regulations may adversely impact our business, including our ability to develop future products.

 

In May 2009, the EC released a recommendation that retail companies in the EU inform their customers when RFID tags are placed on or embedded in their products. In April 2011, the EC signed a voluntary agreement with private and public stakeholders to develop privacy guidelines for companies using RFID technology in the EU. The agreement requires companies to conduct comprehensive privacy impact assessments of new RFID applications and to take measures to address the risks identified by the assessment before the RFID application is deployed. While compliance with the guidelines is voluntary, our customers that do business in the EU may have a preference for RFID solutions that are compliant with the guidelines. If our products do not provide the necessary functionality to allow customers to comply with the guidelines, our business may suffer.

 

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If we fail to develop products that implement end-user requirements for security, end users may choose not to use our products in certain applications, which would harm our business, operating results and financial condition.

 

UHF Gen2 does not currently include the technologies necessary for securely authenticating a tag or a reader, and as a consequence does not have the ability to store information in tag memory securely. The user requirements for Gen2 V2 address these shortcomings. If GS1 EPCglobal fails to address these requirements in Gen2 V2, or we fail to implement the new Gen2 V2 features in our products, our business and prospects may suffer. Even if the Gen2 V2 specification is ratified, adopted by ISO and we implement it in our products, a third party may breach the security in our products, in which case our reputation could be damaged and our business and prospects may suffer.

 

Our participation in standard-setting organizations requires us to license our patents to third parties, including competitors, and limits our ability to enforce our patents.

 

In the course of participating in the development of GS1 EPCglobal specifications, including UHF Gen2, UHF Gen2 V2, tag data standards, or TDS, low-level reader protocol, or LLRP, and others, we have agreed to license on a royalty-free basis those of our patents that are necessarily infringed by the practice of these specifications to other GS1 EPCglobal members, subject to reciprocal royalty-free rights from those other members. Because it may not be clear whether a member’s intellectual property is necessary or optional to the practice of a specification, disputes could arise among members, resulting in our inability to receive a license on royalty-free terms. In addition, in the course of participating in the development of certain ISO standards we have agreed to grant to all users worldwide a license to those of our patents that are necessarily infringed by the practice of those standards, including at frequencies other than UHF, on terms that are reasonable and non-discriminatory, sometimes referred to as RAND, again subject to reciprocity. As a result, we are not always able to limit to whom and, to a certain extent, on what terms we license our technologies, and our control over and our ability to generate licensing revenue from some of our technologies may be limited.

 

We rely on third-party license agreements, and impairment of these agreements may cause production or shipment delays that would harm our business.

 

We have licensing agreements with various entities for patents, software and other technology incorporated into our manufacturing operations or products. For example, we license tools from electronic design automation software vendors to design our silicon products. Third-party licenses for patents, software and other technology important to our business may not continue to be available to us on commercially reasonable terms, if at all. The impairment of these licenses could result in significant manufacturing interruptions, delays or reductions in product shipments until alternative technology could be developed, licensed and integrated, if at all possible, which would materially harm our business and operating results.

 

Our use of open source software may expose us to additional risks and harm our intellectual property.

 

Our products, processes and technology sometimes utilize and incorporate software that is subject to an open-source license. Open-source software is typically freely accessible, usable and modifiable. Certain open-source software licenses require a user who intends to distribute the open-source software as a component of the user’s software to disclose publicly part or all of the user’s source code. In addition, certain open-source software licenses require the user of such software to make any derivative works of the open-source code available to others at low or no cost. This licensing regime can subject previously proprietary software to open-source license terms.

 

While we monitor the use of all open-source software in our products, processes and technology and try to ensure that no open-source software is integrated in a way that inadvertently requires us to disclose the source code to the related product, processes or technology, such use could occur and could harm our intellectual property position and have a material adverse effect on our business, operating results and financial condition.

 

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Our products may cannibalize revenue from each other, which could harm our business.

 

The sale of some of our products enables our customers to compete with other of our products. For example, sales of our Indy reader ICs allow our customers to manufacture and sell readers which may compete with our Speedway Revolution reader. Similarly, sales of our Speedway Revolution reader enables our customers to manufacture and sell integrated portal readers which may compete with our Speedway xPortal reader subsystem. We may see one product line expand at the expense of another, or we may be asked or even pushed by customers of one product line to disadvantage or divest another product line. We are unable to predict whether we can manage such conflicts in the future, or retain customers despite the conflicts. Any of the foregoing could have a material adverse effect on our business, financial condition and operating results.

 

Our reader OEMs rely on component suppliers for their products and any failure of those suppliers to perform could adversely affect demand for our Indy ICs.

 

Our reader OEM customers procure essential components from other suppliers, including sole-source suppliers for some components or products. For example, currently most OEMs who manufacture Indy-based readers procure ARM7 processors for those readers from Atmel Corporation. A delay in supply or a catastrophic loss to Atmel’s facilities would disrupt our reader OEM customers’ operations and may adversely affect demand for our Indy ICs and operating results.

 

Lack of enterprise systems able to exploit the information generated by UHF Gen2 systems may adversely affect the market for our products.

 

A successful end-user UHF Gen2 deployment, for example in a retail apparel store, requires not only the deployment of Gen2 tags and readers, but also back-end infrastructure improvements to derive business value with information from tagged items. Unless technology providers continue to develop and advance back-end business-analytics tools, and end users install or enhance their back-end systems to include these business analytics tools, deployments of UHF Gen2 could stall. The market perception of UHF Gen2 could sour if end users do not deploy the business-analytics tools or if the performance of the tools is poor. Our efforts to foster the deployment of these business-analytics tools by providing technical guidance to technology providers that develop them could falter. Similarly, systems integrators form an essential part of the UHF Gen2 market by delivering UHF Gen2 deployment know-how to end users who otherwise would not be able to deploy UHF Gen2 systems on their own. Our efforts to train and support systems integrators could likewise falter. If one or both of the business-analytics or systems-integrator communities does not succeed adequately, or if we become unable to support these communities adequately, we could see a material adverse impact on our business, operating results, financial condition or prospects.

 

Our business would be adversely affected by the departure of members of our executive management team.

 

Our success depends, in large part, on the continued contributions of our executive management team, including the services of Chris Diorio, Ph.D., our chairman, co-founder, chief technology officer and director; William T. Colleran, Ph.D., our president, chief executive officer and director and Evan Fein, our senior vice president and chief financial officer. None of our executive management team is bound by employment contracts to remain with us for a specified period. The loss of any member of our executive management team could harm our ability to implement our business strategy and respond to the rapidly changing market conditions in which we operate.

 

If we are unable to attract, train and retain qualified personnel, especially our design and technical personnel, we may not be able to effectively execute our business strategy.

 

Our future success depends on our ability to attract, retain and motivate qualified personnel, including our management, sales and marketing, finance and especially our design and technical personnel. We do not know whether we will be able to retain all of these personnel as we continue to pursue our business strategy. As the

 

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source of our technical and product innovations, our design and technical personnel represent a significant asset. The availability of, and competition for, qualified personnel in the Seattle area, where we are headquartered, constrains our ability to attract qualified personnel. The loss of the services of one or more of our key employees, especially of our key design and technical personnel, or our inability to attract, retain and motivate qualified personnel could have a material adverse effect on our business, financial condition and operating results.

 

Provisions in our customer agreements concerning pricing and other terms could adversely affect our operating results.

 

In the ordinary course of business, we have occasionally entered into agreements that contain pricing terms that could adversely affect our operating results and gross margins. For example, we have contracts that specify future pricing on Indy ICs, as well as contracts that contain most favored customer pricing for certain customers on specified products. Additionally, some of our development agreements contain exclusivity terms that may prevent us from developing substantially similar systems for other customers during the exclusivity period. We may decide for competitive or strategic reasons to enter into similar types of agreements in the future, and any such agreements could impair our operating results. Further offering reduced prices or other favorable terms to one customer could adversely affect our ability to negotiate favorable terms with other customers.

 

We and our third-party contractors are subject to environmental laws and regulations that could impose substantial costs upon us and may adversely affect our business, operating results and financial condition.

 

Some of our operations, such as our research, development and laboratory facilities, are regulated under various federal, state, local, foreign and international environmental laws, including those governing the discharge of pollutants into the air and water, the management, disposal, handling and labeling of, and exposure to, hazardous substances and wastes and the cleanup of contaminated sites. We could incur costs, fines and civil or criminal sanctions, third-party property damage or personal injury claims, or could be required to incur substantial investigation or remediation costs, if we were to violate or become liable under environmental laws. Liability under certain environmental laws can be joint and several and without regard to comparative fault. In addition, certain of our products contain hazardous substances and are subject to legal requirements that regulate their content, such as the European Union’s Restriction of Hazardous Substances Directive, or RoHS, and analogous regulations elsewhere. While we have designed our products to be compliant with environmental regulations and require our third party contractors to comply, we cannot guarantee that we or our products will always be in compliance with these requirements. Environmental laws also tend to become more stringent over time, and we cannot predict the ultimate costs under environmental laws and the timing of these costs. Failure to comply with these and other environmental laws could result in fines and penalties and decreased revenue, which could adversely affect our operating results.

 

If our third-party contractors fail to operate in compliance with environmental requirements, properly dispose of wastes associated with our products, or comply with requirements governing the hazardous substances content of our products, we could be held liable or suffer reputational harm.

 

We may not sustain or effectively manage our growth.

 

We have experienced significant revenue growth in a short period of time. We may not achieve similar growth rates in future periods. You should not rely on our operating results for any prior periods as an indication of our future operating performance. If we are unable to maintain adequate revenue growth, our financial results could suffer and our stock price would decline.

 

To successfully manage our growth and the responsibilities of being a public company, we believe we must effectively:

 

   

recruit, hire, train and manage additional qualified engineers for our research and development activities;

 

   

add sales personnel and expand customer support offices;

 

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implement and improve administrative, financial and operational systems, procedures and controls; and

 

   

integrate and train new employees quickly and effectively and coordinate among our executive, engineering, finance, marketing, sales, operations and customer support organizations.

 

All of the activities above add to the complexity of our organization and increase our operating expenses.

 

We may have insufficient management capabilities and internal resources to manage our growth and business effectively. Accordingly, we may require significant additional resources as we increase our business operations in complexity and scale. We cannot assure you that resources will be available when we need them or that we will have sufficient capital to fund these potential resource needs.

 

If we are unable to manage our growth effectively, we may not be able to exploit market opportunities or develop new products, and we may fail to satisfy customer requirements, maintain product quality, execute our business plan or respond to competitive pressures.

 

We are bound by the restrictions contained in our debt instruments that may restrict our ability to pursue our business strategies.

 

Our credit facilities require us to comply with various covenants that limit our ability, among other things, to:

 

   

dispose of assets;

 

   

complete mergers or acquisitions;

 

   

incur indebtedness;

 

   

encumber assets;

 

   

pay dividends or make other distributions to holders of our capital stock;

 

   

make investments;

 

   

change certain key management personnel; and

 

   

engage in transactions with our affiliates.

 

These restrictions could inhibit our ability to pursue our business strategies. If we default under our credit facilities, and such event of default was not cured or waived, the lender could terminate commitments to lend and cause all amounts outstanding with respect to the debt to be due and payable immediately, which in turn could result in cross defaults under our other debt instruments. Our assets and cash flow may not be sufficient to fully repay borrowings under all of our outstanding debt instruments if some or all of these instruments are accelerated upon a default.

 

Although we intend to repay our debt with a portion of the proceeds of this offering, we may incur indebtedness in the future. The debt instruments governing such indebtedness could contain provisions that are as, or more, restrictive that our existing debt instruments. If we are unable to repay, refinance or restructure our indebtedness when payment is due, the lenders could force us into bankruptcy or liquidation.

 

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements would be impaired, which could adversely affect our operating results, our ability to operate our business and our stock price.

 

We must ensure that we have adequate internal financial and accounting controls and procedures in place to produce accurate financial statements on a timely basis. Section 404 of the Sarbanes-Oxley Act requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. We are only at the beginning stages of implementing systems

 

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and controls to comply with Section 404. Both we and our independent auditors will be testing our internal controls in connection with the Section 404 requirements and could identify areas for further attention or improvement. Implementing any changes to our internal controls may require compliance training of our directors, officers and employees, entail substantial costs to modify our accounting systems and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements may materially adversely affect our stock price.

 

We may need to raise additional capital, which may not be available on favorable terms, if at all, and which may cause dilution to existing stockholders, restrict our operations or adversely affect our ability to operate our business.

 

If we need to raise additional funds due to unforeseen circumstances or material expenditures or if our operating results are worse than expected, we cannot be certain that we will be able to obtain additional financing on favorable terms, if at all, and any additional financings could result in additional dilution to our existing stockholders. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions such as incurring additional debt, expending capital, or declaring dividends, or which impose financial covenants on us that limit our ability to achieve our business objectives. If we need additional capital and cannot raise it on acceptable terms, we may not be able to meet our business objectives, our stock price may fall and you may lose some or all of your investment.

 

Our operations could be disrupted by earthquakes or other natural disasters.

 

Our facilities could be disabled or suffer catastrophic losses caused by earthquake, fire, flood or other natural disasters. We have facilities in areas with substantial seismic activity, such as our headquarters and offices in Seattle, Washington, and in areas with tornado activity, such as our office in Bentonville, Arkansas. A catastrophic loss at any of our facilities or the facilities of our third-party suppliers would disrupt our operations, delay production and shipments, reduce revenue and result in large expenses to repair or replace the facility. We do not carry insurance policies that cover potential losses caused by earthquakes or other natural disasters.

 

Our ability to use net operating losses to offset future tax liabilities may be limited.

 

As of March 31, 2011, we had federal net operating loss carryforwards, or NOLs, to offset future taxable income of approximately $106.3 million, which expire in various years beginning in 2020, if not utilized. A lack of future taxable income would adversely affect our ability to utilize these NOLs. In addition, under Section 382 of the U.S. Internal Revenue Code, or the Code, a corporation that experiences a more-than 50% ownership change over a three-year testing period is subject to limitations on its ability to utilize its pre-change NOLs to offset future taxable income. Our existing NOLs may be subject to limitations arising from previous ownership changes, and if we undergo an ownership change in connection with or after this offering, our ability to utilize NOLs could be further limited by Section 382 of the Code. Future changes in our stock ownership, many of the causes of which are outside of our control, could result in an ownership change under Section 382 of the Code. Our NOLs may also be impaired under state law. As a result of these limitations, we may not be able to utilize a material portion of the NOLs.

 

The unfavorable outcome of any future litigation or administrative action could negatively impact us.

 

Our financial results could be negatively impacted by unfavorable outcomes in any future litigation or administrative actions. We cannot assure favorable outcomes in litigation or administrative proceedings. Costs associated with litigation and administrative proceedings are very high and could negatively impact our financial results.

