UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from to

Commission File Number: 001-37582

ADESTO TECHNOLOGIES CORPORATION

(Exact name of registrant as specified in its charter)

Delaware

16-1755067

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

Adesto Technologies Corporation
3600 Peterson Way
Santa Clara, CA 95054
(408) 400-0578

(Address and telephone number of Registrant’s executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


	Class		Outstanding at June 11, 2020
Common Stock, $0.0001 par value per share		31,249,484 shares


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Class A common stock	IOTS	The Nasdaq Stock Market

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ADESTO TECHNOLOGIES CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2020

INDEX

	PART I: FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (unaudited)	3
	Unaudited Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019	3
	Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2020 and 2019	4
	Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2020 and 2019	5
	Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the three months ended March 31, 2020 and 2019	6
	Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2019	8
	Notes to Condensed Consolidated Financial Statements (unaudited)	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	38
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.	Controls and Procedures	48
	PART II: OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	49
Item 1B.	Unresolved Staff Comments	75
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	75
Item 3.	Defaults Upon Senior Securities	75
Item 4.	Mine Safety Disclosures	75
Item 5.	Other Information	75
Item 6.	Exhibits	76
Signatures		77

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PART I: FINANCIAL INFORMATION

Item 1.Financial Statements

ADESTO TECHNOLOGIES CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)


	March 31,		December 31,
	2020		2019
Assets
Current assets:
Cash and cash equivalents	$	9,965	$	21,262
Restricted cash		504		460
Accounts receivable, net		38,074		40,492
Inventories		22,210		20,023
Prepaid expenses		1,678		2,052
Other current assets		1,007		249
Total current assets		73,438		84,538
Property and equipment, net		7,798		8,113
Intangible assets, net		27,320		29,108
Operating lease right-of-use assets		4,118		4,300
Other non-current assets		3,113		2,503
Goodwill		38,640		38,640
Total assets	$	154,427	$	167,202
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	24,245	$	22,844
Accrued compensation and benefits		1,941		5,279
Accrued expenses and other current liabilities		7,106		9,368
Price adjustments and other revenue reserves		3,453		3,640
Earn-out liability		2,000		2,911
Operating lease liabilities, current		1,266		1,230
Total current liabilities		40,011		45,272
Convertible long-term debt		57,264		56,589
Operating lease liabilities, non-current		4,400		4,726
Deferred tax liability, non-current		1,281		1,363
Other non-current liabilities		401		476
Total liabilities		103,357		108,426
Commitments and contingencies (See Note 10)
Stockholders' equity:
Preferred stock, $0.0001 par value, 5,000,000 shares authorized as of March 31, 2020 and December 31, 2019; no shares issued and outstanding as of March 31, 2020 and December 31, 2019		—		—
Common stock, $0.0001 par value, 100,000,000 shares authorized; 30,816,165 and 30,268,685 shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively		3		3
Additional paid-in capital		209,984		206,356
Accumulated other comprehensive income (loss)		(10)		309
Accumulated deficit		(158,907)		(147,892)
Total stockholders' equity		51,070		58,776
Total liabilities and stockholders’ equity	$	154,427	$	167,202

(1)	The condensed consolidated balance sheet as of December 31, 2019 was derived from the audited consolidated financial statements as of that date.

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADESTO TECHNOLOGIES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except share and per share data)
(unaudited)


	Three Months Ended
	March 31,
	2020		2019
Revenue, net	$	20,021	$	28,113
Cost of revenue		11,384		14,893
Gross profit		8,637		13,220
Operating expenses:
Research and development		7,664		7,522
Selling, general and administrative		8,823		7,935
Amortization of intangible assets		1,788		1,788
Acquisition related expenses		1,901		222
Impairment and other charges		—		1,694
Total operating expenses		20,176		19,161
Loss from operations		(11,539)		(5,941)
Other income (expense):
Interest expense, net		(1,515)		(1,370)
Other income, net		1,936		220
Total other income (expense), net		421		(1,150)
Loss before benefit from income taxes		(11,118)		(7,091)
Benefit from income taxes		(103)		(31)
Net loss	$	(11,015)	$	(7,060)
Net loss per share:
Basic and diluted	$	(0.36)	$	(0.24)
Weighted average number of shares used in computing net loss per share:
Basic and diluted		30,561,076		29,592,247

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADESTO TECHNOLOGIES CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)


	Three Months Ended
	March 31,
	2020		2019
Net loss	$	(11,015)	$	(7,060)
Other comprehensive loss, net of tax:
Foreign currency translation adjustment		(319)		(128)
Comprehensive loss	$	(11,334)	$	(7,188)

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADESTO TECHNOLOGIES CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share data)


	Three Months Ended March 31, 2020
						Accumulated
				Additional		Other				Total
	Common Stock			Paid-In		Comprehensive		Accumulated		Stockholders’
	Shares	Amount		Capital		Loss		Deficit		Equity
Balances as of January 1, 2020	30,268,685	$	3	$	206,356	$	309	$	(147,892)	$	58,776
Options exercised	299,737		—		1,172		—		—		1,172
Employee stock purchase plan	128,601		—		777		—		—		777
Restricted stock units, net of taxes paid related to net settlement of equity awards	119,142		—		(246)		—		—		(246)
Stock-based compensation	—		—		1,925		—		—		1,925
Foreign currency translation adjustments	—		—		—		(319)		—		(319)
Net loss	—		—		—		—		(11,015)		(11,015)
Balances as of March 31, 2020	30,816,165	$	3	$	209,984	$	(10)	$	(158,907)	$	51,070

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ADESTO TECHNOLOGIES CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share data) (continued)


	Three Months Ended March 31, 2019
						Accumulated
				Additional		Other				Total
	Common Stock			Paid-In		Comprehensive		Accumulated		Stockholders’
	Shares	Amount		Capital		Loss		Deficit		Equity
Balances as of January 1, 2019	29,442,065	$	3	$	184,158	$	(135)	$	(121,284)	$	62,742
ASC 842 adoption adjustment	—		—		—		—		248		248
Options exercised	9,712		—		26		—		—		26
Employee stock purchase plan	129,815		—		544		—		—		544
Restricted stock units, net of taxes paid related to net settlement of equity awards	66,995		—		(85)		—		—		(85)
Stock-based compensation	—		—		1,075		—		—		1,075
Foreign currency translation adjustments	—		—		—		(128)		—		(128)
Net loss	—		—		—		—		(7,060)		(7,060)
Balances as of March 31, 2019	29,648,587	$	3	$	185,718	$	(263)	$	(128,096)	$	57,362

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADESTO TECHNOLOGIES CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


	Three Months Ended
	March 31,
	2020		2019
Cash flows from operating activities:
Net loss	$	(11,015)	$	(7,060)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock-based compensation expense		1,925		1,075
Depreciation and amortization		997		646
Amortization of intangible assets		1,788		1,788
Amortization of debt discount and issuance costs		675		401
Deferred income taxes		(82)		(75)
Decrease in fair value of earn-out liability		(911)		(320)
Changes in assets and liabilities:
Accounts receivable		2,418		(9)
Inventories		(2,187)		1,992
Prepaid expenses and other current assets		(384)		(301)
Other non-current assets		(316)		176
Accounts payable		2,112		545
Accrued compensation and benefits		(3,338)		57
Accrued expenses and other current liabilities		(2,262)		756
Price adjustments and other revenue reserves		(187)		1
Other non-current liabilities		(365)		(303)
Net cash used in operating activities		(11,132)		(631)
Cash flows from investing activities:
Acquisition of property and equipment		(1,114)		(600)
Investment in unconsolidated affiliate		(112)		(4)
Net cash used in investing activities		(1,226)		(604)
Cash flows from financing activities:
Proceeds from exercise of stock options and employee stock purchase plan		1,949		570
Tax withholdings related to net share settlement of restricted stock units		(246)		(85)
Payments on term loan		—		(437)
Net cash provided by financing activities		1,703		48
Effect of exchange rates on cash, cash equivalents and restricted cash		(598)		203
Net decrease in cash, cash equivalents and restricted cash		(11,253)		(984)
Cash, cash equivalents and restricted cash - beginning of year		21,722		9,088
Cash, cash equivalents and restricted cash - end of period	$	10,469	$	8,104
Supplemental disclosures of other cash flow information:
Cash paid for interest expense	$	1,531	$	981
Supplemental disclosures of non-cash investing and financing information:
Purchase of property and equipment included in accounts payable	$	711	$	165

See accompanying Notes to Condensed Consolidated Financial Statements.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1. Organization and Summary of Significant Accounting Policies.

Organization and Nature of Operations.

Adesto Technologies Corporation (together with its subsidiaries; “Adesto”, “we”, “our”, “us” or the “Company”) was incorporated in the state of California in January 2006 and reincorporated in Delaware in October 2015. We are a leading provider of innovative, application-specific semiconductor and systems for the Internet of Things era. Our corporate headquarters are located in Santa Clara, California.

On May 9, 2018 we acquired 100% of the issued capital of S3 Asic Semiconductors Limited and on September 14, 2018 we acquired 100% of the issued capital of Echelon Corporation. Our financial results include the operating results of those entities from the date of acquisition.

On February 20, 2020, we entered into a definitive merger agreement with Dialog Semiconductor plc (“Dialog”), a company incorporated in England and Wales. According to the terms of the merger, Dialog will acquire 100% of the issued capital of the Company (see Note 17, “Merger with Dialog Semiconductor plc”).

Basis of Presentation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10 Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP to complete annual consolidated financial statements. In the opinion of our management, all adjustments (consisting of normal recurring adjustments) considered necessary to present fairly the financial position of the Company and its results of operations and cash flows for the interim periods presented have been included. Operating results for the three months ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020, for any other interim period or for any other future year.

The condensed consolidated balance sheet as of December 31, 2019 was derived from the audited consolidated financial statements as of that date, but does not include all of the disclosures required by U.S. GAAP. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10 K for the year ended December 31, 2019, filed with the Securities and Exchange Commission on March 16, 2020.

The condensed consolidated financial statements include the results of our operations, and the operations of our wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

There have been no material changes to our significant accounting policies described in Note 1, Organization and Summary of Significant Accounting Policies, in Notes to Consolidated Financial Statements in Item 8 of Part II of our Annual Report on Form 10 K for the year ended December 31, 2019 that have had a material impact on our condensed consolidated financial statements and related notes, except as described below..

Recent Accounting Pronouncements.

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-13, Fair Value Measurement Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. As part of the FASB's disclosure framework project, it has eliminated, amended and added disclosure requirements for fair value measurements. Entities will no longer be required to disclose the amount of, and reasons for, transfers between Level 1 and Level 2 of the fair value hierarchy, the policy of timing of transfers between

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

levels of the fair value hierarchy and the valuation processes for Level 3 fair value measurements. Public companies will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. This ASU is effective for public entities for annual and interim periods beginning after December 15, 2019. This ASU was adopted on January 1, 2020 and changed disclosure requirements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This ASU eliminates Step 2 from the goodwill impairment test. Instead, an entity should recognize an impairment charge for the amount by which the carrying value exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to that reporting unit. This ASU is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. This ASU was adopted on January 1, 2020 and did not have an impact on our consolidated results of operations or cash flows.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13), which requires measurement and recognition of expected credit losses for financial assets held at the reporting date based on external information, or a combination of both relating to past events, current conditions, and reasonable and supportable forecasts. ASU No. 2016-13 replaces the existing incurred loss impairment model with a forward-looking expected credit loss model which will result in earlier recognition of credit losses. Subsequent to the issuance of ASU No. 2016-13, the FASB issued ASU No. 2018-19, Codification Improvement to Topic 326, Financial Instruments – Credit Losses, ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, ASU No. 2019-05, Financial Instruments Credit Losses (Topic 326) Targeted Transition Relief, ASU No. 2016-13, the FASB issued ASU No. 2019-10 Financial Instruments-Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842), and ASU No. 2019-11 Codification Improvements to Topic 326, Financial Instruments-Credit Losses. The subsequent ASUs do not change the core principle of the guidance in ASU No. 2016-13. Instead these amendments are intended to clarify and improve operability of certain topics included within ASU No. 2016-13.

Additionally, ASU No. 2019-10 defers the effective date for the adoption of the new standard on credit losses for public filers that are considered small reporting companies (“SRC”) as defined by the SEC to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, which will be fiscal 2023 for the Company if it continues to be classified as a SRC. In February 2020, the FASB issued ASU 2020-02, which provides guidance regarding methodologies, documentation, and internal controls related to expected credit losses. The subsequent amendments will have the same effective date and transition requirements as ASU No. 2016-13. Early adoption is permitted. Topic 326 requires a modified retrospective approach by recording a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. While the Company is currently evaluating the impact of Topic 326, Company does not expect the adoption of the ASU to have a material impact on its condensed consolidated financial statements and the related disclosures.

Revenue from contracts with customers.

Revenue is recognized when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Sales of products with alternative use account for the majority of our revenue and are recognized at a point in time, the timing of such recognition remained the same under Topic 606.

Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by us from a customer and deposited with the relevant government authority, are excluded from revenue. Our revenue arrangements do not contain significant financing components.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Revenue is recognized over a period of time when it is assessed that performance obligations are satisfied over a period rather than at a point in time. When any of the following criteria is fulfilled, revenue is recognized over a period of time:


(a)	The customer simultaneously receives and consumes the benefits provided by the performance as Adesto performs.

(b)	Adesto’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced.

(c)	Adesto’s performance does not create an asset with an alternative use, and Adesto has an enforceable right to payment for performance completed to date.

If revenue is recognized over a period of time, we would then select an appropriate method for measuring progress toward complete satisfaction of the performance obligation, usually costs incurred to date relative to the total expected costs to the satisfaction of that performance obligation. Typically, our revenue from NVM and Embedded Systems products is recognized at a point in time. Revenues from our ASIC and IP solutions products are generally recognized over of period of time.

Sales to certain distributors are made under arrangements which provide the distributors with price adjustments, price protection, stock rotation and other allowances under certain circumstances. These adjustments and allowances are accounted for as variable consideration. We estimate these amounts based on the expected amount to be provided to customers and reduce revenue recognized. We believe that there will not be significant changes to our estimates of variable consideration.

If a customer pays consideration, or Adesto has a right to an amount of consideration that is unconditional before we transfer a good or service to the customer, those amounts are classified as deferred income/ advances received from customers which are included in other current liabilities or other long-term liabilities when the payment is made or it is due, whichever is earlier.

If the arrangement includes variable contingent consideration, we recognize revenue over time if we can reasonably measure its progress, or we are capable of providing reliable information that would be required to apply an appropriate method of measuring progress. To date, we have not had any arrangements incorporating contingent consideration.

Sales commissions are owed and are recorded at the time of sell through of our products to end customers. These costs are recorded within selling, general and administrative expenses.

The Company has entered into, and will continue to enter into, development agreements. Typically, revenue is recognized over time on a percentage of completion basis based on resources expended to date as compared to budgeted resources. Cost associated with these contracts can be classified as cost of revenue or research and development expense depending on the terms of the contract.

We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Timing of Revenue Recognition.


		Three Months Ended
		March 31,
	2020		2019

Products transferred at a point in time	$	18,009	$	24,135
Products and services transferred over time		2,012		3,978
	$	20,021	$	28,113

The following table reflects the changes in our contract assets, which we classify as accounts receivable, unbilled and our contract liabilities which we classify as deferred revenue:


	March 31,		December 31,
	2020		2019		Change
	(in thousands)
Contract assets:
Accounts receivable, unbilled	$	5,593	$	4,795	$	798
Contract liabilities:
Deferred revenue	$	224	$	415	$	(191)

Accounts receivable, unbilled represents revenue recognized on certain development contracts for which invoicing has not yet occurred based on the terms of the development contract. As of March 31, 2020 and December 31, 2019, we had $5.6 million and $1.4 million, respectively, classified as unbilled accounts receivable within accounts receivable.

Deferred revenue represents amounts invoiced to customers for certain development contracts for which revenue has yet to be recognized based on actual development hours performed. Typically, the timing of invoicing is based on the terms of the contract. As of March 31, 2020 and December 31, 2019, we had $0.2 million and $0.4 million, respectively, of deferred revenue classified as accrued expenses and other current liabilities.

Reclassifications.

Certain reclassifications have been made to prior periods’ condensed consolidated financial statements to conform to the current period presentation. These reclassifications did not result in any change in previously reported total assets, stockholders’ equity or net loss.

Use of Estimates.

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates, judgments and assumptions that affect the reported amount of assets, liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate those estimates, including those related to allowances for doubtful accounts, price adjustments and other revenue reserves, warranty accrual, inventory write-downs, valuation of long-lived assets, including property and equipment and identifiable intangible assets and goodwill, loss on purchase commitments, valuation of deferred taxes and contingencies. In addition, we use assumptions when employing the Black-Scholes option-pricing model to calculate the fair value of stock options granted and Monte Carlo simulation techniques to value certain restricted stock units with market-based vesting conditions. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, when these carrying values are not readily available from other sources. Actual results could differ from these estimates.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Product Warranty.

Our non-volatile memory (“NVM”) products are sold with a limited warranty for a period of one year, warranting that the product conforms to specifications and is free from material defects in design, materials and workmanship. To date, we have had insignificant returns of any defective production parts. During 2019 and the first three months of 2020 we did not record any additional liability related to potential warranty claims. As of March 31, 2020, and December 31, 2019, the warranty accrual related to NVM products was $51,000 and is included in accrued expenses and other current liabilities on the condensed consolidated balance sheets.

At the time of the Echelon acquisition we recorded a warranty liability of $401,000 related to Echelon products. For the period ended December 31, 2018 we recorded an increase in the warranty liability of $53,000. As of March 31, 2020 and December 31, 2019, the warranty accrual related to Echelon products was $453,000 of which $186,000 was recorded in accrued expenses and other current liabilities on the consolidated balance sheets and $267,000 is recorded in other long-term liabilities on the consolidated balance sheets.

Foreign Currency Translation.

The functional currency of our foreign subsidiaries is the local currency. In consolidation, we translate assets and liabilities at exchange rates in effect at the consolidated balance sheet date. We translate revenue and expense accounts at the average exchange rates during the period in which the transaction takes place. Net gains and losses from foreign currency translation of assets and liabilities were losses of $319,000 and $128,000 for the three months ended March 31, 2020 and 2019 respectively, and are included in the cumulative translation adjustment component of accumulated other comprehensive loss, net of tax, a component of stockholders’ equity. Net gains and losses arising from transactions denominated in currencies other than the functional currency were a gain of $271,000 and a loss of $97,000 for the three months ended March 31, 2020 and 2019, respectively, and are included in other income, net in the condensed consolidated statements of operations.

Concentration of Risk.

Our products are primarily manufactured, assembled and tested by third-party foundries and other contractors in Asia and we are heavily dependent on a single foundry in Taiwan for the manufacture of wafers and a single contractor in the Philippines for assembly and testing of our products. We do not have long-term agreements with either of these suppliers. A significant disruption in the operations of these parties would adversely impact the production of our products for a substantial period of time, which could have a material adverse effect on our business, financial condition, operating results and cash flows.

Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of cash and cash equivalents, investments and accounts receivables. We place substantially all of our cash and cash equivalents and investments on deposit with three reputable, high credit quality financial institutions in the United States of America. We believe that the banks that holds substantially all of our cash and cash equivalents and are investments is financially sound and, accordingly, subject to minimal credit risk. Deposits held with the banks may exceed the amount of insurance provided on such deposits.

We generally do not require collateral or other security in support of accounts receivable. We periodically review the need for an allowance for doubtful accounts by considering factors such as historical experience, credit quality, the age of the accounts receivable balances and current economic conditions that may affect a customer’s ability to pay. The allowance for doubtful accounts as of March 31, 2020 and December 31, 2019 was $60,000 and $60,000, respectively.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Customer concentrations as a percentage of revenue, net were as follows:


	Three Months Ended
	March 31,
	2020		2019
Customer A	*	%	26	%
Customer B	12	%	*	%

*	less than 10%

Customer concentrations as a percentage of gross accounts receivable were as follows:

Note 2. Acquisitions.

Echelon Corporation

On September 14, 2018, we acquired 100% of the issued capital of Echelon Corporation, a Delaware corporation (“Echelon”), pursuant to the terms of an Agreement and Plan of Merger dated as of June 28, 2018. The purchase price was approximately $44.1 million paid in cash.