 

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Risks Relating to this Offering and Ownership of Our Common Stock

 

The market price of our common stock may be volatile, and the value of your investment could decline significantly.

 

Investors who purchase common stock in this offering may not be able to sell their shares at or above the initial price to public. Securities of companies similar to ours experience significant price and volume fluctuations. The following factors, in addition to other risks described in this prospectus, may have a significant effect on our common stock price:

 

   

quarterly variations in our results of operations or those of our competitors;

 

   

announcements by us or our competitors of acquisitions, new products, significant contracts, commercial relationships or capital commitments;

 

   

developments with respect to intellectual property rights;

 

   

our ability to develop and market new and enhanced products on a timely basis;

 

   

commencement of, or our involvement in, litigation;

 

   

major changes in our board of directors or management;

 

   

changes in governmental regulations or in the status of our regulatory approvals;

 

   

changes in earnings estimates or recommendations by securities analysts; and

 

   

general economic conditions and slow or negative growth of related markets.

 

In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect our stock price, regardless of our actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering. In addition, in the past, securities class action litigation has often been instituted against companies whose stock prices have declined, especially following periods of volatility in the overall market. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

 

If securities or industry analysts do not publish research reports about our business, or if they issue an adverse opinion about our business, our stock price and trading volume could decline.

 

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us issues an adverse opinion about our company, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

Future sales of our common stock in the public market could cause our stock price to fall.

 

Our stock price could decline as a result of sales of a large number of shares after this offering or the perception that these sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.

 

Upon completion of this offering,              shares of our common stock will be outstanding (             shares of common stock will be outstanding assuming exercise of the underwriters’ over-allotment option in full), based on our shares outstanding as of March 31, 2011. All shares of common stock expected to be sold in this offering will be freely tradable without restriction or further registration under the Securities Act unless held by our

 

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“affiliates,” as that term is defined in Rule 144 under the Securities Act. The resale of the remaining              shares, or     % of our outstanding shares after this offering, are currently prohibited or otherwise restricted as a result of securities law provisions, market standoff agreements entered into by our stockholders with us or lock-up agreements entered into by our stockholders with the underwriters; however, subject to applicable securities law restrictions and certain extensions, these shares will be able to be sold in the public market beginning 180 days after the date of this prospectus. In addition, the shares subject to outstanding options, of which              are exercisable as of March 31, 2011, and the shares reserved for future issuance under our stock option and equity incentive plans will become available for sale immediately upon the exercise of such options and the expiration of any applicable market stand-off or lock-up agreements. For more information see the section of this prospectus captioned “Shares Eligible for Future Sale.”

 

Holders of approximately              shares (including the shares underlying the warrants described in the section of this prospectus captioned “Shares Eligible for Future Sale—Warrants”), or     %, of our common stock will have rights, subject to some conditions, to require us to file registration statements covering the sale of their shares or to include their shares in registration statements that we may file for ourselves or other stockholders. We also intend to register the offer and sale of all shares of common stock that we may issue under our equity compensation plans. Once we register the offer and sale of shares for the holders of registration rights and option holders, they can be freely sold in the public market upon issuance, subject to the lock-up agreements described in the section of this prospectus captioned “Underwriters.”

 

In addition, in the future, we may issue additional shares of common stock or other equity or debt securities convertible into common stock in connection with a financing, acquisition, litigation settlement, employee arrangement or otherwise. Any such issuance could result in substantial dilution to our existing stockholders and could cause our stock price to decline.

 

Our principal stockholders and management own a significant percentage of our stock and will be able to exercise significant influence over matters subject to stockholder approval.

 

Our executive officers, directors and principal stockholders, together with their respective affiliates, beneficially owned approximately 81% of our capital stock as of March 31, 2011, and we expect that upon completion of this offering, that same group will beneficially own at least     % of our capital stock, of which     % will be beneficially owned by our executive officers. Accordingly, after this offering, our executive officers, directors and principal stockholders will be able to determine the composition of our board of directors, retain the voting power to approve all matters requiring stockholder approval, including mergers and other business combinations, and continue to have significant influence over our operations. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material adverse effect on our stock price and may prevent attempts by our stockholders to replace or remove our board of directors or management.

 

We have broad discretion to use the net proceeds from this offering, and our investment of these proceeds may not yield a favorable return. We may invest the proceeds of this offering in ways you disagree with.

 

Our management has broad discretion as to how to spend and invest the proceeds from this offering and we may spend or invest these proceeds in a way with which our stockholders may disagree. Accordingly, you will need to rely on our judgment with respect to the use of these proceeds. We intend to use the proceeds from this offering for debt repayment, product development, working capital and other general corporate purposes, including the costs associated with being a public company. These uses may not yield a favorable return to our stockholders.

 

An active trading market for our common stock may not develop.

 

Prior to this offering, there has been no public market for our common stock. Although we expect that our common stock will be approved for listing on             , an active trading market for our shares may never develop

 

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or be sustained following this offering. The initial price to public for our common stock was determined through negotiations with the underwriters, and the negotiated price may not be indicative of the market price of the common stock after the offering. This initial price to public may vary from the market price of our common stock after the offering. As a result of these and other factors, you may be unable to resell your shares of our common stock at or above the initial price to public.

 

Anti-takeover provisions in our charter documents and under Delaware or Washington law could make an acquisition of us difficult, limit attempts by our stockholders to replace or remove our current management and limit our stock price.

 

Provisions of our certificate of incorporation and bylaws may delay or discourage transactions involving an actual or potential change in our control or change in our management, including transactions in which stockholders might otherwise receive a premium for their shares, or transactions that our stockholders might otherwise deem to be in their best interests. Therefore, these provisions could adversely affect the price of our stock. Among other things, our certificate of incorporation and bylaws will:

 

   

permit our board of directors to issue up to              shares of preferred stock, with any rights, preferences and privileges as they may designate;

 

   

provide that the authorized number of directors may be changed only by resolution of the board of directors;

 

   

provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum;

 

   

divide our board of directors into three classes;

 

   

require that any action to be taken by our stockholders must be effected at a duly called annual or special meeting of stockholders and may not be taken by written consent;

 

   

provide that stockholders seeking to present proposals before a meeting of stockholders or to nominate candidates for election as directors at a meeting of stockholders must provide notice in writing in a timely manner, and also specify requirements as to the form and content of a stockholder’s notice;

 

   

not provide for cumulative voting rights (therefore allowing the holders of a plurality of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose);

 

   

provide that special meetings of our stockholders may be called only by the chairman of the board, our chief executive officer or by the board of directors; and

 

   

provide that stockholders will be permitted to amend our bylaws only upon receiving at least two-thirds of the total votes entitled to be cast by holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class.

 

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder. Likewise, because our principal executive offices are located in Washington, the anti-takeover provisions of the Washington Business Corporation Act may apply to us under certain circumstances now or in the future. These provisions prohibit a “target corporation” from engaging in any of a broad range of business combinations with any stockholder constituting an “acquiring person” for a period of five years following the date on which the stockholder became an “acquiring person.” See “Description of Capital Stock” elsewhere in this prospectus.

 

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We will incur increased costs by being a public company.

 

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also anticipate that we will incur costs associated with relatively recently adopted corporate governance requirements, including requirements of the SEC and the             . We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We also expect these rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

 

This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. Some of the statements under “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this prospectus contain forward-looking statements. In some cases, you can identify forward-looking statements by the following words: “may,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words.

 

These statements involve risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we believe that we have a reasonable basis for each forward-looking statement contained in this prospectus, we caution you that these statements are based on a combination of facts and factors currently known by us and our projections of the future, about which we cannot be certain. Forward-looking statements in this prospectus include, but are not limited to, statements about:

 

   

the breadth and rate of adoption of UHF Gen2 solutions and growth of the UHF Gen2 market;

 

   

our ability to compete effectively against other providers of UHF Gen2 products or competing technology;

 

   

average selling prices of our products and the effect of price erosion, if any, for UHF Gen2 solutions;

 

   

product mix and gross margins for our products;

 

   

our ability to develop and introduce new products and enhancements that achieve market acceptance;

 

   

the performance of the third parties on which we rely for the manufacture, assembly and testing of our products;

 

   

our ability to maintain appropriate inventory levels, including adequate resources from our suppliers;

 

   

our ability to commercialize new end uses for UHF Gen2 solutions, further our market penetration and enter into new geographies and end markets;

 

   

our ability to broaden and deepen our relationships with inlay manufacturers, reader OEMs, distributors, VARs and system integrators;

 

   

our ability to secure “design-in” for UHF Gen2 solutions and the ability of inlay manufacturers, reader OEMs, VARs, distributors and system integrators to sell our products to end users;

 

   

our ability to maintain market share for our products and technology leadership within the UHF Gen2 market;

 

   

our ability to adequately protect our intellectual property;

 

   

our liquidity and capital resources;

 

   

our future leadership of the standards-setting process and the impact of changes in the UHF Gen2 standard; and

 

   

our ability to manage growth in our business.

 

In addition, you should refer to the “Risk Factors” section of this prospectus for a discussion of other important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this prospectus will prove to be accurate. Furthermore, if our forward-looking statements prove to

 

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be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. The Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933 do not protect any forward-looking statements that we make in connection with this offering.

 

This prospectus contains market data and industry forecasts that were obtained from industry publications. These data involve a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. We have not independently verified any third party information. While we believe the market position, market opportunity and market size information included in this prospectus is generally reliable, such information is inherently imprecise.

 

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USE OF PROCEEDS

 

We estimate that the net proceeds to us from the sale of the shares of common stock by us in this offering will be approximately $            , or approximately $            if the underwriters exercise their over-allotment option in full, based upon an assumed initial price to public of $            per share, the mid-point of the range reflected on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses. Each $1.00 increase (decrease) in the assumed initial price to public of $            per share would increase (decrease) the net proceeds to us from this offering by approximately $            , assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We may also increase or decrease the number of shares we are offering. Each increase (decrease) of            shares in the number of shares offered by us would increase (decrease) the net proceeds to us from this offering by approximately $            , assuming that the assumed initial price to public remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We do not expect that a change in the initial price to public or the number of shares by these amounts would have a material effect on our uses of the proceeds from this offering, although it may accelerate the time at which we will need to seek additional capital. We will not receive any of the proceeds from the sale of common stock by the selling stockholders.

 

We intend to use approximately $10.0 million, $2.0 million and up to $13.0 million of the net proceeds from this offering to repay amounts outstanding under our mezzanine term loan facility, the “Facility B” term loan borrowings of our credit facility and our subordinated secured convertible promissory notes, respectively. Of the net proceeds intended to repay amounts outstanding under our subordinated secured convertible promissory notes, approximately $8.2 million would be paid to our affiliates. The mezzanine term loan facility, which is scheduled to mature in March 2013, accrues interest at a fixed rate equal to 11.0% per year and is payable monthly. We used the proceeds of the mezzanine term loan facility to finance the purchase of Monza wafers to avoid supply constraints similar to those which we faced in 2010. The Facility B term loan borrowings portion of our credit facility, which is scheduled to mature in December 2013, accrues interest at a floating rate equal to the greater of 4.5% and the lender’s prime rate plus 1.25% and is payable monthly. We used the Facility B term loan borrowings and the proceeds of subordinated secured convertible promissory notes for working capital and general corporate purposes. The subordinated secured convertible promissory notes, of which there was approximately $6.4 million aggregate principal and accrued interest outstanding as of March 31, 2011, are scheduled to mature in June 2011 and accrue interest at a fixed rate equal to 9.0% per year. Subject to certain exceptions, we are required to repay all of the subordinated secured convertible promissory notes at a price equal to two times the outstanding principal amount and accrued and unpaid interest in connection with the offering contemplated by this prospectus.

 

We currently expect to use the remaining $             of net proceeds of this offering for general corporate purposes.

 

The expected use of net proceeds of this offering represents our current intentions based upon our present plans and business conditions. We cannot specify with certainty all of the particular uses for the net proceeds to be received upon the closing of this offering. Pending their uses, we plan to invest the net proceeds of this offering in short-and intermediate-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.

 

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DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our common stock or any other securities. We anticipate that we will retain all available funds and any future earnings, if any, for use in the operation of our business and do not anticipate paying cash dividends in the foreseeable future. In addition, our credit facility materially restricts, and future debt instruments we issue may materially restrict, our ability to pay dividends on our common stock. Payment of future cash dividends, if any, will be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, the requirements of our current or then-existing credit facilities and other factors our board of directors deems relevant.

 

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CAPITALIZATION

 

The following table summarizes our capitalization as of March 31, 2011:

 

   

on an actual basis; and

 

   

on a pro forma, as adjusted basis, to reflect the sale and issuance by us of              shares of common stock in this offering at an assumed initial price to public of $             per share, the mid-point of the range reflected on the cover page of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses, and the application of such proceeds as described in the section captioned “Use of Proceeds.”

 

You should read the information in this table together with our financial statements and related notes to those statements, as well as the sections captioned “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing elsewhere in this prospectus.

 

     As of March 31, 2011  
     Actual     Pro Forma
As Adjusted(1)
 
     (Unaudited)  
     (In thousands, except per
share data)
 

Long-term debt:

    

Credit facility

     8,708     

Mezzanine credit facility

     9,730     
          

Total long-term debt

     18,438     

Redeemable convertible preferred stock, $0.001 par value per share; issuable in series, 206,227,960 authorized, 97,465,284 shares issued and outstanding, actual; no shares authorized, no shares issued or outstanding, pro forma as adjusted

     160,197     

Stockholders’ equity (deficit):

    

Preferred stock, $0.001 par value per share; no shares authorized, no shares issued or outstanding, actual;              authorized, no shares issued or outstanding, pro forma as adjusted

    

Common stock, $0.001 par value per share, 160,000,000 shares authorized, 35,311,010 shares issued and outstanding, actual; 132,776,294 shares authorized,              shares issued and outstanding, pro forma as adjusted

     35     

Accumulated deficit

     (155,830  

Accumulated other comprehensive loss

     (15  

Additional paid-in capital

         
          

Total stockholders’ deficit

     (155,810  
                

Total capitalization

   $ 22,825      $                
                

 

(1)   Each $1.00 increase (decrease) in the assumed initial price to public of $            per share, the mid-point of the range reflected on the cover page of this prospectus, would increase (decrease) each of cash and equivalents, additional paid-in capital, total stockholders’ deficit and total capitalization by approximately $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase (decrease) of            shares in the number of shares offered by us would increase (decrease) each of additional paid-in capital, total stockholders’ deficit and total capitalization by approximately $            , assuming that the assumed initial price to public remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will adjust based on the actual initial price to public and other terms of this offering determined at pricing.