The assets and liabilities of Echelon were recorded in our condensed consolidated balance sheet as of the acquisition date, at their respective fair values. Fair value is estimated based on one or a combination of income, cost and/or market approaches, as determined based on the nature of the asset or liability, and the level of inputs available. With respect to assets and liabilities, the determination of fair value requires management to make subjective judgments as to projections of future operating performance, the appropriate discount rate to apply, long-term growth rates, and other factors, which affect the amounts recorded in the purchase price allocation. The excess of the consideration transferred over the fair value of the identifiable assets, net of liabilities, is recorded as goodwill, which is indicative of the expected continued growth and development of Echelon. The purchase price allocation that follows is based on these estimated fair values of assets acquired and liabilities assumed.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following table summarizes the fair values of assets acquired and liabilities assumed (in thousands):


Cash	$	15,270
Short term investments		1,274
Accounts receivable		3,020
Inventories		5,710
Other current assets		2,845
Property and equipment, net		614
Intangible assets		17,690
Goodwill		4,266
Other non-current assets		252
Accounts payable		(3,630)
Other current liabilities		(2,642)
Other non-current liabilities		(563)
Fair value of net assets acquired	$	44,106

Intangible assets reflect the following:


		Fair Value	Useful Life (in Years)
	(in thousands)
Customer relationships	$	6,520	7
Developed technology		10,670	4
Trademarks		500	8
Total acquired intangible assets	$	17,690

S3 Asic Semiconductors Limited

On May 9, 2018, we acquired 100% of the issued capital of S3 Asic Semiconductors Limited, a private company limited by shares and incorporated in Ireland (“S3 Semiconductors”), pursuant to the Share Purchase Agreement dated May 9, 2018 (the “Agreement”). S3 Semiconductors is headquartered in Ireland and its subsidiaries are in the United States, Portugal and the Czech Republic. S3 Semiconductors and its subsidiaries are engaged in the business of providing advanced mixed signal semiconductor devices and intellectual property to customers in the industrial and communications markets. The aggregate consideration was approximately $35.0 million in cash and contingent consideration in the form of a $15.0 million earn-out. The earn-out is based on achievement of certain milestones through 2019, including minimum total revenue targets, revenue derived from sales of semiconductor devices and new customer engagements with minimum value thresholds. Based on revised estimates of performance against the earn-out thresholds we recorded a change in the fair value of the earn-out liability to approximately $10.5 million as of December 31, 2018. During 2019 we revalued the earn-out liability and recorded a reduction in that liability of approximately $0.3 million. In October 2019, we paid approximately $7.2 million against the liability and during the three months ended March 31, 2020 we revalued the earn-out liability and recorded a reduction in that liability of $0.9 million which was recorded as other income in the statement of operations. As of March 31, 2020, we estimated the fair value of the earn-out liability to be $2.0 million.

The assets and liabilities of S3 Semiconductors were recorded in our condensed consolidated balance sheet as of the acquisition date, at their respective fair values. Fair value is estimated based on one or a combination of income, cost and/or market approaches, as determined based on the nature of the asset or liability, and the level of inputs available. With respect to assets and liabilities, the determination of fair value requires management to make subjective judgments as to projections of future operating performance, the appropriate discount rate to apply, long-term growth rates, and other factors, which affect the amounts recorded in the purchase price allocation. The excess of the consideration transferred over the fair value of the identifiable assets, net of liabilities, is recorded as goodwill, which is

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

indicative of the expected continued growth and development of S3 Semiconductors. The purchase price allocation that follows is based on these estimated fair values of assets acquired and liabilities assumed.

The following table summarizes the fair values of assets acquired and liabilities assumed (in thousands):


Cash	$	267
Accounts receivable		192
Other current assets		883
Property and equipment, net		191
Intangible assets		15,340
Goodwill		34,352
Accounts payable		(37)
Deferred revenue		(129)
Earn-out liability, current		(10,218)
Other current liabilities		(761)
Deferred tax liability		(1,918)
Earn-out liability, non-current		(3,279)
Fair value of net assets acquired	$	34,883

Intangible assets reflect the following:



		Fair Value	Useful Life (in Years)
	(in thousands)
Customer relationships	$	12,880	7
Contract backlog		210	0.5
Developed technology		1,080	5
Non-compete agreements		380	2
Trademarks		790	12
Total	$	15,340

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 3. Balance Sheet Components.

Accounts Receivable, Net.

Accounts receivable, net consisted of the following (in thousands):


	March 31,		December 31,
	2020		2019
Accounts receivable	$	32,541	$	35,757
Accounts receivable, unbilled		5,593		4,795
Allowance for doubtful accounts		(60)		(60)
Total accounts receivable, net	$	38,074	$	40,492

Inventories.

Inventories consisted of the following (in thousands):


	March 31,		December 31,
	2020		2019
Raw materials	$	1,843	$	6,081
Work-in-process		10,051		6,715
Finished goods		10,316		7,227
Total inventories	$	22,210	$	20,023

For the three months ended March 31, 2020, we did not record any additional write-downs related to excess inventory. For the three months ended March 31, 2019, we recorded a write-down of $0.3 million related to excess inventory.

Inventory write-downs are primarily associated with products built in excess of customer demand which resulted in excess inventory levels, legacy products for which no demand exists, lower of cost or net realizable value write-downs associated with products for which costs exceeded net realizable value, and write-downs associated with the closing of the Echelon lighting business.

Property and Equipment, Net.

Property and equipment, net consisted of the following (in thousands):


	March 31,		December 31,
	2020		2019
Machinery and equipment	$	17,057	$	17,522
Leasehold improvements		4,444		4,445
Computer software		4,791		4,142
Furniture and fixtures		744		733
Construction in progress		299		115
Property and equipment, at cost		27,335		26,957
Accumulated depreciation and amortization		(19,537)		(18,844)
Property and equipment, net	$	7,798	$	8,113

The Company incurs costs for the fabrication of masks used by its foundry partners to manufacture its products. Beginning the first fiscal quarter of 2017, the Company capitalizes mask costs that are expected to be utilized in

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

production manufacturing as the Company’s product development process has become more predictable and thus supports capitalization of the mask. The capitalized mask costs begin depreciating to cost of revenue once the products go into production. Depreciation is computed using the straight-line method over a three- year period which is the expected useful life of the mask. Previously mask sets were expensed to research and development.

Depreciation and amortization expense of property and equipment for the three months ended March 31, 2020 and 2019 was $1.0 million and $0.6 million, respectively.

Accrued Expenses and Other Current Liabilities.

Accrued expenses and other current liabilities consisted of the following (in thousands):


	March 31,		December 31,
	2020		2019
Accrued sales commission payable	$	258	$	389
Accrued manufacturing expenses		1,686		1,106
Liabilities to certain customers		2,242		4,144
Warranty reserve		504		513
Income tax payable		513		132
Deferred revenue, current portion		224		415
Interest payable		171		950
Other accrued liabilities		1,508		1,719
Total accrued expenses and other current liabilities	$	7,106	$	9,368

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 4. Fair Value Measurements.

Fair value is defined as the exchange price that would be received from selling an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We measure financial assets and liabilities at fair value at each reporting period using a fair value hierarchy which requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:

Level 1. Quoted prices in active markets for identical assets or liabilities.

Level 2. Quoted prices for similar assets and liabilities in active markets or inputs other than quoted prices which are observable for the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full term of the financial instruments.

Level 3. Unobservable inputs which are supported by little or no market activity and which are significant to the fair value of the assets or liabilities.

Financial assets measured at fair value on a recurring basis were as follows:


	Fair Value Measurement at Reporting Date Using
			Significant
	Quoted Prices in		Other		Significant
	Active Markets		Observable		Unobservable
	for Identical		Inputs		Inputs
	Assets (Level 1)		(Level 2)		(Level 3)		Total
	(in thousands)
As of March 31, 2020
Assets:
Money market funds	$	504	$	—	$	—	$	504
U.S. government securities		300		—		—		300
	$	804	$	—	$	—	$	804
Liabilities:
Earn-out liability	$	—	$	—	$	2,000	$	2,000

As of December 31, 2019
Assets:
Money market funds	$	460	$	—	$	—	$	460
U.S. government securities		300		—		—		300
	$	760	$	—	$	—	$	760
Liabilities:
Earn-out liability	$	—	$	—	$	2,911	$	2,911

As of March 31, 2020, we had an earn-out liability of $2.0 million, all of which related to the acquisition of S3 Semiconductors, which was completed in May 2018 (see Note 2). The earn-out liability was calculated using the present value of a probability weighted income approach. During the three months ended March 31, 2020 we reached a settlement on the final amount of the earn-out liability and reduced the balance to $2.0 million.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Changes in the earn-out liability during 2020 was as follows (in thousands):


Balance as of January 1, 2020	$	2,911
Acquisitions		—
Change in fair value		(911)
Change in foreign currency exchange rate		—
Balance as of March 31, 2020	$	2,000

The Company’s cash equivalents include U.S. government securities with a minimum and weighted average credit rating of A-1+. The Company values these securities based on pricing from pricing vendors, who may use quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value. As of March 31, 2020 the Company classified all of its fixed income securities as having Level 1 inputs. The Company's procedures include controls to ensure that appropriate fair values are recorded by comparing prices obtained from a third party independent source.

Note 5. Purchased Intangible Assets and Goodwill

In 2012, in connection with our purchase of the serial flash memory product line assets from Atmel Corporation, we recorded $16.4 million of intangible assets.

In connection with the acquisition of S3 (Note 2), we recorded $15.3 million of intangible assets.

In connection with the acquisition of Echelon (Note 2), we recorded $17.7 million of intangible assets.

Intangible assets, net were as follows (in thousands):


			March 31, 2020
	Estimated Useful Life (in Years)	Gross Carrying Amount			Accumulated Amortization			Net Carrying Amount	Net Carrying Amount
Developed technology	4 - 10		$	16,032		$	7,734		$	8,298
Customer relationships	7 - 12			28,411			10,489			17,922
Customer backlog	1			2,779			2,779			—
Contract backlog	0.5			210			210			—
Non-compete agreement	2 - 5			662			635			27
Trademarks	8 - 12			1,290			217			1,073
Total intangible assets subject to amortization			$	49,384		$	22,064		$	27,320

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


		December 31, 2019
	Estimated Useful Life (in Years)	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Developed technology	4 - 10	$	16,032	$	6,905	$	9,127
Customer relationships	7 - 12		28,411		9,608		18,803
Customer backlog	1		2,779		2,779		—
Contract backlog	0.5		210		210		—
Non-compete agreement	2 - 5		662		588		74
Trademarks	8 - 12		1,290		186		1,104
Total intangible assets subject to amortization		$	49,384	$	20,276	$	29,108

We recorded amortization expense related to the acquisition-related intangible assets as follows (in thousands):


	Three Months Ended
	March 31,
	2020		2019
Operating expense category:
Research and development	$	828	$	828
Selling, general and administrative		960		960
Total	$	1,788	$	1,788

The estimated future amortization expense of acquisition-related intangible assets subject to amortization after September 30, 2019 is as follows (in thousands):


Year Ended December 31,
2020 (remaining 9 months)	$	5,249
2021		6,962
2022		6,070
2023		3,735
2024		3,463
Thereafter		1,841
Total	$	27,320

Note 6. Investment in Unconsolidated Affiliates.