 

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The number of shares of our common stock outstanding immediately after this offering is based on 132,776,294 shares of our common stock outstanding as of March 31, 2011. The outstanding share information in the table above excludes as of March 31, 2011:

 

   

21,914,388 shares of common stock issuable upon the exercise of outstanding options with a weighted average exercise price of $0.11 per share;

 

   

1,004,155 shares of common stock reserved for future issuance under our 2010 Equity Incentive Plan as of March 31, 2011; provided, however, that immediately upon the signing of the underwriting agreement for this offering, our 2010 Equity Incentive Plan will terminate so that no further awards may be granted under our 2010 Equity Incentive Plan;

 

   

an aggregate of up to              shares of common stock reserved for future issuance under our 2011 Equity Incentive Plan and 2011 Employee Stock Purchase Plan, each of which will become effective immediately upon the signing of the underwriting agreement for this offering;

 

   

an aggregate of 2,797,112 shares of Series E convertible preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying our subordinated convertible promissory notes (which notes will be repaid using a portion of the net proceeds of the offering contemplated by this prospectus);

 

   

an aggregate of 890,721 shares of Series E convertible preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying warrants with an exercise price of $2.286 per share (which warrants will be exercised automatically on a net exercise basis in connection with the offering contemplated by this prospectus if the initial per share price to public exceeds the exercise price of the warrants); and

 

   

an aggregate of 260,280 shares of our Series E preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying warrants with an exercise price of $2.286 per share and an aggregate of 300,000 shares of our common stock underlying warrants with an exercise price of $0.21 per share.

 

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DILUTION

 

If you invest in our common stock you will experience immediate and substantial dilution in the pro forma net tangible book value of your shares of common stock. Dilution in pro forma net tangible book value represents the difference between the price to public per share of our common stock and the pro forma net tangible book value per share of our common stock immediately after the offering.

 

The historical net tangible book deficit of our common stock as of March 31, 2011 was $0.3 million, or $0.01 per share. Historical net tangible book value (deficit) per share represents our total tangible assets (total assets less intangible assets) less total liabilities divided by the number of shares of outstanding common stock.

 

After giving effect to (1) the automatic conversion of our outstanding preferred stock into an aggregate of            shares of common stock immediately prior to the completion of this offering, (2) the issuance of            shares of our common stock in this offering, and (3) receipt of the net proceeds from our sale of            shares of common stock in this offering at an assumed initial price to public of $            per share (the midpoint of the price range set forth on the cover of this prospectus), after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of March 31, 2011 would have been approximately $            million, or $            per share. This represents an immediate increase in pro forma as adjusted net tangible book value of $            per share to existing stockholders and an immediate dilution of $            per share to new investors purchasing common stock in this offering.

 

The following table illustrates this dilution on a per share basis to new investors:

 

Assumed initial price to public per share

     $                

Historical net tangible book deficit per share as of March 31, 2011

   $ (0.01  

Decrease per share attributable to conversion of convertible preferred stock

     0.01     
          

Pro forma net tangible book deficit per share before this offering

   $     

Increase in net tangible book value per share attributable to investors participating in this offering

    
          

Pro forma as adjusted net tangible book value per share, as adjusted to give effect to this offering

    
          

Pro forma dilution per share to investors participating in this offering

     $     
          

 

Each $1.00 increase (decrease) in the assumed initial price to public of $            per share would increase (decrease) our pro forma as adjusted net tangible book value by approximately $            , or approximately $            per share, and increase (decrease) in the pro forma dilution per share to investors in this offering by approximately $            per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase of              in the number of shares offered by us would increase our pro forma as adjusted net tangible book value by approximately $            , or $            per share, and the pro forma dilution per share to investors in this offering would be $            per share, assuming that the assumed initial price to public remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, a decrease of            shares in the number of shares offered by us would decrease our pro forma as adjusted net tangible book value by approximately $            , or $            per share, and the pro forma dilution per share to investors in this offering would be $            per share, assuming that the assumed initial price to public remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will adjust based on the actual initial price to public and other terms of this offering determined at pricing.

 

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If the underwriters exercise their option in full to purchase            additional shares of common stock in this offering, the pro forma as adjusted net tangible book value per share after the offering would be $            per share, the increase in the pro forma net tangible book value per share to existing stockholders would be $            per share and the pro forma dilution to new investors purchasing common stock in this offering would be $            per share.

 

Sales by the selling stockholders in this offering will reduce the number of shares held by existing stockholders to            or approximately            % of the total shares of our common stock outstanding after this offering, or            shares and approximately            % of the total shares of our common stock outstanding after this offering if the over-allotment option is exercised in full. The number of shares to be purchased by new investors will be increased to            or approximately            % of the total shares of our common stock outstanding after this offering, or            shares and approximately            of the total shares of common stock outstanding after this offering, if the over-allotment option is exercised in full.

 

The following table summarizes, on a pro forma basis as of March 31, 2011, the differences between the number of shares of common stock purchased from us, the total consideration and the weighted average price per share paid by existing stockholders and by investors participating in this offering at an assumed initial price to public of $            per share, before deducting underwriting discounts and commissions and estimated offering expenses:

 

     Shares Purchased     Total Consideration     Weighted
Average
Price

Per Share
 
     Number      Percent     Amount      Percent    

Existing stockholders before this offering

                   $                             $            

Investors participating in this offering

            
                                    

Total

                   $                     
                                    

 

Each $1.00 increase (decrease) in the assumed initial price to public of $            per share would increase (decrease) total consideration paid by new investors by approximately $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase (decrease) of            in the number of shares offered by us would increase (decrease) total consideration paid by new investors, assuming that the assumed initial price to public remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

The above discussion and tables are based on 132,776,294 shares of our common stock outstanding as of March 31, 2011. This number excludes, as of March 31, 2011:

 

   

21,914,388 shares of common stock issuable upon the exercise of outstanding options with a weighted average exercise price of $0.11 per share;

 

   

1,004,155 shares of common stock reserved for future issuance under our 2010 Equity Incentive Plan as of March 31, 2011; provided, however, that immediately upon the signing of the underwriting agreement for this offering, our 2010 Equity Incentive Plan will terminate so that no further awards may be granted under our 2010 Equity Incentive Plan;

 

   

an aggregate of up to              shares of common stock reserved for future issuance under our 2011 Equity Incentive Plan and 2011 Employee Stock Purchase Plan, each of which will become effective immediately upon the signing of the underwriting agreement for this offering;

 

   

an aggregate of 2,797,112 shares of Series E convertible preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying our subordinated convertible promissory notes (which notes will be repaid using a portion of the net proceeds of the offering contemplated by this prospectus);

 

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an aggregate of 890,721 shares of Series E convertible preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying warrants with an exercise price of $2.286 per share (which warrants will be exercised automatically on a net exercise basis in connection with the offering contemplated by this prospectus if the initial per share price to public exceeds the exercise price of the warrants); and

 

   

an aggregate of 260,280 shares of our Series E preferred stock (which will convert into shares of common stock on a one-for-one basis in connection with the offering) underlying warrants with an exercise price of $2.286 per share and an aggregate of 300,000 shares of our common stock underlying warrants with an exercise price of $0.21 per share.

 

Effective upon the closing of this offering, an aggregate of up to              shares of our common stock will be reserved for future issuance under our equity benefit plans, and these share reserves will also be subject to automatic annual increases in accordance with the terms of the plans. To the extent that new options are issued under our equity benefit plans or we issue additional shares of common stock in the future, there will be further dilution to investors participating in this offering.

 

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SELECTED FINANCIAL DATA

 

We derived the following selected statements of operations data for the years ended December 31, 2008, 2009 and 2010 and the balance sheet data as of December 31, 2009 and 2010 from our audited financial statements appearing elsewhere in this prospectus. We derived the unaudited statements of operations data for the three months ended March 31, 2010 and 2011 and the balance sheet data as of March 31, 2011 from our unaudited interim financial statements included elsewhere in this prospectus. In the opinion of management, the unaudited financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to a fair statement of our results of operations and financial position. The selected statements of operations data for the years ended December 31, 2006 and 2007 and balance sheet data as of December 31, 2006, 2007 and 2008 were derived from audited financial statements not appearing elsewhere in this prospectus. Our historical results are not necessarily indicative of the results that may be expected in the future. The selected financial data set forth below should be read together with our financial statements and the related notes to those statements, as well as the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the “Unaudited Pro Forma Condensed Financial Statements” appearing elsewhere in this prospectus.

 

    Year Ended December 31,     Three Months
Ended March 31,
 
    2006     2007     2008     2009     2010     2010     2011  
          (Unaudited)  
    (In thousands, except per share amounts)  

Revenue:

             

Product revenue

  $ 18,322      $ 14,872      $ 15,457      $ 10,305      $ 29,221      $ 4,640      $ 11,397   

Development, service and licensing revenue

    455        1,022        9,586        10,511        2,576        500        868   
                                                       

Total revenue

    18,777        15,894        25,043        20,816        31,797        5,140        12,265   

Costs of revenue(1):

             

Cost of product revenue

    12,236        9,410        10,791        6,782        17,008        2,455        6,325   

Cost of development, service and licensing revenue

    397        480        2,006        2,219        603        111        472   
                                                       

Total cost of revenue

    12,633        9,890        12,797        9,001        17,611        2,566        6,797   
                                                       

Gross profit

    6,144        6,004        12,246        11,815        14,186        2,574        5,468   

Operating expenses:

             

Research development(1)

    10,329        11,675        12,257        9,492        10,662        2,389        2,781   

Selling and marketing(1)

    3,300        5,253        7,375        7,320        8,256        1,957        2,375   

General and administrative(1)

    6,783        6,718        6,711        5,271        5,585        1,241        1,594   
                                                       

Total operating expenses

    20,412        23,646        26,343        22,083        24,503        5,587        6,750   
                                                       

Loss from operations

    (14,268     (17,642     (14,097     (10,268     (10,317     (3,013     (1,282

Interest income (expense) and other, net

    824        1,042        316        67        (978     (55     (495
                                                       

Net loss before income tax (expense) benefit

    (13,444     (16,600     (13,781     (10,201     (11,295     (3,068     (1,777

Income tax (expense) benefit

                  644        50        (90     (19     (24
                                                       

Loss from continuing operations

    (13,444     (16,600     (13,137     (10,151     (11,385     (3,087     (1,801

 

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    Year Ended December 31,     Three Months Ended
March 31,
 
    2006     2007     2008     2009     2010     2010     2011  
          (Unaudited)  
    (In thousands, except per share amounts)  

Income (loss) from discontinued operations, net of tax

    (607     (3,431     1,275        291                        
                                                       

Net loss

  $ (14,051   $ (20,031   $ (11,862   $ (9,860   $ (11,385   $ (3,087   $ (1,801
                                                       

Net loss attributable to common stockholders

  $ (18,437   $ (25,779   $ (19,481   $ (18,419   $ (19,943   $ (5,227   $ (3,838
                                                       
Basic and diluted loss per share:              

Loss from continuing operations

  $ (0.68   $ (0.82   $ (0.68   $ (0.56   $ (0.58   $ (0.15   $ (0.11

Income (loss) from discontinued operations

    (0.03     (0.13     0.04        0.01                        
                                                       

Net loss

  $ (0.71   $ (0.95   $ (0.64   $ (0.55   $ (0.58   $ (0.15   $ (0.11
                                                       

Weighted-average number of shares used in per share amounts

    26,085        27,238        30,509        33,527        34,127        33,723        34,824   
                                                       

Pro forma net loss per share, basic and diluted(2)

          $ (0.08     $ (0.01
                         

Pro forma weighted average shares outstanding, basic and diluted(2)

            131,592          132,289   
                         

 

(1)   Includes stock-based compensation as follows:

 

Total cost of revenue

  $ 5      $ 43      $ 16      $ 20      $ 25      $ 6      $ 7   

Research and development

    41        178        123        114        203        31        109   

Selling and marketing

    10        42        96        82        138        21        47   

General and administrative

    8        26        112        97        133        39        68   
                                                       

Total stock-based compensation

  $ 64      $ 289      $ 347      $ 313      $ 499      $ 97      $ 231   
                                                       

 

(2)   Assumes the conversion of all outstanding shares of convertible preferred stock outstanding as of March 31, 2011 into common stock.

 

     As of December 31,     As of
March 31,
2011
 
     2006     2007     2008     2009     2010    
           (Unaudited)  
     (In thousands)  

Balance Sheet Data:

            

Cash, cash equivalents and short-term marketable securities

   $ 14,022      $ 32,151      $ 20,190      $ 11,320      $ 6,743      $ 12,052   

Working capital

     16,032        31,886        19,640        9,984        6,606        18,779   

Total assets

     26,076        41,423        35,127        22,498        29,454        43,121   

Total long-term debt

            2,000        1,733        133        5,278        18,438   

Redeemable convertible preferred stock

     89,193        127,563        141,043        149,602        158,160        160,197   

Accumulated deficit

     (71,406     (96,815     (115,127     (133,188     (152,525     (155,830

Total stockholders’ deficit

     (71,379     (96,775     (114,995     (133,166     (152,505     (155,810

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

You should read the following discussion and analysis together with our financial statements and the related notes to those statements included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under “Risk Factors” and elsewhere in this prospectus, our actual results may differ materially from those anticipated in these forward-looking statements.

 

Overview

 

Impinj is the leading provider of UHF RFID solutions for identifying, locating and authenticating items. We believe our technology platform, known as GrandPrix, is the most comprehensive and widely adopted in our industry. RFID systems built on GrandPrix deliver real-time information about tagged items, thereby enabling applications and analytics designed to improve business decisions and enhance consumer experience. Leading retail, apparel, pharmaceutical, food and beverage, technology and logistics companies as well as government agencies rely on our GrandPrix platform.

 

The history of our product development and sales and marketing efforts follows:

 

   

Our company was founded in 2000 and began RFID activities in 2002.

 

   

In June 2003, our chairman and chief technology officer led the development of the UHF Gen2 standard, which GS1 EPCglobal ratified in December 2004 and ISO adopted in July 2006.

 

   

In April 2005, we launched Monza 1, the first UHF Gen2 tag IC.

 

   

In April 2005, we launched our Speedway UHF Gen2 reader, the first high-performance UHF Gen2 reader.

 

   

In June 2008, we sold our logic nonvolatile memory, or NVM, intellectual property licensing business to Synopsys for approximately $5.2 million in cash to focus on our core UHF Gen2 business.

 

   

In July 2008, we acquired our Indy reader IC business from Intel Corporation for approximately $6.5 million in stock.

 

   

In July 2009, we launched our Speedway Revolution reader, the first UHF Gen2 high-performance reader powered by an Ethernet cable, which lowers cost of operation and simplifies installation.

 

   

In February 2010, we launched our True3D antenna technology and our QT technology, both of which are enhancements to our current Monza product family.

 

   

In April 2010, we launched our Speedway xPortal integrated portal reader, which incorporates our Speedway Revolution reader with innovative antenna technology in an integrated package.

 

   

In July 2010, we launched our Indy R500 reader IC, developed specifically to address the emerging market for low-cost handheld, desktop and embedded RFID readers.

 

   

In April 2011, we introduced our Monza 5 tag IC, optimized for high-performance, high-volume, item-level tagging, and our Source Tagging Platform, or STP, software application that, when paired with our Monza 4 and 5 tag ICs, enables tag encoding that is three times faster than prior ICs.

 

We derive a substantial majority of our revenue from the sale of Monza tag ICs, Indy reader ICs and Speedway readers. We also derive revenue from custom development engagements. Although we will continue to strategically pursue development engagements, we expect product revenue to represent an increasing percentage of total revenue over time. In 2009, certain leading retailers initiated pilot programs for item-level tagging of apparel designed to provide real-time visibility into their inventory. The success of these pilot

 

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programs led to large deployments of our item-level UHF Gen2 solutions by companies such as Walmart and Banana Republic beginning in 2010, and we experienced a substantial increase in demand for our products. However, we experienced Monza supply shortages during the last three quarters of 2010, which constrained product revenue. In addition, we experienced a decrease in wafer yield resulting from transitory problems encountered in connection with the adoption of a new laser-based process for dicing Monza wafers, which resulted in increased returns in the fourth quarter of 2010. Our total product revenue increased to $29.2 million in 2010, which represents a 184% increase from 2009.

 

We use third-party trailing-edge CMOS foundries and subcontractors to produce our semiconductor products and contract manufacturers to assemble our readers and subsystems. Our capital-efficient operating model is designed to scale efficiently as our volume grows, allowing us to focus our resources on developing new products and solutions and building our reputation as the UHF Gen2 technology leader. We invested $12.3 million, $9.5 million and $10.7 million in 2008, 2009 and 2010, respectively, in research and development and intend to continue to make significant investments in research and development to maintain our technology leadership.

 

Our total revenue increased to $31.8 million in 2010 from $20.8 million in 2009, which was driven by the 184% increase in product revenue. We have never been profitable and have losses from continuing operations of $9.9 million and $11.4 million in 2009 and 2010, respectively. For the three months ended March 31, 2011, we had total revenue and net loss of $12.3 million and $1.8 million, respectively, and as of March 31, 2011, our accumulated deficit was $155.8 million.

 

Factors Affecting Our Performance

 

Market Adoption

 

Our future financial performance will be driven by the rate, scope and depth of adoption of our UHF Gen2 products in multiple end markets and applications. In 2010, some major retailers, including Walmart, Bloomingdale’s and J.C. Penney, rolled-out UHF Gen2 deployments for item-level tagging. These deployments significantly increased our sales of our UHF Gen2 products. We believe these deployments are indicative of a trend toward greater adoption of UHF Gen2 standard-based systems in retail and other markets; however, we cannot be assured that this trend will continue.

 

Market Share

 

We expect the UHF Gen2 market to continue to grow rapidly, as more companies embrace the benefits that UHF Gen2 solutions can provide. To date, we have been able to maintain a high market share for all of our products, but we expect that this share will decrease over time. Specifically, we expect increased competition in our end markets to erode our market share. We intend to invest our time and resources to deliver the most innovative UHF Gen2 solutions, embrace and extend the UHF Gen2 standard, commercialize new use cases and expand and enable our implementation and go-to-market partnerships.

 

Revenue Mix and Gross Margin

 

Substantially all of our product revenue is derived from sales of Monza tag ICs, Indy reader ICs, and Speedway readers, each of which has a different margin profile and selling price. In 2010, sales of Monza tag ICs represented approximately two-thirds of our product revenue, and we expect Monza sales to represent a substantial majority of our product revenue in the future. Depending on the proportion of our revenue that these three products represent in any given period, our gross margin may vary. Our Indy ICs and Speedway readers have higher gross margins than our Monza tag ICs. We expect that product revenue from Monza tag ICs will increase relative to revenue from our other products as UHF Gen2 adoption increases, reducing our total gross margins. In addition, we expect gross margins for Monza tag ICs may also fluctuate as we introduce products with new or enhanced features that command premium pricing and reduce our product costs. Management focuses on Monza unit sales as a primary indicator of current business success.

 

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We will continue to pursue strategically important non-recurring engineering, or NRE, based developments, which generally have higher gross margins than do our product revenue. Revenue and margin for such NRE engagements may fluctuate period to period, given that they are non-recurring in nature and are customized to a specific customer’s requirements. We expect development revenue to decrease as a percentage of total revenue over time.

 

Average Selling Price

 

The average selling price of our UHF Gen2 products has decreased as the market for UHF Gen2 solutions has grown. Although the average selling prices of our UHF Gen2 products may continue to decline in the future, we do not expect them to decline at the same rate as they have historically, based on our recent experience and our product differentiation efforts that allow us to offer customers various feature and pricing options.

 

Basis of Presentation

 

Revenue

 

We generate revenue from the sale of UHF Gen2 products, development and service contracts, and licensing agreements. We are organized as, and operate in, one reportable segment: the development and sale of UHF Gen2 products based on our GrandPrix platform.

 

Product Revenue. The UHF Gen2 products we sell include Monza tag ICs, Indy reader ICs and Speedway readers. We generate our product revenue as follows:

 

   

We sell substantially all of our Monza tag ICs to inlay manufacturers. In 2010, Monza IC sales to Avery Dennison and UPM accounted for 42% and 29%, respectively, of our Monza IC revenue. We expect that these percentages will decrease over time as the demand for our Monza ICs increases and as the number of inlay manufacturers grows.

 

   

We sell a substantial majority of our Indy reader ICs to reader OEMs and other customers, such as Trimble, Motorola and Coca-Cola. In 2010, sales to our top two Indy customers accounted for 34% and 17% % of our Indy reader IC revenue. We sell our Indy ICs primarily through distributors. As with our Monza ICs, we expect customer concentration for Indy reader ICs to decrease over time.

 

   

We sell most of our Speedway readers directly to VARs and system integrators via distributors. We have not experienced customer concentration in our Speedway reader product line.

 

We have established, and will strive to broaden and deepen, relationships with our ecosystem of inlay manufacturers, reader OEMs, distributors, VARs, system integrators and other technology companies. We also seek to establish close relationships with end users, particularly those who we believe are exemplars in the industry. These relationships with end users allow us to better understand key market trends and direction.

 

In 2010, demand for our products grew rapidly. This growth was driven by adoption across several industries, but particularly in the retail apparel industry. Our ability to meet demand for our Monza ICs was constrained by inadequate wafer supply during the last three quarters of 2010. Consequently, in the first quarter of 2011 we purchased more than six months of our forecasted Monza IC wafer supply using borrowings from our mezzanine term loan facility described below, and we will carry more inventory in 2011 than in prior years. Over the longer term, as our product volume increases, we anticipate qualifying additional wafer suppliers. In addition, we experienced a decrease in wafer yield resulting from transitory problems encountered in connection with the adoption of a new laser-based process for dicing Monza wafers, which resulted in increased returns of Monza tag ICs in the fourth quarter of 2010.

 

Development, Service and Licensing Revenue

 

Development. We engage in NRE-based custom solution development for end users and others. Development revenue represented 31.3%, 39.1% and 3.9% of our total revenue in 2008, 2009 and 2010,

 

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respectively. We derived approximately $7.7 million of our development, service and licensing revenue from a single customer in each of 2008 and 2009. We often receive payment for these development engagements in advance of work completed, and record these payments as deferred revenue until they are earned. We intend to continue pursuing development contracts with end users and others to further develop the UHF Gen2 ecosystem and to fund product developments that we may apply to other applications.

 

Service. We provide one-year service, warranty, and software updates to our Speedway customers. Some of our Indy and Speedway customers purchase long-term service contracts, support contracts, or extended warranties. Service revenue represented 4.3%, 7.5% and 2.7% of our revenue in 2008, 2009 and 2010, respectively.

 

Licensing. We license Speedway firmware and Indy software to reader OEMs and antenna reference designs to inlay manufacturers. We bundle the Indy software with annual maintenance and support including unspecified software updates and enhancements during the term of the support period. Licensing revenue represented 2.7%, 3.9% and 1.5% of our revenue in 2008, 2009 and 2010, respectively.

 

We recognize revenue as described in Note 2 of the notes to our financial statements appearing elsewhere in this prospectus.

 

Revenue by Geography. We categorize our sales based on the location of our inlay manufacturers, reader OEMs, distributors, VARs or end users who purchase products and services directly from us. Americas includes North and South America; EMEA includes Europe, the Middle East and Africa; and APAC includes Asia Pacific and Australia. We sell fewer of our Monza tag ICs and Indy reader ICs in EMEA given its relatively smaller manufacturing base compared to APAC and the Americas. We believe the percentage of our products deployed in EMEA is greater than the percentage of revenue we derive from EMEA because we sell our products to channel partners in APAC and the Americas that in turn sell to end users in EMEA. APAC revenue has increased as percentage of total revenue as we have expanded our presence in China to address an emerging market for UHF Gen2 products.

 

Cost of Revenue

 

Cost of product revenue includes costs associated with the manufacture of our Monza tag ICs, Indy reader ICs and Speedway readers. Costs associated with the manufacture of Monza ICs and Indy ICs typically include purchases of wafers, post processing and testing and packaging, as well as associated overhead costs such as logistics, quality control, planning and procurement. These costs depend, at least in part, on the terms that we negotiate with our suppliers, including pricing and payment terms. We outsource the manufacturing of our readers to a third-party contract manufacturer, and our costs for readers are based on negotiated prices for finished goods. Cost of product revenue also includes charges for inventory write-downs, warranty costs and accrued losses on purchase commitments to third-party contract manufacturers.

 

Cost of service, development and license revenue consists primarily of direct labor and other associated costs, such as travel and materials associated with fulfilling contracts under which services are provided.

 

Operating Expenses

 

Research and Development Expense. Research and development expense consists primarily of salaries and related compensation costs for our product development personnel, contract developers, prototype materials and other expenses related to the development of new and improved products. In the past, we have invested, and we plan to continue to invest, significant amounts in research and development activities to develop new products and enhance existing products and the performance and interoperability of products in our GrandPrix platform. Accordingly, we expect research and development expense to increase in absolute dollars in future periods.

 

Selling and Marketing Expense. Selling and marketing expense consists primarily of salaries and related compensation costs for our sales personnel, as well as travel, advertising and promotional expenses and other

 

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related expenses. We anticipate that sales and marketing expense will continue to increase in absolute dollars, as we increase headcount and focus on expanding our market penetration, and enter new geographic and vertical markets. In addition, we expect variable sales compensation to fluctuate as a function of sales.

 

General and Administrative Expense. General and administrative expense consists primarily of salaries and related compensation costs for our executive, finance, human resources and information technology personnel, legal, accounting and other professional services, travel and related expenses, insurance, occupancy and other overhead costs. We expect our general and administrative expenses to increase in absolute dollars as we add personnel and facilities to support our growth. We will incur additional compliance and reporting costs as a public company.

 

Interest Expense

 

Interest expense consists primarily of interest expense on our debt instruments and amortization of deferred financing fees associated with such instruments. We intend to use a portion of the net proceeds from the offering to repay the outstanding principal amount of and accrued but unpaid interest on our subordinated convertible promissory notes. Subject to certain exceptions, we are also required to pay a premium upon such repayment equal to the outstanding principal amount and accrued unpaid interest. The payment of such premium will be reflected in interest expense for the period in which repayment occurs. As of March 31, 2011, there was approximately $6.4 million aggregate principal and accrued interest of subordinated convertible promissory notes outstanding. For more information about our debt instruments, see “—Liquidity and Capital Resources—Sources of Funds.”

 

Results of Operations

 

The following table presents our results of operations for the periods indicated as a percentage of total revenue. Percentages from certain line items do not sum to the subtotal or total line items due to rounding. The period-to-period comparisons of results are not necessarily indicative of results for future periods.

 

     Year Ended
December 31,
    Three Months
Ended March 31,
 
     2008     2009     2010     2010     2011  
           (Unaudited)  

Revenue:

        

Product revenue

     61.7     49.5     91.9     90.3     92.9

Development, service and licensing revenue

     38.3        50.5        8.1        9.7        7.1   
                                        

Total revenue

     100.0        100.0        100.0        100.0        100.0   

Costs of revenue:

          

Cost of product revenue, as a percentage of related revenue

     69.8        65.8        58.2        52.9        55.5   

Cost of development, service and licensing revenue, as a percentage of related revenue

     20.9        21.1        23.4        22.2        54.4   

Total cost of revenue

     51.1        43.2        55.4        49.9        55.4   

Gross profit

     48.9        56.8        44.6        50.1        44.6   

Operating expenses:

          

Research development

     48.9        45.6        33.5        46.5        22.7   

Selling and marketing

     29.4        35.2        26.0        38.1        19.4   

General and administrative

     26.8        25.3        17.6        24.1        13.0   
                                        

Total operating expenses

     105.1        106.1        77.1        108.7        55.1   
                                        

Loss from operations

     (56.3     (49.3     (32.5     (58.6     (10.5

Interest income (expense) and other, net

     1.3        0.3        (3.1     (1.1     (4.0
                                        

Net loss before income tax (expense) benefit

     (55.0     (49.0     (35.5     (59.7     (14.5

Income tax (expense) benefit

     2.6        0.2        (0.3     (0.4     (0.2
                                        

Loss from continuing operations

     (52.5     (48.8     (35.8     (60.1     (14.7

Income from discontinued operations, net of tax

     5.1        1.4                        
                                        

Net loss

     (47.4 )%      (47.4 )%      (35.8 )%      (60.1 )%      (14.7 )% 
                                        

 

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Comparison of Three Months Ended March 31, 2011 and 2010

 

Revenue

 

     Three Months Ended
March  31,
     Change 2010 v. 2011  
     2010      2011      In Dollars      Percentage  
     (Dollars in thousands)  

Product revenue

   $ 4,640       $ 11,397       $ 6,757         145.6

Development, service and licensing revenue

     500         868         368         73.6   
                             

Total revenue

   $ 5,140       $ 12,265       $ 7,125         138.6   
                             

 

The increase in total revenue for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was attributable to an increase in the volume of Monza tag ICs, Indy reader ICs and Speedway readers sold due to the increased demand for our products primarily as a result of large retailers expanding their adoption of our item-level UHF Gen2 solutions, partially offset by a decrease in ASPs due to competition and volume-based discounts. Development, service and licensing revenue increased as a result of new consulting agreements with existing customers.