During 2017 and 2016, we made investments in Semitech Semiconductor Pty. Ltd., an Australian corporation (“Semitech”), as part of a license and development agreement dated April 16, 2016. Semitech has developed Narrowband-Power Line Communications (“N-PLC”) products and market knowledge in the N-PLC devices space and plans to sell its products into the smart grid, solar, smart lighting and industrial space. Investments during 2016 through June 14, 2017 were recorded as notes receivable. On June 15, 2017, $0.4 million of notes receivable and accrued interest were converted into 233,335 shares of preferred stock in Semitech. In June 2018, we converted $0.5 million of notes receivable and accrued interest into 312,076 shares of preferred stock in Semitech. During the three months ended March 31, 2020 we invested $0.11 million in additional notes receivable in Semitech. This investment is recorded at cost in other non-current assets on the condensed consolidated balance sheets as of March 31, 2020 and December 31, 2019. As of March 31, 2020 and December 31, 2019, we held investments in notes receivable in Semitech in the amount of $0.8 million and $0.7 million, respectively, which were classified in other non-current assets on the condensed consolidated balance sheets.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 7. Borrowings.

Tennenbaum Capital Partners, LLC Term Loan.

On May 8, 2018, we entered into a credit agreement with Tennenbaum Capital Partners, LLC (“Tennenbaum”) (“Credit Agreement”). The Credit Agreement provides for a first lien senior secured term loan of $35.0 million (“Term Loan”). The Term Loan bore interest at a rate per annum equal to the sum of the Libor Rate plus 8.75% and was payable in consecutive quarterly installments starting December 31, 2018. The Term Loan was scheduled to mature on May 8, 2022. The Credit Agreement provided that any indebtedness we incurred thereunder was collateralized by substantially all assets of the Company and any domestic subsidiaries, subject to certain customary exceptions.

The Credit Agreement, as amended, contained customary representations and warranties and affirmative and negative covenants, including maximum consolidated leverage ratios and minimum liquidity. Upon an occurrence of an event of default, under the Credit Facility we could have been required to pay interest on all outstanding obligations under the agreement at a rate of 2% above the otherwise applicable interest rate, and the lender may have accelerated our obligations under the agreement.

In connection with the Credit Agreement, Tennenbaum received a warrant to purchase 850,000 shares of common stock at an exercise price of $8.62 and a term of six years. In addition, we paid financing costs of $1.4 million. The financing costs and the value of the warrant, $4.8 million, were recorded as a debt discount and were being amortized over the life of the Credit Agreement.

Borrowings of $33.8 million under this facility were repaid in full in September 2019. In addition, the Company was required to pay a prepayment premium of $0.8 million which represented 2% of the outstanding loan balance.

Note 8. Convertible Notes.

On September 23, 2019, the Company completed offering of $80.5 million aggregate principal amount of 4.25% Convertible Senior Notes due 2024 (the "Notes"). The Notes were sold pursuant to an indenture, dated September 23, 2019, between the Company and U.S. Bank National Association (the “Trustee”), referred to herein as the “Indenture.” The Notes are senior, unsecured obligations of the Company. The Notes pay interest at a rate equal to 4.25% per year. Interest on the Notes is payable semiannually in arrears on March 15 and September 15 of each year, beginning March 15, 2020. Interest accrues on the Notes from the last date to which interest has been paid or duly provided for or, if no interest has been paid or duly provided for, from September 23, 2019. Unless earlier converted, redeemed or repurchased, the Notes mature on September 15, 2024.

The implied estimated effective rate of the liability component of the Notes is 12.3%.

The Notes are convertible into Company common stock at an initial conversion rate of 83.3021 shares per $1,000 principal amount of Notes, subject to adjustment upon certain events.

The Notes are convertible, in whole or in part, at the option of the holder, at any time prior to the close of business on the business day immediately preceding June 15, 2024, but only in the following circumstances:

(1) during any calendar quarter commencing after the calendar quarter ending on December 31, 2019 (and only during such calendar quarter), if the last reported sale price of the Company’s common stock for each of at least 20 trading days (whether or not consecutive) during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than 130% of the conversion price on such trading day;

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

(2) during the five business day period immediately after any ten consecutive trading day period (the five consecutive trading day period being referred to as the ‘‘measurement period’’) in which the trading price per $1,000 principal amount of the Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on such trading day;

(3) upon the occurrence of certain specified corporate events, including fundamental changes (as described in the Indenture); or

(4) if the Company calls the Notes for redemption.

In addition, regardless of the foregoing circumstances, holders may convert their Notes at any time on or after June 15, 2024 and prior to the close of business on the day immediately preceding the maturity date of the Notes. Upon conversion, the Company may elect to settle by paying or delivering either solely cash, shares of Company common stock or a combination of cash and shares of common stock.

In accordance with ASC 470-20, the initial measurement of the Notes at fair value resulted in a liability of $57.9 million, as such, the calculated discount resulted in an implied value of the convertible feature recognized in Capital in excess of Par Value of $22.6 million. Issuance costs include initial purchasers’ discounts of $3.22 million and other costs of $0.3 million amounting to $3.5 million were allocated to components on a ratable basis as follows; Additional Paid-In Capital, $1.0 million, and Convertible Notes, $2.5 million.

The Indenture contains covenants that, among other things, restricts the Company’s ability to merge, consolidate or sell, or otherwise dispose of, all or substantially all of its assets. These limitations are subject to a number of important qualifications and exceptions.

The Indenture contains customary Events of Default (as defined in the Indenture), including default in the event the Company fails to pay interest on the Notes when due, and such failure continues for 30 days, or the Company fails to pay the principal of the Notes when due, including at maturity, upon redemption or otherwise; failure to comply with covenants and other obligations under the Indenture, including delivery of required notices and obligations in connection with conversion, in certain cases subject to notice and grace periods; payment defaults and accelerations with respect to other indebtedness of the Company and its significant subsidiaries in the aggregate principal amount of $15.0 million or more; failure by the Company or its significant subsidiaries to pay certain final judgments aggregating in excess of $15.0 million within 60 consecutive days of such final judgment; and specified events involving bankruptcy, insolvency or reorganization of the Company or its significant subsidiaries.

Upon an Event of Default, the trustee or the holders of at least 25% in aggregate principal amount of the Notes then outstanding may declare all the Notes to be due and payable immediately. In the case of Events of Default relating to bankruptcy, insolvency or reorganization, all outstanding Notes will become due and payable immediately without further action or notice.

On September 18, 2019, in connection with the pricing of the Notes, the Company entered into privately negotiated capped call transactions (the “Base Capped Call Transactions”) with each of Credit Suisse Capital LLC and Société Générale (the “option counterparties). On September 19, 2019, in connection with the exercise of the option in full by the initial purchasers, Adesto entered into additional privately negotiated capped call transactions (the “Additional Capped Call Transactions,” and together with the Base Capped Call Transactions, the “Capped Call Transactions”) with each of the option counterparties.

The Capped Call Transactions relating to the Notes will initially cover, subject to customary anti-dilution adjustments, the number of shares of common stock that initially underlie the Notes. The cap price of the Capped Call Transactions is initially $15.86 per share of common stock, representing a premium of 75.0% above the last reported

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

sales price of $9.06 per share of common stock on September 18, 2019, and is subject to certain adjustments under the terms of the Capped Call Transactions. The Capped Call Transactions are expected generally to reduce the potential dilution to the common stock as a result of any conversion of the Notes and/or offset any cash payments that Adesto would be required to make in excess of the principal amount upon conversion of the Notes, as the case may be, with such reduction or offset subject to a cap based on the cap price.

In connection with establishing their initial hedges of the Capped Call Transactions, the Company expects that the option counterparties or their respective affiliates will purchase shares of common stock and/or enter into various derivative transactions with respect to common stock concurrently with, or shortly after, the pricing of the Notes. This activity could increase (or reduce the size of any decrease in) the market price of common stock or Notes at that time.

In addition, the Company expects that the option counterparties or their respective affiliates may modify their hedge positions by entering into or unwinding various derivatives with respect to common stock and/or purchasing or selling common stock in secondary market transactions following the pricing of the Notes and prior to the maturity of the Notes. This activity could cause or avoid an increase or decrease in the market price of common stock or the Notes which could affect holders’ ability to convert the Notes.

The Capped Call Transactions are separate transactions entered into by Adesto with the option counterparties, are not part of the terms of the Notes, and will not affect any holder’s rights under the Notes. Holders of the Notes will not have any right with respect to the Capped Calls Transactions. The premium paid for the purchase of the capped calls in the amount of $6.2 million has been recorded as a reduction to additional paid-in capital and will not be remeasured.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following table summarizes information about the equity and liability components of the Notes (in thousands):


	March 31,
	2020
Principal amount	$	80,500
Unamortized discount		(20,908)
Unamortized debt issuance costs		(2,328)
Total convertible senior notes	$	57,264

Equity component, net of issuance costs	$	21,662

Note 9. Segment Information.

We operate in one business segment: application-specific, semiconductors and embedded systems. Our chief decision-maker, the President and Chief Executive Officer, evaluates our performance based on company-wide consolidated results. Revenue is evaluated by product category and by geographic region.

Product revenue from customers is designated based on the geographic region to which the product is delivered. Revenue by geographic region was as follows (in thousands):


	Three Months Ended
	March 31,
	2020		2019
United States	$	3,006	$	7,470
Rest of Americas		485		1,861
Europe		3,454		4,788
Asia Pacific		13,008		13,716
Rest of world		68		278
Total	$	20,021	$	28,113

Long-lived assets are attributed to the geographic region where they are located. Long-lived assets by geographic region were as follows (in thousands):


	March 31,		December 31,
	2020		2019
United States	$	3,191	$	3,248
Asia Pacific		3,831		4,093
Europe		776		772
Total property and equipment, net	$	7,798	$	8,113


	March 31,		December 31,
	2020		2019
United States	$	1,985	$	2,078
Asia Pacific		171		185
Europe		1,962		2,037
Total operating lease right-of-use assets	$	4,118	$	4,300

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 10. Commitments and Contingencies.

Operating Leases.

We lease certain manufacturing facilities, warehouses, office space, and equipment under non-cancelable operating leases that expire at various times up to November 2033 and have options to renew most leases, with rentals to be negotiated. Certain of our leases contain provisions for rental adjustments. Operating lease rentals are expensed on a straight-line basis over the life of the lease beginning on the date we take possession of the property. At lease inception, we determine the lease term by assuming the exercise of those renewal options that are reasonably assured. The exercise of lease renewal options is at our sole discretion. The lease term is used to determine whether a lease is financing or operating and is used to calculate straight-line rent expense. Additionally, the depreciable life of leasehold improvements is limited by the expected lease term. Leases with an initial term of 12 months or less are not recorded on the balance sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.

The following table reflects our lease assets and our lease liabilities at March 31, 2020 and December 31, 2019 (in thousands).


	March 31,		December 31,
	2020		2019
Assets:
Operating lease right-of-use assets	$	4,118	$	4,300

Liabilities:
Operating lease liabilities, current	$	1,266	$	1,230
Operating lease liabilities, non-current	$	4,400	$	4,726

Lease Costs:

The components of lease costs were as follows (in thousands):

As of March 31, 2020, the maturity of operating lease liabilities was as follows (in thousands):


(In thousands)
2020 (remaining 9 months)	$	1,512
2021		1,691
2022		1,552
2023		1,015
2024		221
Thereafter		1,954
Total lease payments		7,945
Less: Interest		(2,279)
Present value of lease liabilities	$	5,666

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Lease Term and Discount Rate:


	March 31,
	2020
Weighted-average remaining lease term (in years)	7.3
Weighted-average discount rate	11.56	%

Other Information:

Supplemental cash flow information related to leases for the three months ended March 31, 2020 and 2019 was as follows (in thousands):


	Three Months Ended		Three Months Ended
	March 31, 2020		March 31, 2019
Operating cash outflows from operating leases	$	473	$	551
Right-of-use assets obtained in exchange for new operating lease liabilities	$	—	$	—

Purchase Commitments.

As of March 31, 2020, we had purchase commitments with our third-party foundries of $9.1 million due within one year.

Litigation.

We are subject to legal proceedings, claims and litigation, including intellectual property litigation, arising in the ordinary course of business. Such matters are subject to many uncertainties and outcomes and are not predictable with assurance. We accrue amounts that we believe are adequate to address any liabilities related to legal proceedings and other loss contingencies that we believe will result in a probable loss that is reasonably estimable.

Indemnification.

During the normal course of business, we may make certain indemnities, commitments and guarantees which may include intellectual property indemnities to certain of our customers in connection with the sales of our products and indemnities for liabilities associated with the infringement of other parties’ technology based upon our products. Our exposure under these indemnification provisions is generally limited to the total amount paid by a customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under the agreement. In addition, we indemnify our officers, directors and certain key employees while they are serving in good faith in such capacities.

We have not recorded any liability for these indemnities, commitments and guarantees in the accompanying condensed consolidated balance sheets. Where necessary, we accrue for losses for any known contingent liabilities, including those that may arise from indemnification provisions, when future payment is probable.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 11. Common Stock, Common Stock Warrants and Stock Option Plan.

Common Stock.

We are authorized to issue 100,000,000 shares of common stock with $0.0001 par value per share as of March 31, 2020 and December 31, 2019. Each holder of common stock is entitled to one vote per share. As of March 31, 2020, no dividends have been declared by the Board of Directors, however, the holders of common stock are also entitled to receive dividends, when and if declared by our Board of Directors.

Common Stock Reserved for Future Issuance.

As of March 31, 2020 and December 31, 2019, we had reserved shares of common stock for future issuances as follows:


	March 31,	December 31,
	2020	2019
Warrants to purchase common stock	1,165,282	1,165,282
Options outstanding	1,626,244	1,929,391
Restricted stock units outstanding	2,253,181	1,451,507
Shares available for future grants	557,671	288,813
Shares available for ESPP	547,513	373,428
Shares reserved for issuance upon conversion of the Notes	8,885,204	8,885,204
Total	15,035,095	14,093,625

Common Stock Warrants.

In connection with the Credit Agreement (Note 7), the Company issued Tennenbaum a warrant to purchase 850,000 shares of common stock at an exercise price of $8.62 per share with a term of six years.

The following common stock warrants were outstanding:


As of March 31, 2020
Total amount of securities issuable
under the outstanding warrants	Exercise Price		Issuance Date	Expiration Date
315,282	$	2.38	2014-2015	2022-2024
850,000	$	8.62	2018	2024
1,165,282	$	6.93

Common stock warrants are exercisable at the option of the holder any time after the date of issuance into shares of our common stock.

Employee Benefit Plans.

2007 Equity Incentive Plan.

In 2007, our Board of Directors and shareholders approved the 2007 Equity Incentive Plan (the “2007 Plan”) under which 272,727 shares of common stock were reserved and available for the issuance of stock options and restricted stock to eligible participants. The 2007 Plan was subsequently amended to increase the number of shares of common stock reserved for issuance under the 2007 Plan to 787,878 and during the year ended December 31, 2015, the number of shares reserved for issuance under the 2007 Plan was increased to 2,651,515. Options and restricted stock

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

awards were granted at a price per share not less than the 85% of the fair value at the date of grant or award, respectively. Restricted stock awarded to persons controlling more than 10% of our stock were granted at a price per share not less than the 100% of the fair value at the date of the award. Options that were granted to new employees generally vest over a four-year period with 25% vesting at the end of one year and the remaining to vest monthly thereafter, while options that were granted to existing employees generally vest over a four-year period. Options granted generally are exercisable up to 10 years from the date of grant. As of October 26, 2015, no shares were available for grant under the 2007 Plan and all outstanding options would continue to be governed and remain outstanding in accordance with their existing terms. In addition, any shares subject to outstanding awards under the 2007 Plan that are issuable upon the exercise of options that expire or become unexercisable for any reason without having been exercised in full will be available for future grant and issuance under the 2015 Equity Incentive Plan.

2015 Equity Incentive Plan.

In September 2015, our Board of Directors adopted, and in October 2015 our stockholders approved, our 2015 Equity Incentive Plan. The 2015 Equity Incentive Plan became effective on the date immediately prior to the date of our initial public offering (“IPO”). As a result, 1,813,272 shares of common stock previously reserved but unissued under the 2007 Plan on the effective date of the 2015 Equity Incentive Plan became reserved for issuance under our 2015 Equity Incentive Plan, and we ceased granting awards under our 2007 Plan. The number of shares reserved for issuance under our 2015 Equity Incentive Plan will increase automatically on the first day of January of each of 2016 through 2025 by the number of shares equal to 4% of the total outstanding shares of our common stock as of the immediately preceding December 31. However, our Board of Directors may reduce the amount of the increase in any particular year.

Our 2015 Equity Incentive Plan authorizes the award of stock options, restricted stock awards, stock appreciation rights, restricted stock units (“RSUs”), performance awards and stock bonuses. No person will be eligible to receive more than 2,000,000 shares in any calendar year under our 2015 Equity Incentive Plan other than a new employee of ours, who will be eligible to receive no more than 4,000,000 shares under the plan in the calendar year in which the employee commences employment. The aggregate number of shares of our common stock that may be subject to awards granted to any one non-employee director pursuant to the 2015 Equity Incentive Plan in any calendar year shall not exceed 300,000. Our 2015 Equity Incentive Plan provides that no more than 25,000,000 shares will be issued as incentive stock options.

2015 Employee Stock Purchase Plan.

In September 2015, our Board of Directors adopted, and in October 2015 our stockholders approved, our 2015 Employee Stock Purchase Plan (“ESPP”). The 2015 Employee Stock Purchase Plan became effective on the date of our IPO. We reserved 150,000 shares of our common stock for issuance under our 2015 Employee Stock Purchase Plan. The number of shares reserved for issuance under our 2015 Employee Stock Purchase Plan will increase automatically on the first day of January following the first offering date by the number of shares equal to 1% of the total outstanding shares of our common stock as of the immediately preceding December 31 (rounded to the nearest whole share). However, our Board of Directors may reduce the amount of the increase in any particular year. The aggregate number of shares issued over the term of our 2015 Employee Stock Purchase Plan will not exceed 2,250,000 shares of our common stock.

Under our 2015 Employee Stock Purchase Plan, eligible employees will be able to acquire shares of our common stock by accumulating funds through payroll deductions. Eligible employees will be able to select a rate of payroll deduction up to 15% of their base cash compensation. The purchase price for shares of our common stock purchased under our 2015 Employee Stock Purchase Plan will be 85% of the lesser of the fair market value of our common stock on (i) the first trading day of the applicable offering period and (ii) the last trading day of each purchase period in the applicable offering period. Except for the first offering period, each offering period will run for no more than six months, with purchases occurring every six months. The first offering period began upon the effective date of our IPO and was originally set to end on June 30, 2016. On May 25, 2016, the Board of Directors extended the initial

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

offering period to July 31, 2016. Subsequent purchase periods will be 6 months in duration beginning on August 1, 2016. On July 29, 2016, we issued 68,392 shares of common stock in conjunction with the end date of the initial purchase window. During 2017, we issued 110,711 shares of common stock pursuant to the ESPP. On January 31, 2018 we issued 55,806 shares of common stock pursuant to the ESPP. On July 31, 2018 we issued 69,761 shares of common stock pursuant to the ESPP. On January 31, 2019 we issued 129,815 shares of common stock pursuant to the ESPP. On July 31, 2019 we issued 154,116 shares of common stock pursuant to the ESPP. On January 31, 2020 we issued 128,601 shares of common stock in conjunction with the end date of the latest purchase window.

No participant will have the right to purchase shares of our common stock in an amount that has a fair market value greater than $25,000, determined as of the first day of the applicable purchase period, for each calendar year in which that right is outstanding. In addition, no participant will be permitted to purchase more than 2,500 shares during any one purchase period or a lesser amount as determined by our compensation committee.

Our 2015 Employee Stock Purchase Plan will continue until the earlier to occur of its termination by our Board of Directors, the issuance of all shares reserved for issuance under it or the tenth anniversary of its effective date.

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

A summary of stock option and RSUs (including performance-based RSU) activity under the 2007 Plan and the 2015 Equity Incentive Plan is as follows:


	Stock Options
				Weighted-
		Weighted-		Average
		Average		Remaining	Aggregate
		Exercise		Contractual	Intrinsic
	Shares	Price		Term (Years)	Value
	(aggregate intrinsic value in thousands)
Outstanding as of December 31, 2017	1,560,453	$	3.63	7.6	$	4,632
Granted	479,375		7.25
Exercised	(112,965)		2.48
Canceled	(61,448)		3.65
Outstanding as of December 31, 2018	1,865,415		4.63	7.6	$	1,540
Granted	189,856		6.16
Exercised	(112,647)		3.36
Canceled	(13,233)		6.53
Outstanding as of December 31, 2019	1,929,391		4.84	6.9	$	7,146
Granted	—		—
Exercised	(299,737)		3.91
Canceled	(3,410)		6.94
Outstanding as of March 31, 2020	1,626,244	$	5.01	6.9	$	10,057
Options vested and expected to vest as of March 31, 2020	1,582,822	$	4.97	6.9	$	9,849
Options vested and exercisable as of March 31, 2020	1,034,771	$	4.42	6.3	$	7,002


	Restricted Stock Units
				Weighted-
		Weighted-		Average
		Average		Remaining	Aggregate
		Grant Date		Contractual	Intrinsic
	Shares	Fair Value		Term (Years)	Value
	(aggregate intrinsic value in thousands)
Outstanding as of December 31, 2017	509,894	$	2.84	1.4	$	3,288
Granted	925,578		6.55
Released	(264,568)		4.02
Forfeited/expired	(15,924)		8.34
Outstanding as of December 31, 2018	1,154,980		5.50	1.4	$	5,082
Granted	978,851		6.35
Released	(512,703)		5.31
Forfeited/expired	(169,621)		5.15
Outstanding as of December 31, 2019	1,451,507		6.18	1.3	$	12,314
Granted	958,825		7.88
Released	(143,625)		5.40
Forfeited/expired	(13,526)		7.67
Outstanding as of March 31, 2020	2,253,181	$	6.94	1.5	$	25,182

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 12. Stock-based Compensation.