 

Product Revenue. The increase in product revenue for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was primarily attributable to a 302% increase in the volume of Monza tag ICs sold to new and existing customers as UHF Gen2 solutions were deployed more widely. Our first quarter 2011 results also benefitted from sales of Monza tag ICs deferred in the fourth quarter of 2010 due to supply constraints. These increases were partially offset by declines in Monza tag IC ASPs of approximately 11% due to competition and volume-based discounts.

 

Development, Service and Licensing Revenue. The increase in development, service and licensing revenue for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was attributable to new consulting agreements with existing customers. We recognized $548,000 and $210,000 in development revenue in the three months ended March 31, 2011 and 2010, respectively. Service and licensing revenue was relatively flat for the three months ended March 31, 2011 compared to the three months ended March 31, 2010.

 

Revenue by Geography. Revenue from the Americas, APAC and EMEA grew 102.9%, 154.2% and 229.5%, respectively, in the three months ended March 31, 2011 compared to the three months ended March 31, 2010. The growth in all three regions was primarily attributable to the volume increase in Monza tag ICs discussed above as large retailers expanded their adoption of our item-level UHF Gen2 solutions. For additional information, see Note 14 to the financial statements accompanying this prospectus.

 

Gross Profit

 

     Three Months
Ended March 31,
    Change 2010 v. 2011  
     2010     2011     In Dollars      Percentage  
     (Dollars in thousands)  

Product gross profit

   $ 2,185      $ 5,072      $ 2,887         132.1

Development, service and licensing gross profit

     389        396        7         1.7   
                           

Total gross profit

   $ 2,574      $ 5,468      $ 2,894         112.4   
                           

Product gross margin

     47.1     44.5     

Development, service and licensing gross margin

     77.8        45.6        

Total gross margin

     50.1        44.6        

 

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The $2.9 million increase in total gross profit for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was attributable to increases in both product revenue and in development, service and licensing revenue. Gross margin declined in the three months ended March 31, 2011 compared to the three months ended March 31, 2010 as a result of lower development, service and licensing revenue as a percentage of total revenue.

 

Product Gross Margin. The decrease in product gross margin in the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was attributable to a shift in product mix toward our Monza tag ICs, partially offset by our ability to leverage overhead costs over a higher amount of total product revenue.

 

Development, Service and Licensing Gross Margin. The decrease in gross margin on our development, service and licensing revenue in the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was attributable to a change in development projects. Our development projects are customized to the customer’s requirements, and therefore our gross margin varies from project to project.

 

Operating Expenses

 

Research and Development Expense

 

     Three Months
Ended March 31,
     Change 2010 v. 2011  
     2010      2011      In Dollars      Percentage  
     (Dollars in thousands)  

Research and development expense

   $ 2,389       $ 2,781       $ 392         16.4

 

The increase in research and development expense for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was attributable to a $386,000 increase in personnel costs as we added staff for product development and a $216,000 increase in lab supplies, equipment and professional services. Partially offsetting this increase was a $209,000 reduction due to the assignment of more of our engineering staff to development projects as we engaged in new development consulting agreements.

 

Selling and Marketing Expense

 

     Three Months
Ended March 31,
     Change 2010 v. 2011  
     2010      2011      In Dollars      Percentage  
     (Dollars in thousands)  

Selling and marketing expense

   $ 1,957       $ 2,375       $ 418         21.4

 

The increase in selling and marketing expense for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was primarily attributable to a $357,000 increase in personnel costs due to an increase in selling and marketing headcount to expand channel sales and geographic coverage and an increase in variable compensation due to increased revenue. In addition, advertising and marketing program costs increased $39,000 in the three months ended March 31, 2011 compared to the three months ended March 31, 2010.

 

General and Administrative Expense

 

     Three Months
Ended March 31,
     Change 2010 v. 2011  
     2010      2011      In Dollars      Percentage  
     (Dollars in thousands)  

General and administrative expense

   $ 1,241       $ 1,594       $ 353         28.4

 

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The increase in general and administrative expense for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was primarily attributable to a $302,000 increase in our personnel costs in the three months ended March 31, 2011 as we increased the number of finance, information systems and human resources employees in anticipation of future growth, as well as a $103,000 increase in professional consulting services related to the upgrade of our information systems. Partially offsetting these increases was a $52,000 decrease in depreciation expense.

 

Interest Income (Expense) and Other, Net

 

     Three Months
Ended March 31,
    Change 2010 v. 2011  
     2010     2011     In Dollars     Percentage  
     (Dollars in thousands)  

Interest income

   $ 3      $ 1      $ (2     (66.7 )% 

Interest expense

     (55     (382     (327     N/A   

Other income (expense), net

     (3     (114     (111     N/A   

 

The increase in interest expense for the three months ended March 31, 2011 compared to the three months ended March 31, 2010 was driven by increased borrowings under our credit facilities after March 31, 2010, as well as the issuance of convertible promissory notes in June and July 2010. The increase in other income (expense) for the three months ended March 31, 2011 compared to the prior year period was primarily due to the change in the fair value of convertible preferred stock warrants.

 

Comparison of Years Ended December 31, 2008, 2009 and 2010

 

Revenue

 

     Year Ended December 31,      Change 2008 v. 2009     Change 2009 v. 2010  
     2008      2009      2010      In Dollars     Percentage     In Dollars     Percentage  
     (Dollars in thousands)  

Product revenue

   $ 15,457       $ 10,305       $ 29,221       $ (5,152     (33.3 %)    $ 18,916        183.6

Development, service and licensing revenue

     9,586         10,511         2,576         925        9.6        (7,935     (75.5
                                               

Total revenue

   $ 25,043       $ 20,816       $ 31,797       $ (4,227     (16.9   $ 10,981        52.8   
                                               

 

The increase in total revenue for 2010 compared to 2009 was attributable to the increased demand for our Monza tag ICs, Indy reader ICs and Speedway reader products, primarily as a result of successful pilot programs conducted by large retailers in 2009 which led to large deployments of our item-level UHF Gen2 solutions in 2010, offset in part by a decrease in ASPs due to competition and volume-based discounts and a decrease in development, service and licensing revenue as a result of the completion of a consulting agreement with a significant customer in 2009. The decrease in total revenue for 2009 compared to 2008 was due to a decrease in demand for our product revenue as a result of macroeconomic conditions.

 

Product Revenue. The increase in product revenue for 2010 compared to 2009 was attributable to large deployments of our products, primarily Monza tag ICs, by several retailers, including Walmart and Banana Republic. In 2010, the volume of Monza tag ICs sold increased 279%. The increase was partially offset by a decline in Monza tag IC ASPs of approximately 16% due to competition and volume-based discounts.

 

The decrease in product revenue for 2009 compared to 2008 was attributable to a large bulk order of readers sold to a single customer in 2008. In addition to the effect of this $3.0 million order, product revenue decreased in 2009 compared to 2008 primarily as a result of approximately a 30% decrease in the ASPs for our Monza tag ICs, which was attributable to competitive factors, volume-based discounts and macroeconomic weakness, and more than offset a 19% increase in the volume of Monza tag ICs sold.

 

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Development, Service and Licensing Revenue. The decrease in development, service and licensing revenue for 2010 compared to 2009 was attributable to the completion in 2009 of a large consulting agreement with a single customer. We recognized $7.7 million in development, service and licensing revenue with respect to such agreement in both 2009 and 2008. Excluding the effect of this large consulting agreement, development, service and licensing revenue was relatively constant from 2008 through 2010.

 

Revenue by Geography. Revenue from the Americas, APAC and EMEA grew 22.1%, 176.1% and 98.8%, respectively, in 2010 compared to 2009. The increase in the Americas and EMEA in 2010 was primarily due to an increase in the volume of Monza tag ICs sold as discussed above, partially offset by decreases in ASPs for this product line due to competition and volume-based discounts. In addition, partially offsetting the increase in the Americas was a decline in development, service and licensing revenue due to the completion in 2009 of a large consulting agreement with a single customer with respect to which we recognized $7.7 million in 2009. The increase in APAC was primarily attributable to adding additional sales and marketing resources. Revenue in the Americas and EMEA declined 23.6% and 21.1%, respectively, in 2009 compared to 2008, while revenue in APAC grew 55.7% in 2009 compared to 2008. The decrease in revenue in the Americas was primarily attributable to a large $3.0 million bulk order of readers sold to a single customer in the United States in 2008. In addition, revenue in the Americas and EMEA declined due to a decrease in ASPs, primarily for our Monza tag ICs, which more than offset an increase in the volume of Monza tag ICs sold. ASPs declined due to competition, volume-based discounts and macroeconomic weakness in both the Americas and EMEA. The increase in revenue in APAC in 2009 compared to 2008 was due to the addition of channel partners in China during 2009, as well as increased adoption of UHF Gen2 solutions in China.

 

Gross Profit

 

     Year Ended December 31,     Change 2008 v. 2009     Change 2009 v. 2010  
     2008     2009     2010     In Dollars     Percentage     In Dollars     Percentage  
     (Dollars in thousands)  

Product gross profit

   $ 4,666      $ 3,523      $ 12,213      $ (1,143     (24.5 )%    $ 8,690        246.7

Development, service and licensing gross profit

     7,580        8,292        1,973        712        9.4        (6,319     (76.2
                                            

Total gross profit

   $ 12,246      $ 11,815      $ 14,186      $ (431     (3.5   $ 2,371        20.1   
                                            

Product gross margin

     30.2     34.2     41.8        

Development, service and licensing gross margin

     79.1        78.9        76.6           

Total gross margin

     48.9        56.8        44.6           

 

The $2.4 million increase in total gross profit for 2010 compared to 2009 was attributable to the increase in product revenue partially offset by the decrease in development, service and licensing revenue. Gross margin declined in 2010 compared to 2009 as a result of a substantial decline in development, service and licensing revenue, both in absolute dollars and as a percentage of total revenue.

 

The decrease in gross profit for 2009 compared to 2008 was attributable to the decrease in product revenue partially offset by the increase in development, service and licensing revenue. The increase in gross margin in 2009 compared to 2008 was attributable to a decline in product revenue, both in absolute dollars and as a percentage of total revenue.

 

Product Gross Margin. The increase in product gross margin in 2010 compared to 2009 was attributable to our ability to leverage our overhead costs over a higher amount of revenue, partially offset by a shift in product mix toward our Monza tag ICs. The increase in product gross margin in 2009 compared to 2008 was attributable to the inclusion of a full year of revenue from sale of Indy reader ICs following the acquisition of this product line from Intel Corporation in June 2008.

 

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Development, Service and Licensing Gross Margin. The decrease in gross margin on our development, service and licensing revenue in 2010 compared to 2009 was attributable to a change in mix between development projects and licensing. Our development projects are customized to the customer’s requirements and therefore our gross margin varies from project to project, but generally have lower margins than licensing.

 

Operating Expenses

 

Research and Development Expense

 

     Year Ended December 31,      Change 2008 v. 2009     Change 2009 v. 2010  
     2008      2009      2010      In Dollars     Percentage     In Dollars      Percentage  
     (Dollars in thousands)  

Research and development expense

   $ 12,257       $ 9,492       $ 10,662       $ (2,765     (22.6 %)    $ 1,170         12.3

 

The increase in research and development expense for 2010 compared to 2009 was attributable to a $1.5 million increase in personnel costs as we shifted personnel from development engagements with customers to product development. Partially offsetting the increase in personnel costs was a $214,000 decrease in lab supplies and equipment expenses, an $86,000 decrease in consulting services and a $30,000 decrease in fabrication, test and other expenses.

 

In 2009 we decreased research and development expense compared to 2008 in an effort to better align our expense with expected cash flows given the relatively weak macroeconomic environment. We decreased personnel costs by $1.9 million by reducing our research and development headcount from 67 to 51, lab supplies and equipment expense by $423,000 and consulting services expense by $288,000. Partially offsetting these decreases was an increase in rent expense of $338,000 and an increase in fabrication and testing expenses of $152,000 as a result of including a full year of research and development expense related to the acquisition of the Indy reader IC product line. In addition, research and development expense in 2008 included $650,000 of in-process research and development acquired with the Indy reader IC product line. We did not acquire any in-process research and development in 2009.

 

Selling and Marketing Expense

 

     Year Ended December 31,      Change 2008 v. 2009     Change 2009 v. 2010  
     2008      2009      2010      In Dollars     Percentage     In Dollars      Percentage  
     (Dollars in thousands)  

Selling and marketing expense

   $ 7,375       $ 7,320       $ 8,256       $ (55     (0.7 %)    $ 936         12.8

 

The increase in selling and marketing expense for 2010 compared to 2009 was primarily attributable to a $608,000 increase in personnel costs as we increased selling and marketing headcount to increase channel sales and geographic coverage. In addition, advertising and marketing program costs increased by $255,000 in 2010 compared to 2009 as we introduced new products to the market, and our variable compensation increased $94,000 as a result of the increase in product revenue.

 

Selling and marketing expense was relatively flat in 2009 compared to 2008. In 2009 our professional fees decreased $424,000 because we replaced outside consultants with employees and an additional $378,000 due to cutbacks in our advertising and marketing program. These decreases were partially offset by a $678,000 increase in personnel costs as a result of including a full year of sales and marketing expense related to the acquisition of the Indy IC product line and a $69,000 increase in rent and facilities costs.

 

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General and Administrative Expense

 

     Year Ended December 31,      Change 2008 v. 2009     Change 2009 v. 2010  
     2008      2009      2010      In Dollars     Percentage     In Dollars      Percentage  
     (Dollars in thousands)  

General and administrative expense

   $ 6,711       $ 5,271       $ 5,585       $ (1,440     (21.5 %)    $ 314         6.0

 

The increase in general and administrative expense for 2010 compared to 2009 was primarily attributable to a $370,000 increase in employee relocation expenses related to the closing of our Orange County, California office and a $220,000 increase in our personnel costs in 2010 as we increased the number of finance, information systems and human resource employees in anticipation of future growth. Partially offsetting these increases were decreases in professional services fees for legal, accounting and patent advisory services of $133,000 and a decrease in depreciation and other expenses of $133,000.

 

The decrease in general and administrative expense for 2009 compared to 2008 was primarily attributable to a $848,000 decrease in personnel costs as we reduced headcount to better align expenses with revenue expectations given the uncertain macroeconomic environment. In addition, our rent and facilities expense decreased $380,000 as we subleased out some of our office space, our professional services expenses decreased $171,000 as we spent less on consultants and patent advisory services in 2009, and our bad debt expense decreased 99,000. A $58,000 increase in depreciation expense offset these decreases.