We record stock-based compensation based on fair value as of the grant date using the Black-Scholes option-pricing model for stock options granted and Monte Carlo simulation techniques for certain RSUs with performance-based vesting conditions. We recognize such costs as compensation expense on a straight-line basis over the employee’s requisite service period, which is generally four years. Our valuation assumptions are as follows:

Risk-free interest rate. We base the risk-free interest rate used in the Black-Scholes option-pricing model on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent expected term of the options for each option group.

Expected term. The expected term represents the period that our stock-based awards are expected to be outstanding. The expected term assumption is based on the simplified method in which the expected term is equal to the average of the stock-based award’s weighted-average vesting period and its contractual term. We expect to continue using the simplified method until sufficient information about historical behavior is available.

Volatility. We determine volatility based on the historical stock volatility of our publicly traded stock.

Dividend yield. We have never declared or paid any cash dividend and do not currently plan to pay a cash dividend in the foreseeable future. Consequently, we used an expected dividend yield of zero.

The following table summarizes the weighted-average assumptions used in the Black-Scholes option-pricing model to determine fair value of stock options:


	Three months ended
	March 31, 2019
Volatility	66	%
Expected dividend yield	—
Risk-free rate	2.27	%
Expected term (in years)	6

The weighted-average grant date fair value of the options granted under the 2015 Equity Incentive Plan as calculated using the Black-Scholes option-pricing model was $3.57 per share for the three months ended March 31, 2019. There were no options granted during the three months ended March 31, 2020.

On March 25, 2019, our compensation committee granted 147,954 RSUs that do not begin vesting unless certain performance goals are met. Vesting of these shares will not begin unless the stock price performance goals are met and the number of shares eligible to begin vesting are based on Adesto’s share performance as compared to the Russell 2000 stock index which is the performance threshold established by the compensation committee. The evaluation period for the stock performance is from March 15, 2019 through March 15, 2020. Vesting would begin on the one-year anniversary of the grant date with 20% of the shares vesting immediately and the remaining 80% of the shares vesting over the next eight quarters. As a result of these performance-based vesting conditions we valued these RSUs using Monte Carlo simulation techniques to establish a fair value per share of $4.05 at the time of grant. Expense for these RSUs is being amortized over three years. As of March 15, 2020 it was determined that the performance criteria had been met and that these RSU’s had been earned and would begin vesting.

On February 17, 2019, our compensation committee granted 97,087 RSUs that do not begin vesting unless certain performance goals are met. Vesting of these shares will not begin unless the stock price performance goals are met and the number of shares eligible to begin vesting are based on Adesto’s share performance as compared to the Russell 2000 stock index which is the performance threshold established by the compensation committee. The

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

evaluation period for the stock performance is from January 31, 2020 through January 31, 2021. Vesting would begin on January 31, 2021 with 25% of the shares vesting every six months over two years. As a result of these performance-based vesting conditions we valued these RSUs using Monte Carlo simulation techniques to establish a fair value per share of $10.75 at the time of grant. Expense for these RSUs is being amortized over three years.

The following table presents the effects of stock-based compensation for stock options, RSUs (including performance-based RSUs), and ESPP purchase rights (in thousands):


	Three Months Ended
	March 31,
	2020		2019
Cost of revenue	$	142	$	65
Research and development		696		389
Selling, general and administrative		1,087		621
Total	$	1,925	$	1,075

Stock-based compensation expense capitalized to inventories was not material during the three months ended March 31, 2020 and 2019.

We did not realize any income tax benefit from stock option exercises in any of the periods presented due to recurring losses and valuation allowances.

As of March 31, 2020, the total unrecognized compensation cost related to stock options, net of estimated forfeitures, was approximately $1.9 million, and this amount is expected to be recognized over a weighted-average period of approximately 1.9 years.

As of March 31, 2020, the total unrecognized compensation cost related to RSUs (including performance-based RSUs) and ESPP purchase rights was $12.1 million and $0.2 million respectively, and these amounts are expected to be recognized over 2.5 years and 0.3 years, respectively.

Note 13. Income Taxes.

We recorded a benefit from income tax of ($103,000) and ($31,000), respectively, for the three months ended March 31, 2020 and 2019, respectively. The income tax provision is comprised of estimates of current and deferred taxes in domestic and foreign jurisdictions. The income tax provision reflects tax expense associated with foreign current and deferred taxes, state income tax, and uncertain tax positions. The decrease in the tax provision between 2020 and 2019 is primarily due to a deferred tax benefit associated with our foreign deferred tax liability and release of tax reserves due to the statute of limitations lapse on such reserve.

In January 2018, the FASB released guidance on the accounting for tax on the global intangible low-taxed income ("GILTI") provisions of the 2017 Tax Act. The GILTI provisions impose a tax on foreign income in excess of a deemed return on tangible assets of foreign corporations. The guidance indicates that either accounting for deferred taxes related to GILTI inclusions or to treat any taxes on GILTI inclusions as period cost are both acceptable methods subject to an accounting policy election. Effective January 1, 2018, we elected to treat any potential GILTI inclusions as a period cost as we are not projecting any material impact from GILTI inclusions and any deferred taxes related to any inclusion would be immaterial.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted on March 27, 2020. It contains several provisions that may have financial statement effects. Key Aspects of the CARES Act include the following:

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

●

Repealed the 80% taxable income limitation for 2018, 2019 and 2020. Also allows those years to be carried back up to five years;

●

Allows corporations to claim 100% of AMT credits in 2019. It also provides for an election to take the entire refundable credit amount in 2018;

●

Section 163(j) Adjusted Taxable Income limit raised from 30% to 50% for businesses; and

●

Technical corrections to TCJA for Qualified Improvement Property (“QIP”). Designates as 15-year property for depreciation purposes, which makes QIP a category eligible for 100% bonus depreciation.

The CARES Act is not expected have a material impact to Income Taxes in the Company's financial statements.

As of March 31, 2020, our deferred tax assets are fully offset by a valuation allowance except in those jurisdictions where it is determined that a valuation allowance is not required. Accounting for income taxes provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based on the weight of available evidence, which includes historical operating performance, reported cumulative net losses since inception and difficulty in accurately forecasting our future results, we provided a full valuation allowance against our net U.S. deferred tax assets. We reassess the need for our valuation allowance on a quarterly basis. If it is later determined that a portion or all of the valuation allowance is not required, the valuation allowance release will generally be a benefit to the income tax provision in the period that such determination is made.

We evaluate tax positions for recognition using a more-likely-than-not recognition threshold, and those tax positions eligible for recognition are measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon the effective settlement with a taxing authority that has full knowledge of all relevant information. We believe that we have provided adequate reserves for our income tax uncertainties in all open tax years. We do not anticipate a material change in the total amount or composition of its unrecognized tax benefits within 12 months of March 31, 2020.

We file federal, state, and foreign income tax returns in jurisdictions with varying statutes of limitations. Due to our net operating loss and credit carryforwards, our income tax returns generally remain subject to examination by federal, state, and international authorities.

Note 14. Net Loss Per Share.

The following outstanding common stock equivalents were excluded from the computation of diluted net loss per share for the periods presented because including them would have been antidilutive:


	Three Months Ended
	March 31,
	2020	2019
Stock options	1,626,244	2,018,469
Restricted stock units	2,253,181	1,346,031
Common stock warrants	1,165,282	1,239,423
Shares from the convertible senior notes	6,705,819	—
	11,750,526	4,603,923

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 15. Related Party Transactions.

The Company purchases certain wafers from Altis Semiconductor S.N.C., which was acquired by X-FAB Silicon Foundries, a stockholder of the Company, in 2016. There were no payments to X-Fab Silicon Foundries during the three months ended March 31, 2020 and 2019. As of March 31, 2020 and December 31, 2019, there were no amounts due.

On July 27, 2019, Susan Uthayakumar, the president of Schneider Electric, Canada joined the Company’s board of directors. The Company, through Echelon, sells Embedded Systems products to Schneider Electric. From September 14, 2018 (the date on which the Company acquired 100% of the issued capital of Echelon) and through the period ending March 31, 2020, the Company has recognized revenues of approximately $0.6 million from Schneider Electric. As of March 31, 2020 we had approximately $11,000 of outstanding accounts receivable with Schneider Electric.

Note 16. Restructuring

During 2019, the Company made the decision to close the lighting business which was acquired as part of the Echelon acquisition in September 2018. The lighting disposal liabilities included accrued costs for certain estimated warranty expenses, employee severance, additional inventory write-downs, additional bad debts, and additional materials at the Company’s subcontractors which have yet to be delivered.

Note 17. Merger with Dialog Semiconductor plc

On February 20, 2020, the Company, Dialog Semiconductor plc, a company incorporated in England and Wales (“ Parent ”), and Azara Acquisition Corp. (“ Merger Sub ”), a Delaware corporation and a wholly owned direct or indirect subsidiary of Parent, entered into an Agreement and Plan of Merger (the “ Merger Agreement ”). The Board of Directors of the Company has unanimously determined that the Merger is advisable and fair to, and in the best interests of, the Company and its stockholders, and unanimously recommended the adoption of the Merger Agreement by the holders of the Company’s common stock (the “ Shares ”).

Pursuant to the terms of, and subject to the conditions specified in, the Merger Agreement, Merger Sub will merge with and into the Company, and the Company will become a wholly owned direct or indirect subsidiary of Parent (the “ Merger ”). If the Merger is consummated, each Share outstanding as of immediately prior to the effective time of the Merger (other than (i) shares held, directly or indirectly, by any wholly owned subsidiary of the Company, (ii) shares held by the Company (or held in the Company’s treasury) or held, directly or indirectly by Parent, Merger Sub or any other wholly owned subsidiary of Parent and (iii) stockholders of the Company who are entitled to and who properly exercise appraisal rights under Delaware law) will be converted into the right to receive $12.55 in cash, without interest and subject to any required tax withholding.

The consummation of the Merger is subject to the satisfaction or waiver of customary closing conditions, including, among other things, (i) the adoption of the Merger Agreement by the holders of a majority of the Company’s Shares outstanding on the record date, which occurred on May 5, 2020 at a special meeting of the stockholders called for such purpose; (ii) the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended without the imposition of a Burdensome Condition (as defined in the Merger Agreement); (iii) obtainment of CFIUS Approval (as defined in the Merger Agreement); (iv) the absence of any order or other legal restraint or injunction preventing the consummation of the Merger and the absence of any law making the consummation of the Merger illegal, in any case, by any court or governmental entity having jurisdiction over the parties to the Merger Agreement; (v) the absence of certain legal proceedings brought by certain governmental entities relating to the Merger; (vi) the continued accuracy of the Company’s representations and warranties, subject to specified

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

materiality qualifications; (vii) the performance of the Company’s obligations and covenants under the Merger Agreement (to be performed at or prior to the consummation of the Merger) in all material respects and (vii) the absence of a Material Adverse Effect (as defined in the Merger Agreement). The transaction is not subject to a financing condition. The Company has filed the definitive proxy statement with the Securities and Exchange Commission on March 27, 2020. The Merger was approved by the stockholders of the Company on May 5, 2020. Subject to satisfaction of the closing conditions, the Company currently expects the merger to close in the second calendar quarter of 2020.

The Company has made customary representations and warranties in the Merger Agreement and has agreed to customary covenants, including (i) subject to certain limitations set forth in the Merger Agreement, to conduct the business and operations of the Company and its subsidiaries, in all material respects, in the ordinary course and in accordance with past practices prior to the consummation of the Merger and (ii) to not engage in certain specified transactions or activities prior to the consummation of the Merger without Parent’s prior written consent. In addition, the Company has agreed (i) not to solicit, initiate, knowingly encourage, or knowingly facilitate any alternative acquisition proposals or acquisition inquiries or take any action that could reasonably be expected to lead to an acquisition proposal or acquisition inquiry; (ii) not to furnish or otherwise provide access to any information regarding the Company or its subsidiaries to any person or entity in connection with or in response to an acquisition proposal or acquisition inquiry; (iii) not to engage in discussions or negotiations with any person or entity with respect to any acquisition proposal or acquisition inquiry; (iv) not to approve, endorse or recommend any acquisition proposal; and (v) not to enter into any letter of intent, memorandum of understanding, agreement in principle or similar document or any contract constituting or relating directly or indirectly to, or that contemplates or is intended or could reasonably be expected to result directly or indirectly in, an acquisition transaction, subject to customary exceptions in the exercise of the Board’s fiduciary duties.

The Merger Agreement contains customary termination rights for the parties, including the right to terminate the Merger Agreement if the Merger has not been consummated at or prior to 11:59 p.m. (California time) on August 20, 2020 (or, if so extended by either party in accordance with the terms of the Merger Agreement, November 20, 2020) (the “End Date”). The Merger Agreement provides that the Company will be required to pay Parent a termination fee of $15.76 million if the Merger Agreement is terminated under certain circumstances, including by the Company to accept a Superior Offer (as defined in the Merger Agreement) and enter into a definitive agreement providing for consummation of the transaction contemplated by such Superior Offer. The Merger Agreement also provides that Parent will be required to pay to the Company a termination fee of $15.76 million if the Merger is not consummated due to a failure to obtain CFIUS Approval prior to the End Date.

Note 18. Subsequent events.

The global COVID-19 pandemic has impacted the operations and purchasing decisions of companies worldwide. It also has created and may continue to create significant uncertainty in the global economy. The Company has undertaken measures to protect its employees, partners, customers, and vendors. In addition, the Company’s personnel worldwide are subject to various travel restrictions, which limit the ability of the Company to provide services to customers and affiliates. This impacts the Company's normal operations. To date, the Company has been able to provide uninterrupted access to its products and services due to its globally distributed workforce, many of whom are working remotely, and its pre-existing infrastructure that supports secure access to the Company’s internal systems. If, however, the COVID-19 pandemic has a substantial impact on the productivity of the Company’s employees or its partners’ or customers’ decision to use the Company’s products and services, the results of the Company’s operations and overall financial performance may be adversely impacted. The duration and extent of the impact from the COVID-19 pandemic depends on future developments that cannot be accurately predicted at this time. As of the date of issuance of the financial statements, the Company is not aware of any specific event or circumstance that would require updates to the Company’s estimates and judgments or revisions to the carrying value of its assets or liabilities. These estimates may change, as new events occur and additional information is obtained, and are recognized in the condensed

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ADESTO TECHNOLOGIES CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

consolidated financial statements as soon as they become known. Actual results could differ from those estimates and any such differences may be material to the financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking statements and factors that may affect future results

The discussion below contains forward-looking statements, which are subject to safe harbors under the Securities Act of 1933, as amended (the “Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements generally relate to future events or to our future financial or operating performance. You can generally identify forward-looking statements because they contain words such as “may,” “might,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intend,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions that concern our expectations, strategy, plans or intentions. We have based these forward-looking statements primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations and prospects. Except as required by law, we do not undertake any obligation to update these forward-looking statements to reflect events occurring or circumstances arising after the date of this report. You should not rely upon forward-looking statements as predictions of future events. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those projected in the forward-looking statements. These forward-looking statements involve risks and uncertainties, and our actual results, performance, or achievements could differ materially from those expressed or implied by the forward-looking statements on the basis of several factors, including those that we discuss in Risk Factors, set forth in Part II, Item 1A, of this Quarterly Report on Form 10-Q. We encourage you to read that section carefully.

The following is a discussion and analysis of our financial condition and results of operations and should be read together with our condensed consolidated financial statements and related notes to condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes to audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019. In this Quarterly Report, unless otherwise specified or the context otherwise requires, “Adesto,” “we,” “us,” and “our” refer to Adesto Technologies Corporation and its consolidated subsidiaries.

Impact of COVID-19

The global COVID-19 pandemic has impacted the operations and purchasing decisions of companies worldwide. It also has created and may continue to create significant uncertainty in the global economy. We have undertaken measures to protect our employees, partners, customers, and vendors. In addition, our personnel worldwide are subject to various travel restrictions and, which limit our ability of to provide services to customers and affiliates. This impacts our normal operations. To date, We have been able to provide uninterrupted access to our products and services due to our globally distributed workforce, many of whom are working remotely, and our pre-existing infrastructure that supports secure access to our internal systems. If, however, the COVID-19 pandemic has a substantial impact on the productivity of our employees or our partners’ or customers’ decision to use our products and services, the results of our operations and overall financial performance may be adversely impacted. The extent of the impact from the COVID-19 pandemic on our business will depend largely on future developments that are highly uncertain and cannot be predicted. For a discussion of risks of COVID-19 relating to our business, see “Part II: Other Information-Item 1A.- Risk Factors- Risks Related to Our Business and Our Industry- The recent coronavirus outbreak could have an adverse effect on our business.”

Overview

We are a leading provider of innovative, application-specific semiconductors and embedded systems that provide the key building blocks of Internet of Things (“IOT”) edge devices operating on networks worldwide. Our broad portfolio of semiconductor and embedded technologies are optimized for connected IoT devices used in industrial, consumer, communications and medical applications. Through expert design, systems expertise and proprietary intellectual property, we enable our customers to differentiate their systems where it matters most for IoT: longer battery life, greater reliability, integrated intelligence and lower cost. Through our solutions, we enable seamless access to data and control of ‘things’ in the connected world. Our product portfolio includes analog, digital and non-volatile memory

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(“NVM”) technologies delivered in the form of standard products, application-specific integrated circuits (“ASICs”) and intellectual property (“IP”) cores.

Our revenue is primarily derived from the sale of our NVM products, specifically our serial flash memory products, which represented substantially all of our revenue for the three months ended March 31, 2020. In recent years, we have invested in developing new flash memory products that are well suited for low-power, high-growth applications. Revenue from our next-generation NVM products were $13.7 million and $17.2 million for the three months ended March 31, 2020 and March 31, 2019, respectively. With the acquisition of S3 Semiconductors, in May 2018, we expanded our product offering and began selling analog, mixed-signal and radio frequency ASICs and IP blocks, and managing the supply of high-quality devices to our customers. We acquired 100% of the issued capital of Echelon Corporation, a Delaware corporation (“Echelon”), on September 14, 2018. During the three months ended March 31, 2020 and March 31, 2019 S3 Semiconductors and Echelon revenues were approximately $6.3 million and $10.9 million, respectively.

For the three months ended March 31, 2020, our products were sold to more than 5,000 end customers. In general, we work directly with our customers to have our NVM devices designed into and qualified for their products. Although we maintain direct sales, support and development relationships with our customers, once our products are designed into a customer’s product, we sell a majority of our products to those customers through distributors. We generated 55% and 61% of our revenue from distributors in each of the three months ended March 31, 2020 and March 31, 2019, respectively. Sales to three distributors generated approximately 31% and 40% of our revenue during the three months ended March 31, 2020 and March 31, 2019, respectively. Additionally, we derived approximately 85% and 73% of our revenue internationally during the three months ended March 31, 2020 and March 31, 2019, respectively, the majority of which was recognized in the Asia Pacific (“APAC”) region. Revenue by geography is recognized based on the region to which our products are sold, and not to where the end products are shipped.

We employ a fabless manufacturing strategy and use market-leading suppliers for all phases of the manufacturing process, including wafer fabrication, assembly, testing and packaging. This strategy significantly reduces the capital investment that would otherwise be required to operate manufacturing facilities of our own.

On February 20, 2020, we entered into the Merger Agreement with Dialog and Merger Sub, pursuant to which Merger Sub will, pursuant to the terms of and subject to the conditions specified in the Merger Agreement, merge with and into us, and we will be the surviving corporation of the Merger and become a wholly owned direct or indirect subsidiary of Dialog. Upon the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger, each share of our common stock (subject to certain exceptions) issued and outstanding immediately prior to the effective time of the Merger will be canceled and automatically converted into the right to receive $12.55 in cash, without interest and subject to any required tax withholding. Our Board of Directors has unanimously determined that the Merger is advisable and fair to, and in the best interests of, us and our stockholders, and unanimously recommended the adoption of the Merger Agreement by the holders of our common stock. The Company has filed the definitive proxy statement with the Securities and Exchange Commission on March 27, 2020. The Merger was approved by the stockholders of the Company on May 5, 2020. Subject to satisfaction of the closing conditions, we currently expect the merger to close in the second calendar quarter of 2020. For more information see Note 17, “Merger with Dialog Semiconductor plc,” in the notes to our condensed consolidated financial statements.

Factors Affecting Our Performance

Product adoption in new markets and applications. We optimize our products to meet the technical requirements of the emerging IoT market. The growth in the IoT market is dependent on many factors, most of which are outside of our control. Should the IoT market not develop or develop more slowly, our financial results could be adversely affected.

Ability to attract and retain customers that make large orders. In 2019, our products were sold to more than 5,000 end customers, of which approximately 25 generated more than half of our revenue. One end customer accounted for 10% or more of our revenue in the first three months of 2020. One end customer accounted for 10% or more of our revenue in 2019. While we expect the composition of our customers to change over time, especially given our recent

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acquisitions, our business and operating results will depend on our ability to continually target new customers and retain existing customers that place large orders, particularly those in growth markets which are less dependent on macroeconomic conditions.