 

Interest Income (Expense) and Other, Net

 

     Year Ended December 31,     Change 2008 v. 2009     Change 2009 v. 2010  
     2008     2009     2010     In Dollars     Percentage     In Dollars     Percentage  
     (Dollars in thousands)  

Interest income

   $ 723      $ 234      $ 8      $ (489     (67.6 %)    $ (226     96.6

Interest (expense)

     (514     (524     (793     (10     (1.9     (269     (51.3

Other income

     107        357        (193     250        233.6        (550     (154.1

 

The decrease in interest income in 2010 compared to 2009 and in 2009 compared to 2008 was primarily attributable to lower average cash and cash equivalent balances as well as a decrease in interest rates.

 

The increase in interest expense in 2010 compared to 2009 was primarily attributable to the issuance of $6.0 million of convertible debt at an interest rate of 9% in June 2010 and July 2010 and an increase in average debt outstanding on bank loans. Interest expense in 2009 was flat compared to 2008.

 

The decrease in other income in 2010 compared to 2009 was primarily due to a $193,000 loss in 2010 compared to a $174,000 gain in 2009 attributable to the change in the fair value of convertible preferred stock warrants.

 

The increase in other income in 2009 compared to 2008 was primarily due to a $174,000 gain in 2009 compared to a $45,000 gain in 2008 attributable to the change in the fair value of convertible preferred stock warrants.

 

Income Tax Benefit (Expense)

 

     Year Ended December 31,     Change 2008 v. 2009     Change 2009 v. 2010  
     2008      2009      2010     In Dollars     Percentage     In Dollars     Percentage  
     (Dollars in thousands)  

Income tax (expense) benefit

   $ 644       $ 50       $ (90   $ (594     (92.2 %)    $ (140     (280.0 %) 

 

The increase in income tax expense in 2010 compared to 2009 was primarily due to a $159,000 decrease in tax benefit related to our gain from discontinued operations recognized in 2009. Excluding this decrease in tax benefit, our tax expense in 2010 compared to 2009 was flat.

 

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In 2008 and 2009 we recognized a gain from discontinued operations which resulted in the recognition of a tax benefit equal to the portion of our net operating loss carryforward utilized to offset the tax expense associated with the gain from discontinued operations. Since the gain from discontinued operations in 2009 was less than the gain in 2008, the related tax benefit recognized in 2009 is less than in 2008.

 

Income (Loss) from Discontinued Operations, Net of Tax

 

     Year Ended December 31,      Change 2008 v. 2009     Change 2009 v. 2010  
     2008      2009      2010      In Dollars    

Percentage

    In Dollars     Percentage  
     (Dollars in thousands)  

Income (loss) from discontinued operations, net of tax

   $ 1,275       $ 291       $   —       $ (984     (77.2 %)    $ (291     (100.0 %) 

 

In June 2008, we sold our NVM intellectual property business line for approximately $5.2 million in cash proceeds, resulting in a gain of $1.3 million net of income tax expense of $698,000. Of the total proceeds, $450,000 was restricted pending resolution of sales contingencies. In 2009, the contingencies were resolved and the $450,000 deferred gain was recorded, net of income tax expense of $159,000. Historical financial results for our NVM intellectual property business have been reclassified as discontinued operations for all periods.

 

Quarterly Results of Operations

 

The following tables set forth selected unaudited quarterly statements of operations data for the last five fiscal quarters, as well as the percentage that each line item represents of total net revenue. The financial statements for each of these quarters have been prepared on the same basis as the audited financial statements included elsewhere in this prospectus and, in the opinion of management, reflect all adjustments, which include solely normal recurring adjustments, necessary to a fair statement of our results of operations and financial position for these periods. These data should be read in conjunction with the audited financial statements and accompanying notes included elsewhere in this prospectus. These quarterly operating results are not necessarily indicative of our operating results for any future period.

 

     Three Months Ended  
     Mar 31,
2010
     June 30,
2010
     Sep 30,
2010
     Dec 31,
2010
     March 31,
2011
 
     (Unaudited)
(In thousands, except per share data)
 

Revenue:

              

Product revenue

   $ 4,640       $ 6,362       $ 7,246       $ 10,973       $ 11,397   

Development, service and licensing revenue

     500         773         684         619         868   
                                            

Total revenue

     5,140         7,135         7,930         11,592         12,265   

Costs of revenue:

              

Cost of product revenue

     2,455         3,423         3,877         7,253         6,325   

Cost of development, service and licensing revenue

     111         154         132         206         472   
                                            

Total cost of revenue

     2,566         3,577         4,009         7,459         6,797   
                                            

Gross profit

     2,574         3,558         3,921         4,133         5,468   

 

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     Three Months Ended  
     Mar 31,
2010
    June 30,
2010
    Sep 30,
2010
    Dec 31,
2010
    March 31,
2011
 
     (Unaudited)
(In thousands, except per share data)
 

Operating expenses:

          

Research and development

     2,389        2,767        3,042        2,464        2,781   

Selling and marketing

     1,957        2,056        2,038        2,205        2,375   

General and administrative

     1,241        1,437        1,327        1,570        1,594   
                                        

Total operating expenses

     5,587        6,260        6,417        6,239        6,750   
                                        

Loss from operations

     (3,013     (2,702     (2,496     (2,106     (1,282

Interest income (expense) and other, net

     (55     (67     (387     (469     (495
                                        

Net loss before income tax (expense) benefit

     (3,068     (2,769     (2,883     (2,575     (1,777

Income tax (expense) benefit

     (19     (38     (23     (10     (24
                                        

Net loss

   $ (3,087   $ (2,807   $ (2,906   $ (2,585   $ (1,801
                                        

 

     Three Months Ended(1)  
     Mar 31,
2010
    June 30,
2010
    Sep 30,
2010
    Dec 31,
2010
    March 31,
2011
 
     (Unaudited)  

Revenue:

          

Product revenue

     90.3     89.2     91.4     94.7     92.9

Development, service and licensing revenue

     9.7        10.8        8.6        5.3        7.1   
                                        

Total revenue

     100.0        100.0        100.0        100.0        100.0   

Costs of revenue:

          

Cost of product revenue

     52.9        53.8        53.5        66.1        55.5   

Cost of development, service and licensing revenue

     22.2        19.9        19.3        33.3        54.4   

Total cost of revenue

     49.9        50.1        50.6        64.4        55.4   

Gross margin

     50.1        49.9        49.5        35.7        44.6   

Operating expenses:

          

Research development

     46.5        38.8        38.4        21.3        22.7   

Selling and marketing

     38.1        28.8        25.7        19.0        19.4   

General and administrative

     24.1        20.1        16.9        13.5        13.0   
                                        

Total operating expenses

     108.7        87.7        81.0        53.8        55.1   
                                        

Loss from operations

     (58.6     (37.9     (31.5     (18.2     (10.5

Interest income and other, net

     (1.1     (0.9     (4.9     (4.0     (4.0
                                        

Net loss before income tax (expense) benefit

     (59.7     (38.8     (36.4     (22.2     (14.5

Income tax (expense) benefit

     (0.4     (0.5     (0.3     (0.1     (0.2
                                        

Net loss

     (60.1     (39.3     (36.7     (22.3     (14.7
                                        

 

(1)   Percentages from certain line items do not sum to the subtotal or total of those line items due to rounding.

 

Beginning in 2010 we experienced a substantial increase in demand for our products as end users significantly expanded deployments of UHF Gen2 solutions. In addition, prior to 2010 we generated a substantially larger percentage of our revenue from NRE engagements. Although we intend to continue to pursue development contracts with strategic end users, given the maturation of the ecosystem of UHF Gen2 providers and the expected demand for our products, we expect development, service and licensing revenue to be less on a percentage of total revenue basis than it was prior to 2010. As a result, we do not believe that comparisons of our quarterly results prior to 2010 to subsequent periods are helpful.

 

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Our operating results fluctuate from quarter to quarter as a result of a variety of factors. Our ability to meet demand for our Monza tag ICs was constrained by supply of Monza wafers during the last three quarters of 2010. In the fourth quarter of 2010, gross margins were adversely affected as certain customers who had ordered Monza 3 ICs accepted our offer to deliver Monza 4 ICs at reduced prices in response to supply constraints. Fourth quarter 2010 product margins were also adversely affected by a decrease in wafer yield resulting from transitory problems encountered in connection with a change in our Monza post-processing. In addition, development gross margins were adversely affected in fourth quarter of 2010 and first quarter of 2011, due to the the variability of the terms of our development projects. Our first quarter 2011 results benefited from sales of products deferred in fourth quarter 2010 due to supply constraints. Research and development expense increased in the third quarter of 2010 due to a $333,000 expense related to expanding the number of foundries that could manufacture our Monza silicon wafers.

 

Retailers typically do not install or change infrastructure during the holiday season in the fourth calendar quarter. Consequently, we have experienced and expect to continue to experience decreased sales of readers and other UHF Gen2 infrastructure products to retailers during the fourth quarter.

 

Liquidity and Capital Resources

 

As of March 31, 2011, we had cash, cash equivalents and short-term marketable securities of $12.1 million, which primarily consisted of cash deposits and money market funds held at major financial institutions. Since inception, we have financed our operations primarily through private sales of equity and, to a lesser extent, from borrowings. Our principal uses of cash are funding our operations, debt service payments, as described below, and capital expenditures.

 

Sources of Funds

 

We believe, based on our current operating plan, that our existing cash and cash equivalents and available borrowings under our credit facility will be sufficient to meet our anticipated cash needs for at least the next 12 months.

 

From time to time, we may explore additional financing sources and means to lower our cost of capital, which could include equity, equity-linked and debt financing. In addition, in connection with any future acquisitions, we may require additional funding which may be provided in the form of additional debt, equity or equity-linked financing or a combination thereof. There can be no assurance that any additional financing will be available to us on acceptable terms.

 

Credit Facility. In May 2010, we entered into a loan and security agreement, which we refer to as our credit facility, pursuant to which we (1) incurred $1.5 million in term loan borrowings and were allowed to incur an additional $500,000 of term loan borrowings prior to January 31, 2011 and (2) from time to time could incur revolver borrowings of up to the lesser of $4.0 million and a borrowing base tied to the amount of eligible accounts. The credit facility also provides for the issuance of letters of credit, foreign exchange forward contracts and cash management services; however, the amount of revolver borrowings available to us is reduced by any such indebtedness that we incur. Interest on term loan borrowings accrues at a floating rate equal to the greater of 5.0% and the lender’s prime rate plus 0.5%. We are required to repay the initial term loan borrowings in 24 equal monthly installments beginning on May 1, 2011 and any subsequent term loan borrowings in 27 equal monthly installments beginning on the first day of the month following the day on which such indebtedness was incurred. We may at our option prepay all of the term loan borrowings by paying the lender, among other things, all principal and accrued interest plus a make-whole premium. Interest on revolver borrowings accrues at a floating rate equal to the greater of the lender’s prime rate and 4.0% and is payable monthly.

 

In February 2011, such loan and security agreement was amended to provide for the incurrence of an additional $2.0 million of “Facility B” term loan borrowings. Interest on Facility B term loan borrowings accrues at a floating rate equal to the greater of 4.5% and the lender’s prime rate plus 1.25% and is payable monthly. We

 

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are required to repay the Facility B loan in 27 monthly installments beginning on October 1, 2011. We may at our option prepay all Facility B term loan borrowings by paying the lender, among other things, all principal and accrued interest plus a make-whole premium. In addition, the credit facility was amended to increase the amount of available revolver borrowings to $10.0 million, to provide for interest on revolver borrowings at a floating rate equal to the lender’s prime rate plus 0.75%, to extend the maturity date to February 1, 2013 and to provide for monthly payments. The U.S. Export-Import Bank has agreed to guarantee up to $6.8 million of revolver borrowings incurred under the credit facility to finance the cost of manufacturing, purchasing or selling items intended for export.

 

The credit facility contains customary conditions to borrowing, events of default and covenants, including covenants that restrict our ability to dispose of assets, merge with or acquire other entities, incur indebtedness, incur encumbrances, make distributions to holders of our capital stock, make investments or engage in transactions with our affiliates. The credit facility also requires us to maintain a minimum tangible net worth and liquidity ratio. We were in compliance with such covenants as of December 31, 2010 and March 31, 2011. Our obligations under the credit facility are secured by substantially all of our assets other than intellectual property.

 

Mezzanine Term Loan Facility. In March 2011, we entered into a loan and security agreement with the same lender as under the credit facility, which we refer to as the mezzanine credit facility, pursuant to which we incurred $10.0 million in term loan borrowings. Interest on term loan borrowings incurred under the mezzanine credit facility accrues at a fixed rate equal to 11.0% per year and is payable monthly. The principal amount of all outstanding borrowings under the mezzanine credit facility is payable on March 25, 2013. We may, at our option, prepay all borrowings without penalty by paying the lender all principal and accrued interest with respect to such term loan borrowing. The mezzanine credit facility contains customary events of default and covenants that are substantially similar to those contained in the credit facility, except for certain covenants relating to reporting, tangible net worth and liquidity ratio requirements which are omitted from the mezzanine credit facility. We were in compliance with such covenants as of December 31, 2010 and March 31, 2011. Our obligations under the loan and security agreement are secured by substantially all of our assets other than intellectual property. In addition, we entered into a success fee agreement in connection with the mezzanine loan facility, which requires us to pay a success fee if we are acquired or we sell all or substantially all of our assets. The success fee agreement will automatically terminate upon the completion of the offering contemplated by this prospectus.

 

As of March 31, 2011, we had approximately $1.5 million of term loan borrowings, $400,000 of Facility B term loan borrowings, $10.0 million of mezzanine borrowings and $7.7 million of revolver borrowings outstanding, which accrue interest at 5.0%, 5.0%, 11.0% and 4.0%, respectively.

 

We issued the lender warrants to purchase 24,059 and 17,498 shares of our Series E preferred stock in June 2010 and February 2011, respectively, in connection with entering into the credit facility and amendment described above. Such warrants have a ten year terms and an exercise price of $2.286 per share. We issued the lender a warrant to purchase 300,000 shares of our common stock in connection with entering into the mezzanine credit facility in March 2011. Such warrant has a ten year term and an exercise price of $0.21 per share.

 

Convertible Promissory Notes. In June and July 2010, we issued approximately $6.0 million aggregate principal amount of our subordinated secured convertible promissory notes to existing investors. Interest on the subordinated secured convertible promissory notes accrues interest on the unpaid principal balance at 9.0% per year, and all unpaid principal, accrued interest and any other amounts payable under the subordinated secured convertible promissory notes are due and payable on the earlier to occur of: (1) June 30, 2011, (2) when upon the occurrence and during the continuance of an event of default listed in the subordinated secured convertible promissory notes, such amounts are declared due and payable by the investor; provided, the subordinated secured convertible promissory notes shall become payable immediately prior to the closing of a liquidation event, including an initial public offering; provided further that, if a liquidity event has not occurred prior to the scheduled maturity date, the maturity date may be extended by the vote of holders of more than 60% of the then outstanding aggregate principal amount of the subordinated secured convertible promissory notes. We expect that the maturity date of the subordinated secured convertible promissory notes will be extended if the offering

 

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contemplated by this prospectus is consummated after the scheduled maturity date. We are required to repay all the outstanding principal amount of the subordinated secured convertible promissory notes and all accrued and unpaid interest on the subordinated secured convertible promissory notes plus a premium equal to the sum of the outstanding principal and accrued interest on the subordinated secured convertible promissory notes in connection with the consummation of an initial public offering; however, holders of at least $100,000 aggregate principal amount of notes may, at their option, convert the principal amount of their notes plus accrued and unpaid interest into (1) shares of our Series E preferred stock at a conversion price of $2.286 per share (which conversion price is subject to adjustments for stock splits, reverse stock splits, stock dividends and the like) or (2) if all of the shares of our Series E preferred stock are converted into shares of our common stock, a number of shares of common stock that holders would have received had they converted their notes into Series E preferred stock immediately prior to the conversion pursuant to our certificate of incorporation. The subordinated secured convertible promissory notes contain customary events of default and covenants. We were in compliance with such covenants as of March 31, 2011. Our obligations under the subordinated secured convertible promissory notes are secured by substantially all of our assets other than intellectual property. Note holders have agreed not to pursue repayment of any indebtedness under the subordinated secured convertible promissory notes or under any other instrument or writing evidencing our indebtedness to them while there are outstanding borrowings under the credit facility and mezzanine credit facility. As of March 31, 2011, total outstanding aggregate principal and accrued interest for the subordinated secured convertible promissory notes was approximately $6.4 million.

 

In addition, we issued warrants to purchase an aggregate of 890,721 shares of our Series E preferred stock at a purchase price per share of $2.286 to the holders of subordinated secured convertible promissory notes. Such warrants will be exercised automatically on a net exercise basis in connection with the offering contemplated by this prospectus if the initial per share price to public exceeds the exercise price of the warrants; otherwise the warrants will expire upon the closing of the offering.

 

Loan and Security Agreement. In October 2007, we entered into a loan and security agreement pursuant to which we could incur up to $10.0 million in indebtedness. Interest on each advance under the agreement accrued at the lower of (1) 14.0% and (2) the greater of 11.50% and the lender’s prime rate plus 4.25%. We were required to pay interest only for the first 24 months of the agreement, subsequent to which we were required to pay 15 equal monthly installments of principal and interest. All of the indebtedness incurred under such loan and security agreement was repaid in connection with the entry into our credit facility. We also issued the lender warrants to purchase 218,723 shares of our Series E convertible redeemable preferred stock. Each of such warrants has a seven year term and an exercise price of $2.286 per share. Following the completion of the offering contemplated by this prospectus, such warrants will be exercisable for shares of our common stock.

 

Use of Funds

 

Our principal uses of cash are our operating expenses, satisfaction of our obligations under our debt instruments, debt repayment and other working capital requirements. We employ a fabless manufacturing model by outsourcing production of our products to third-party trailing edge CMOS manufacturers. This capital-efficient operating model is designed to scale efficiently as our volume grows, allowing us to focus our resources on developing new products and solutions.

 

We may need to raise additional funds to support our operations, and such funding may not be available to us on acceptable terms, or at all. If we are unable to raise additional funds when needed, our operations and ability to execute our business strategy could be adversely affected. We may seek to raise additional funds through public or private debt or equity financings. If we raise additional funds through the incurrence of indebtedness, such indebtedness would have rights that are senior to holders of our common stock and could contain covenants that restrict our operations. Any additional equity financing may be dilutive to our stockholders.

 

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Historical Cash Flow Trends

 

The following table shows a summary of our cash flows for the periods indicated:

 

     Years Ended December 31,     Three Months Ended
March 31,
 
     2008     2009     2010     2010     2011  
           (Unaudited)  
     (In thousands)  

Cash used in operating activities

   $ (16,690   $ (8,853   $ (14,601   $ (3,190   $ (8,236

Cash provided by investing activities

     14,511        11,852        3,572        2,377        819   

Cash provided by (used in) financing activities

     (117     (427     10,161        (445     13,626   

 

Operating Cash Flows. Net cash used in operating activities in each of the periods presented was primarily a result of net losses, investments in inventory and an increase in accounts receivable. In the latter part of 2010, we were unable to meet demand for our Monza tag ICs due to inadequate wafer supply. Consequently, in the first quarter of 2011 we purchased more than six months of our forecasted Monza tag IC wafer supply using borrowings from our mezzanine term loan facility. We will carry more inventory in 2011 than in prior years. Our accounts receivable balance increased as a result of increased revenue in the three months ended March 31, 2011. We expect accounts receivable to grow as our revenue increases because a significant portion of our revenue occurs late in the quarter. Net cash used in operating activities in the three months ended March 31, 2011 consisted of a $1.8 million net loss, $6.6 million increase in inventory, a $1.9 million increase in accounts receivable, a $733,000 increase in prepaid expenses and a $368,000 decrease in accounts payable and accrued liabilities, partially offset by a $1.5 million increase in deferred revenue. Net cash used in operating activities in the three months ended March 31, 2010 consisted of a $3.1 million net loss, a $1.7 million increase in accounts receivable and a $801,000 increase in inventory, partially offset by a $1.1 million increase in accounts payable and accrued expenses and a $695,000 increase in deferred revenue.

 

Net cash used in operating activities in 2010 consisted of an $11.4 million net loss, a $6.7 million increase in accounts receivable due to a significant increase in revenue during the fourth quarter of 2010 compared to 2009 and a $6.6 million increase in inventory as we purchased inventory in December 2010 to meet an increase in forecasted demand for our products in the first quarter of 2011, partially offset by a $6.1 million increase in accounts payable and accrued expenses primarily due to the purchase of additional inventory and a $441,000 increase in deferred revenue. Net cash used in operating activities in 2009 consisted of a $9.9 million net loss, a $1.0 million increase in accrued liabilities and a $667,000 decrease in deferred revenue partially offset by a $1.3 million decrease in accounts receivable. Net cash used in operating activities in 2008 consisted of an $11.9 million net loss, a $1.8 million decrease in deferred revenue, a $1.1 million increase in cash used for discontinued operations, a $926,000 decrease in accounts payable and accrued liabilities, a $436,000 increase in accounts receivable and a $226,000 increase in inventory. In 2009, we used approximately $7.8 million less cash for operating activities than in 2008. This decreased use of cash was primarily attributable to a decrease in spending and working capital used for research and development and general and administrative activities as a result of reducing our staffing levels to better align our expenses with expected revenue. In addition, in 2008, we sold our NVM intellectual property business in which we used $1.1 million for operating activities in 2008.

 

Investing Cash Flows. Net cash provided by investing activities in the three months ended March 31, 2011 consisted of $900,000 of the maturity of marketable securities and release of restricted cash of $100,000, partially offset by the purchase of $181,000 of equipment. Net cash provided by investing activities in the three months ended March 31, 2010 consisted of $2.4 million net effect of the maturities and purchases of marketable securities. Net cash provided by investing activities in 2010 was primarily as the result of the approximately $3.7 million net effect of the maturities and purchases of marketable securities, and the release of $349,000 of restricted cash partially offset by the purchase of $468,000 of equipment. Net cash provided by investing activities in 2009 was primarily the result of the approximately $11.3 million net effect of the maturities and purchases of marketable securities, and the release of $672,000 of restricted cash partially offset by the purchase of $100,000 of equipment. Net cash provided by investing activities in 2008 was primarily as the result of the

 

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approximately $10.0 million net effect of the maturities and purchases of marketable securities, an increase in restricted cash of $141,000 and $5.2 million from the sale of our NVM line of business, partially offset by the purchase of $308,000 of equipment. We expect to continue to increase investments in property and equipment in 2011 as we expand our operations.

 

Financing Cash Flows. Net cash provided by financing activities in the three months ended March 31, 2011 and 2010 was primarily due to the incurrence of indebtedness as discussed above. In 2010, net cash provided by financing activities consisted of aggregate net proceeds of $6.0 million from the subordinated secured convertible promissory notes and net incurrence of debt under our credit facility of $4.3 million for working capital. In 2009, net cash used by financing activities consisted of payments with respect to our loan and security agreement and capital lease obligations. In 2008 net cash used in financing activities consisted of payments with respect to our capital lease obligations partially offset in part by proceeds from the issuance of our common stock upon exercise of employee stock options.

 

Contractual Obligations

 

The following table reflects a summary of our contractual obligations as of March 31, 2011:

 

     Payments due by period  

Contractual Obligations

   Total      Less than
1 Year
     1-3
Years
     3-5
Years
     More than
5 Years
 
     (In thousands)  

Credit facilities

   $ 19,618       $ 910       $ 18,708       $       $   

Subordinated secured convertible promissory notes—related parties

     6,396         6,396                           

Operating lease obligations(1)

     2,852         566         1,558         728           

Capital lease obligations(2)

     533         216         305         12           

Other obligations(3)

     10,780         10,780                           
                                            

Total

   $ 40,179       $ 18,868       $ 20,571       $ 740       $   
                                            

 

(1)   Includes the minimum rental payments for our corporate office building in Seattle, Washington.
(2)   Consists of the minimum rental payments plus imputed interest expense on our leased equipment.
(3)   Consists of obligations to purchase inventory.

 

Critical Accounting Policies and Significant Estimates

 

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue and expenses at the date of the financial statements. Generally, we base our estimates on historical experience and on various other assumptions in accordance with GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under other assumptions or conditions.

 

Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies and estimates include those related to:

 

   

revenue recognition;

 

   

accounts receivable;

 

   

inventory;

 

   

goodwill and long-lived assets;

 

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income taxes;

 

   

fair value measurements; and

 

   

stock-based compensation.

 

Revenue Recognition

 

We generate revenue from sales of our hardware products, software, development and service contracts and licensing agreements. We recognize product revenue when: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and there are no significant post-delivery obligations remaining; (3) the price is fixed or determinable; and (4) collection is probable.

 

Product Revenue. Hardware products are typically considered delivered upon shipment. Certain arrangements contain provisions for customer acceptance. Where we are unable to demonstrate that the customer acceptance provisions are met on shipment, revenue is deferred until all acceptance criteria have been met or the acceptance clause or contingency lapses.

 

For the sale of products to a distributor, we evaluate our ability to estimate returns, considering a number of factors, including the geography in which a sales transaction originates, payment terms and our relationship and past history with the distributor. If we are not able to estimate returns at the time of sale to a distributor, revenue recognition is deferred until there is persuasive evidence indicating the product has sold-through to an end user. Persuasive evidence of sell-through may include reports from distributors documenting sell-through activity, data indicating an order has shipped to an end user or other similar information. At the time of revenue recognition, we record reserves for estimated sales returns and stock rotation arrangements. Sales returns and stock rotation reserves are estimated based on a number of factors, including historical activity, forecasted demand in relation to inventory levels, expected price changes, expected timing of new product releases and other related factors. We monitor and analyze actual experience and adjust these reserves on a quarterly basis. It is possible that these estimates will change in the future or that the actual amounts could differ from our estimates.

 

Our Speedway reader products are sold in combination with services, which primarily consist of hardware and software support. Hardware support includes Internet access to technical content, repair or replacement of hardware in the event of breakage or failure and telephone and Internet access to technical support personnel during the term of the support period. Software is integrated with our Speedway reader products and is essential to the functionality of the integrated products.

 

In October 2009, the Financial Accounting Standards Board, or FASB, amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to: (1) provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated and how the consideration should be allocated; (2) require an entity to allocate revenue in an arrangement using best estimated selling prices, or ESP, of deliverables if a vendor does not have vendor-specific objective evidence of selling price, VSOE, or third-party evidence of selling price, or TPE; and (3) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. We elected to early adopt this accounting guidance at the beginning of 2010 on a prospective basis for applicable transactions originating or materially modified after January 1, 2010. This guidance does not generally change the units of accounting for our revenue transactions.

 

For multi-element arrangements that include hardware products containing software essential to the hardware product’s functionality and undelivered software elements relating to the hardware product’s essential software, we allocate revenue to all deliverables based on their relative selling prices. In such circumstances, the newly adopted accounting principles establish a hierarchy to determine the selling price to be used for allocating

 

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revenue to deliverables as follows: (1) VSOE; (2) TPE; and (3) ESP. VSOE generally exists only when we sell the deliverable separately and is the price actually charged by us for that deliverable. When VSOE cannot be established, we attempt to establish the selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. We are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis and are therefore typically not able to determine TPE. When we are unable to establish selling price using VSOE or TPE, we use ESP in the allocation of arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis.

 

Our ESPs for the hardware and software products are calculated using a method consistent with the way management prices new products. We consider multiple factors in developing the ESPs for our products including our historical pricing and discounting practices, the costs incurred to manufacture the product, the nature of the customer relationship and market trends. In addition, we may consider other factors as appropriate, including the pricing of competitive alternatives if they exist and product-specific business objectives. We regularly review VSOE and ESP and maintain internal controls over the establishment and updates of these estimates. Estimating our ESP requires significant judgment. Changes in our judgment could materially impact the amount of revenue recognized.

 

We present revenue net of sales tax in our statement of operations. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.

 

Development, Service and Licensing Revenue. We account for nonrecurring engineering development contracts and license contracts that involve significant production, modification or customization of our products by generally recognizing the revenue over the performance period under the percentage of completion, or POC, method measured on a cost incurred basis and when amounts are legally due under the terms of the agreement. Advance payments under these license and development contracts are deferred and recognized as revenue ratably over the contract period. Under the POC method of accounting, sales and gross profit are recognized as work is performed based on the relationship between actual costs incurred and total estimated costs at the completion of the contract. Changes to the original estimates may be required during the life of the contract. Estimates are reviewed periodically and the effect of any change in the estimated gross margin percentage for a contract is reflected in cost of sales in the period the change becomes known. The use of the POC method of accounting involves considerable use of estimates and judgments in determining revenue, costs and profits and in assigning the amounts to accounting periods. Changes in our judgment could materially impact the amount of revenue recognized.

 

We recognize revenue in accordance with industry specific software accounting guidance for stand alone software licenses and related support services. Revenue from license agreements that do not require significant production, modification or customization of our software is generally recognized when: (1) delivery has occurred; (2) there is no customer acceptance clause in the contract; (3) there are no significant post-delivery obligations remaining; (3) the price is fixed; and (4) collection of the resulting receivable is reasonably assured. For transactions, where we have established VSOE for the fair value of support services as measured by the renewal prices paid by our customers when the services are sold separately on a stand alone basis, we use the residual method to determine the amount of software product revenue to be recognized. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the sales amount is recognized as license revenue. Support services revenue is deferred and recognized ratably over the period during which the services are to be performed, which is typically from one to three years. In those instances where we have not established VSOE of our support services, the license and service revenue is recognized on a straight-line basis over the support period.

 

Amounts allocated to the support services sold with our Speedway reader products are deferred and recognized on a straight-line basis over the support services term.

 

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Accounts Receivable

 

Accounts receivable consist of amounts billed currently due from customers net of an allowance for doubtful accounts and an allowance for sales returns. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in existing accounts receivable and is determined based on historical write-off experience, the creditworthiness of our customers and market and economic conditions. Account balances are written off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Estimating uncollectible accounts requires considerable judgment. Changes in our judgments or actual losses greater than estimated could have a material impact on our results of operations, financial position and cash flows.

 

Inventory

 

Inventory consists of a combination of raw materials, work-in-progress and finished goods and are stated at the lower of cost and market. Cost is determined using the average costing method, which approximates the first in, first out, or FIFO, method. Reserves for excess and obsolete inventory are established based on our analysis of inventory levels and future sales forecasts. Inventory write-downs are included in cost of revenue and were $894,000, $0 and $592,000 for the years ended December 31, 2008, 2009 and 2010, respectively, and $14,000 and $109,000 for the three months ended March 31, 2010 and 2011, respectively. We specifically identify inventory to write down by considering various factors including inventory age, forecasted demand, new product release schedules, market conditions and other related factors. Given our decision to significantly increase our inventory levels in an effort to avoid wafer shortages later in 2011, similar to those experienced in 2010, we placed considerable weight on our sales forecasts for the next nine to 12 months for each inventory item in evaluating our inventory value at December 31, 2010 and March 31, 2011. Estimating the value of our inventory requires considerable judgment. Changes in our judgment could have a material impact on our results of operations, financial position and cash flows.

 

Goodwill; Intangibles and Long Lived Assets

 

Goodwill represents the excess of the purchase price over the fair value of the net identified assets acquired in a business combination. We evaluate the goodwill which is assigned to our Indy reader IC reporting unit for impairment on an annual basis on September 30 or when indicators for impairment exist. Indicators of impairment would include the impacts of significant adverse changes in legal factors; market and economic conditions; the result of our operational performance and strategic plans; adverse actions by regulators; unanticipated changes in competition and market share; and the potential for sale or disposal of all or a significant portion of our business. A significant impairment could have a material adverse effect on our financial position and results of operations. No impairment charge for goodwill was recorded during the years ended December 31, 2008, 2009 and 2010. The assessment of whether our goodwill is impaired requires significant judgment. Changes in our judgment or the consideration of additional unknown factors could have a material impact on our results of operations, financial position and cash flows.

 

Long-lived assets include property and equipment life. We assess the carrying value of our long-lived assets and intangible assets with a definite life when indicators of impairment exist and recognize an impairment loss when the carrying amount of an asset is not recoverable from the undiscounted cash flows expected to result from the use and eventual disposition of the asset. Impairment losses are measured by comparing the carrying amount of a long-lived asset to its fair value. Indicators of impairment would include the impacts of significant adverse changes in legal factors; market and economic conditions; the result of our operating performance and strategic plans; adverse actions by regulators; unanticipated changes in competition; and market conditions. The assessment of whether our intangible assets are impaired requires significant judgment. Changes in our judgment or the consideration of additional unknown factors could have a material impact on our results of operations, financial position and cash flows.

 

Identifiable intangible assets are comprised of purchased customer lists, patents and developed technologies. Identifiable intangible assets are amortized over their estimated useful lives, ranging from seven to eight years

 

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for customer lists, four years for developed technology and seven years for patents, using the straight-line method. Changes in the estimated useful lives of our intangible assets could have a material impact on our results of operations and financial position.

 

Property and equipment are recorded at cost. Depreciation is determined using the straight-line method over the estimated useful life of the assets. Additions and improvements that increase the value or extend the life of an asset are capitalized. Ordinary repairs and maintenance are expensed as incurred. Assets under capital leases and leasehold improvements are amortized over the shorter of the term of the lease or the estimated useful life of the asset. Changes in the estimated useful lives of our property and equipment could have a material impact on our results of operations and financial position.

 

Income Taxes

 

We use the liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when such assets and liabilities are recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the year that includes the enactment date. We determine deferred tax assets including net operating losses and liabilities, based on temporary differences between the book and tax bases of assets and liabilities. We believe that it is currently more likely than not that our deferred tax assets will not be realized and as such, a full valuation allowance is required.

 

We utilize a two-step approach for evaluating uncertain tax positions. Step one, recognition, requires us to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes, if any. If a tax position is not considered “more likely than not” to be sustained, no benefits of the position are recognized. If we determine that a position is “more likely than not” to be sustained, then we proceed to step two, measurement, which is based on the largest amount of benefit which is more likely than not to be realized on effective settlement. This process involves estimating our actual current tax exposure, including assessing the risks associated with tax audits, together with assessing temporary differences resulting from the different treatment of items for tax and financial reporting purposes. If actual results differ from our estimates, our net operating loss and credit carryforwards could be materially impacted.

 

At December 31, 2010, we had federal net operating loss carryforwards, or NOLs, of approximately $105.9 million and federal research and experimentation credit carryforwards of approximately $5.1 million, which may be used to reduce future taxable income or offset income taxes due. These NOLs and credit carryforwards expire beginning in 2020 through 2029.

 

Our realization of the benefits of the NOLs and credit carryforwards is dependent on sufficient taxable income in future fiscal years. We have established a valuation allowance against the carrying value of our deferred tax assets, as it is not currently more likely than not that we will be able to realize these deferred tax assets. In addition, utilization of NOLs and credits to offset future income subject to taxes may be subject to substantial annual limitations due to the “change in ownership” provisions of the Internal Revenue Code of 1986, or the Code, and similar state provisions. Events that cause limitations in the amount of NOLs that we may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined by Code Section 382, over a three-year period. Utilization of our NOLs and tax credit carryforwards could be significantly reduced if a cumulative ownership change of more than 50% has occurred in our past or occurs in our future.

 

We do not anticipate that the amount of our existing unrecognized tax benefits will significantly increase or decrease within the next 12 months. Due to the presence of NOLs in most jurisdictions, our tax years remain open for examination by taxing authorities back to 2000.

 

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Fair Value Measurements

 

We record short-term investments and preferred stock warrant liabilities at fair value. We establish fair value of our assets and liabilities using the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price) and a fair value hierarchy based on the inputs used to measure fair value. The three levels of the fair value hierarchy are as follows:

 

Level 1—Quoted prices in active markets for identical instruments.

 

Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

 

Level 3—Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

 

Whenever possible, we use observable market data and rely on unobservable inputs only when observable market data is not available. Our preferred stock warrants are categorized as Level 3 because they were valued based on unobservable inputs and our judgment due to the absence of quoted market prices, inherent lack of liquidity and the long-term nature of such financial instruments. We perform a fair value assessment of the preferred stock warrant inputs on a quarterly basis using the Black-Scholes model. The assumptions used in the Black-Scholes model are inherently subjective and involve significant judgment. Changes in our judgments could have a material impact on our results of operations and financial position. Any change in fair value is recognized as a component of other income (expense) on the statements of operations.

 

Stock-Based Compensation

 

We have granted stock options at exercise prices believed to be equal to the fair market value of the common stock underlying such options as determined by our board of directors, with input from management, on the date of grant. Because our common stock is not currently publicly traded, our board of directors exercises significant judgment in determining the fair market value of our common stock. Changes in our judgments could have a material impact on our results of operations and financial position. Members of our board of directors and management team have extensive business, financial and investing experience. In assessing the fair value of our common stock as of option grant dates, our board of directors considered numerous objective and subjective factors including:

 

   

our financial projections and future prospects;

 

   

the current lack of marketability of our common stock as a private company;

 

   

the stock price performance of comparable public companies;

 

   

the hiring of key personnel;

 

   

the likelihood of achieving a liquidity event for the shares of common stock underlying the options, given prevailing market conditions;

 

   

our results of operations, history of losses and other financial metrics

 

   

conditions in our industry and the economy generally; and

 

   

valuations of our common stock performed as of January 1, June 30, September 30 and December 31, 2010.

 

As of each stock option grant date listed below, our board of directors believes it made a thorough evaluation of the relevant factors to determine the fair market value of our common stock and accordingly set the exercise price of the options granted equal to its estimate of the fair value of our common stock determined as of such date. On each option grant date, our board of directors considered the most recent valuation of our common

 

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stock as one of several factors in estimating the fair market value of our common stock. In addition, our board of directors considered changes in our financial condition that had occurred subsequent to the previous valuation date, then current general economic and market conditions as described more fully below and the other objective and subjective factors described above. Based on these considerations, our board of directors also determined that no significant change in our business or expectations of future business had occurred as of each grant date since the most recent valuation that would have warranted a materially different determination of value of our common stock than that suggested by the valuation. The valuations were consistent with the guidance and methods outlined in the AICPA Practice Aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or AICPA Practice Aid, for all option grant dates listed below.

 

January 2010 Valuation. In conducting the January 2010 valuation of our common stock we used a two-step methodology. First we estimated the market value of invested capital, or MVIC, of us as a whole (which is defined as interest-bearing debt plus market value of preferred and common equity), and then we allocated the enterprise value to each element of the capital structure, including our common stock, to determine the fair value of a single share of common stock.

 

We estimated our MVIC using the market and guideline public company approaches. The market approach entailed analyzing acquisitions involving companies similar to us and our acquisition of the UHF RFID assets from Intel Corporation and applying the MVIC to revenue ratios implied by such acquisitions to our revenue projections. The market approach suggested that our MVIC was between $73.0 million and $126.5 million, and we used their average, $84.6 million.

 

The guideline public company approach entailed applying the stock price to revenue ratios of public companies similar to us to our revenue projections. The guideline public company approach suggested that our MVIC was between $38.2 million and $53.7 million, and we used their average, approximately $46.0 million. The valuation suggested by the guideline public company approach was less than that suggested by the market approach because it assumed the sale of our shares that represent a minority interest of our capital stock instead of the sale of control of us.

 

The resulting estimates of our MVIC were then allocated to the various securities that comprise our capital structure, using the Black-Scholes option-pricing model. This option pricing model treats the rights of the holders of preferred and common stock as equivalent to that of call options on any value of the enterprise above certain break points of value based on the claims of lenders and the liquidation preferences and rights of participation and conversion of the holders of preferred stock. To determine the break points, we made estimates of the anticipated timing of a potential acquisition of us and estimates of the volatility of our equity securities based on available information on volatility of stocks of publicly-traded companies similar to ours.

 

We applied the Black-Scholes option model based on a liquidity event that would occur one to five years in the future. We assumed volatilities of our common stock of 50% and 70%, which corresponds to the upper half of the range of the volatilities of common stock of the publicly-traded companies deemed to be similar to us. The risk-free interest rate was based on U.S. Treasury Securities matching the expected timing of the liquidity event. Based on this information, we determined the total value of each security. A discount was then applied to reflect the lack of marketability of our common stock based on put option analyses of the publicly-traded companies deeded to be similar to us. Such discounts ranged from 29% for a liquidity event assumed to occur in one year to 34% for a liquidity event assumed to occur in five years.

 

Finally, we considered two possible scenarios: (1) a change of control transaction and (2) the sale by a common stockholder of shares that represent a minority interest in a private company. At the time of the January 2010 valuation, we did not consider an initial public offering as a third potential liquidity event because we deemed the likelihood of such a scenario was remote. We applied a range of probabilities for the two scenarios, beginning with the probability of a change of control and sale of a minority interest of 80% and 20%, respectively, and ending with 40% and 60%, respectively. The fair market value of our common stock suggested by the January 2010 valuation was $0.03 to $0.08 per share.

 

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June 2010 Valuation. The June 2010 valuation was conducted using substantially the same methodology as the January 2010 valuation. We did not consider an initial public offering as a third potential liquidity event because, at the time of such valuation, the values suggested by such scenario appeared to be less favorable compared to a change of control transaction. The fair market value of our common stock suggested by the June 2010 valuation was $0.04 to $0.10 per share.

 

September 2010 Valuation. The September 2010 valuation was conducted using substantially the same methodology as the January 2010 valuation. We did not consider an initial public offering as a third potential liquidity event because, at the time of such valuation, the values suggested by such scenario appeared to be less favorable compared to a change of control transaction. The fair market value of our common stock suggested by the September 2010 valuation was $0.05 to $0.11 per share.

 

December 2010 Valuation. The December 2010 valuation was conducted using substantially the same methodology as the January 2010 valuation; however, in addition to considering a change of control transaction and sale of a minority interest in a private company, we also considered the possibility that we would complete an initial public offering of our common stock. For the purpose of the December 2010 valuation, we fixed the probability of the sale of a minority interest in a private company at 40% and applied a range of probabilities for the other two scenarios, beginning with the probability of a change of control and sale of a minority interest of a public company of 40% and 20%, respectively, and ending with 20% and 40%, respectively. The fair market value of our common stock suggested by the January 2010 valuation was $0.12 to $0.21 per share.

 

In connection with the preparation of our financial statements for the year ended December 31, 2010 and the three months ended March 31, 2011, we assessed our estimate of fair value of our common stock for financial reporting purposes given our improving financial performance and prospects, evolving belief during the second half of 2010 and the first quarter of 2011 that an initial public offering was increasingly viable and the generally improving conditions in the capital markets. In the process of this assessment, we evaluated the stock price-to-revenue multiples of public companies we deemed similar to us in light of our historical and forecasted financial results. While these multiples had been one of the factors we considered in connection with our prior valuations, in connection with the assessment of the estimate of the fair value of our common stock for financial reporting purposes we determined that it was more appropriate to give much greater weight to revenue multiples given the increased likelihood of an initial public offering. We did not consider stock price-to-earnings multiples of such companies because we did not believe they would be meaningful given our stage of development. As a result of such assessment, we determined that for financial reporting purposes the fair value of our common stock was higher than the board of directors’ fair market value estimate for each of the option grant dates from May 26, 2010 through February 24, 2011. As a result, we retroactively adjusted the fair value per common share as of each such grant date based on the progress of our business at each relevant date, giving particular emphasis to the amount of revenue for each quarter relative to the total historical and forecasted revenue for the period we assessed.

 

From January 1, 2010 through the date of this prospectus, we granted stock options with exercise prices and fair value assessments as follows:

 

Grant Date

   Common Shares
Underlying
Options Granted
     Exercise Price
Per Share
     Fair Value
Per Common Share
for Financial
Reporting Purposes
at Grant Date
     Intrinsic Value
Per Underlying
Common Share
 

February 24, 2010

     55,000       $ 0.05