Design wins with new and existing customers. We believe our solutions significantly improve the performance and potentially lower the system cost of our customers’ designs, particularly if we are part of the early design phase. Accordingly, we work closely with our customers and targeted prospects to understand their product roadmaps and strategies. We consider design wins to be critical to our future success. We define a design win as the successful completion of the evaluation stage, where a customer has tested our product, verified that our product meets its requirements and qualified our NVM device for their products. The number of our design wins has grown from 417 in 2017 to 570 in 2018. We had 459 additional design wins in 2019. The revenue that we generate, if any, from each design win can vary significantly. Our long-term sales expectations are based on forecasts from customers, internal estimates of customer demand factoring in expected time to market for end customer products incorporating our solutions and associated revenue potential and internal estimates of overall demand based on historical trends. We had 159 new design wins during the first three months of 2020.

Pricing, product cost and gross margins of our products. Our gross margin has been and will continue to be affected by a variety of factors, including the timing of changes in pricing, shipment volumes, new product introductions, changes in product mixes, changes in our purchase price of fabricated wafers and assembly and test service costs, the cost of raw materials for our embedded systems products, manufacturing yields and inventory write downs, if any. In general, newly introduced products and products with higher performance and more features tend to be priced higher than older, more mature products. Average selling prices in the semiconductor industry typically decline as products mature. Consistent with this historical trend, we expect that the average selling prices of our products will decline as they mature. In the normal course of business, we will seek to offset the effect of declining average selling prices on existing products by reducing manufacturing costs and introducing new and higher value-added products. More recently, certain of our suppliers have increased costs although such increase did not have a material impact on our results of operations for the three months ended March 31, 2020. If we are unable to maintain overall average selling prices or offset any declines in average selling prices with realized savings on product costs, our gross margin will decline.

Investment in growth. We have invested, and intend to continue to invest, in expanding our operations, increasing our headcount, developing our products and differentiated technologies to support our growth and expanding our infrastructure. We expect our total operating expenses to increase in the foreseeable future to meet our growth objectives. We plan to continue to invest in our sales and support operations throughout the world, with a particular focus in adding additional sales and field applications personnel to further broaden our support and coverage of our existing customer base, in addition to developing new customer relationships and generating design wins. We also intend to continue to invest additional resources in research and development to support the development of our products and differentiated technologies. Any investments we make in our sales and marketing organization or research and development will occur in advance of experiencing any benefits from such investments, and the return on these investments may be lower than we expect. In addition, as we invest in expanding our operations internationally, our business and results will become further subject to the risks and challenges of international operations, including higher operating expenses and the impact of legal and regulatory developments outside the United States.

Components of Our Results of Operations

Revenue

For the three months ended March 31, 2020 we derived approximately 68% of our revenue through the sale of our NVM products to original equipment manufacturers (“OEMs”) and original design manufacturers (“ODMs”), primarily through distributors. We generated 55%, and 61% of our revenue from distributors for the three months ended March 31, 2020 and March 31, 2019, respectively. We derived approximately 32% and 39% of our revenue from the operations of S3 Semiconductors and Echelon for the three months ended March 31, 2020 and March 31, 2019. Revenue is recognized when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. We sell the majority of our

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NVM products to distributors and generally recognize revenue when we ship the product directly to the distributors since title and risk of loss transfers at that time.

Because our distributors market and sell their products worldwide, our revenue by geographic location is not necessarily indicative of where our end customers’ product sales and design win activity occur, but rather of where their manufacturing operations occur.

Cost of Revenue and Gross Margin

Cost of revenue primarily consists of costs paid to our third-party manufacturers for wafer fabrication, assembly and testing of our NVM products, raw material purchases for embedded products, and write-downs of NVM and embedded inventory for excess and obsolete inventories. To a lesser extent, cost of revenue also includes depreciation of test equipment and expenses relating to manufacturing support activities, including personnel-related costs for both NVM and embedded products, logistics and quality assurance and shipping. Cost of revenue for ASIC and IP products is driven primarily by personnel-related costs including outside consultants along with facilities costs.

Our gross margin has been and will continue to be affected by a variety of factors, including the timing of changes in pricing, shipment volumes, new product introductions, changes in product mix, changes in our purchase price of fabricated wafers and assembly and test service costs, manufacturing yields and inventory write downs, if any. We expect our gross margin to fluctuate over time depending on the factors described above.

Operating Expenses

Our operating expenses consist of research and development, selling, general and administrative expense, amortization of intangible assets, acquisition related expenses and impairment and other charges. Personnel-related costs, including salaries, benefits, bonuses and stock-based compensation, are the most significant component of each of our operating expense categories. In addition, in the near term we expect to hire additional personnel, primarily in our selling and marketing functions, and increase research and development expenditures. Accordingly, we expect our operating expenses to increase in absolute dollars as we invest in these initiatives.

Research and Development. Our research and development expenses consist primarily of personnel-related costs for the design and development of our products and technologies. Additional research and development expenses include product prototype costs, amortization of mask costs and other materials costs, external test and characterization expenses, depreciation, amortization of design tool software licenses, amortization of acquisition-related intangible assets and allocated overhead expenses. We also incur costs related to outsourced research and development activities and joint venture activities. We expect research and development expenses to increase in absolute dollars for the foreseeable future as we continue to improve our product features and increase our portfolio of solutions.

Selling, general and administrative. Selling, general, and administrative expenses consist primarily of personnel-related costs for our sales, business development, marketing, and applications engineering activities, third-party sales representative commissions, promotional and other marketing expenses, amortization of acquisition-related intangible assets and travel expenses. General and administrative expenses consist primarily of personnel-related costs, consulting expenses and professional fees. Professional fees principally consist of legal, audit, tax and accounting services. We expect sales, general and administrative expenses to increase in absolute dollars for the foreseeable future as we hire additional personnel, increase our marketing activities, and make improvements to our infrastructure and incur additional costs for legal, insurance and accounting expenses associated with our recent acquisitions.

Amortization of intangible assets. Amortization of intangible assets is the periodic expense related to the use of intangible assets created as a result of the acquisitions with respect to S3 Semiconductors, Echelon and Atmel Corporation. The periodic expense is based on useful lives determined as part of the initial valuation of the assets acquired.

Acquisition related expenses. Acquisition related expenses are those costs incurred as a result of the S3 Semiconductors and Echelon acquisitions and the proposed merger with Dialog Semiconductor plc and include banking

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fees, legal, accounting, and tax fees, and certain professional fees including costs related to the valuation of each acquisition.

Impairment and other charges. Impairment and other charges are costs incurred related to write-downs of certain equipment and assets, terminated projects and excess facilities.

Other Income (Expense), Net

Other income (expense), net is comprised of interest income (expense) and other income (expense). Interest expense consists of cash interest on our outstanding debt and the amortization of debt discount. Other expense, net consists of foreign exchange gains and losses and the change in the fair value of the earn-out liability which was part of the S3 Semiconductors share purchase agreement. The earn-out liability is tied to certain financial performance criteria defined in the S3 Semiconductors share purchase agreement. Our foreign currency exchange gains and losses relate to transactions and asset and liability balances denominated in currencies other than the U.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates.

Benefit from Income Taxes

Benefit from income taxes consists primarily of U.S. federal and state income taxes in the United States and income taxes in certain foreign jurisdictions in which we conduct business. We have a full valuation allowance for deferred tax assets, including net operating loss carryforwards, and tax credits related primarily to research and development. We expect to maintain this full valuation allowance for the foreseeable future.

Comparison of the three months ended March 31, 2020 and 2019 (in thousands, except percentage data):

Revenue


		Three Months Ended
		March 31,			Change
		2020		2019	$	%
Revenue, net	$	20,021	$	28,113	(8,092)	-29	%


	Three Months Ended
	March 31,
	2020		2019
Revenue by geography:
United States	15	%	27	%
Europe	17	%	17	%
Asia Pacific	65	%	49	%
Rest of world	2	%	7	%

Revenue decreased by $8.1 million, or 29%, during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. This decrease was due primarily to decreased unit shipments of NVM products to Tier 1 customers along with a decrease in revenues from the S3 Semiconductors and Echelon businesses of $4.6 million.

Cost of Revenue and Gross Margin


	Three Months Ended
		March 31,					Change
	2020			2019			$		%
Cost of revenue	$	11,384		$	14,893		$	(3,509)	-24	%
Gross profit		8,637			13,220			(4,583)	-35	%
Gross margin		43	%		47	%

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Cost of revenue decreased by $3.5 million, or 24%, during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. This decrease was due primarily to a decrease in unit shipments of NVM products to Tier 1 customers offset by relatively stable expenses resulting from our S3 Semiconductors and Echelon businesses.

Gross profit decreased by $4.6 million, or 35%, during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019 due primarily to a decrease in unit shipments of NVM products along with decreased revenues and gross profits from S3 Semiconductors and Echelon.

Operating Expenses


	Three Months Ended
	March 31,				Change
	2020		2019		$		%
Operating expenses:
Research and development	$	7,664	$	7,522	$	142	2	%
Selling, general and administrative		8,823		7,935		888	11
Amortization of intangible assets		1,788		1,788		—	—
Acquisition related expenses		1,901		222		1,679	756
Impairment and other charges		—		1,694		(1,694)	(100)
Total operating expenses	$	20,176	$	19,161	$	1,015	5	%

Research and Development. Research and development expense decreased by $0.1 million, or 2%, during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. This decrease was due primarily to a reduction in outside services.

Selling, General and Administrative. Selling, general and administrative expense increased by $0.9 million, or 11%, for the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. This increase was due primarily to a $0.4 million increase in personnel-related costs, a $0.2 million increase in legal and accounting costs, a $0.2 million increase in facilities costs, and a $0.1 million increase in travel costs.

Amortization of Intangible Assets. There was no change in the amortization of intangible assets for the three months ended March 31, 2020 as compared to the three months ended March 31, 2019.

Acquisition expenses. Acquisition related expenses increased by $1.7 million for the three months ended March 31, 2020 as compared to the three months ended March 31, 2019 and were primarily due to increased legal and accounting costs related to the announced acquisition of the Company by Dialog Semiconductor plc.

Impairment and Other Charges. There was no impairment and other charges for the three months ended March 31, 2020. During the three months ended March 31, 2019 we recorded $1.7 million of impairment and other charges for inventory write-downs and additional warranty and other liabilities related to exiting the Echelon lighting business.

Other Income (Expense), Net


	Three months ended
	March 31,				Change
	2020		2019		$		%
Interest expense, net	$	(1,515)		(1,370)	$	(145)	(11)	%
Other income (expense), net		1,936		220		1,716	780
Total other income (expense), net	$	421	$	(1,150)	$	1,571	137	%

Interest expense, net increased by approximately $0.1 million during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019, as a result of our increased indebtedness related to the issuance of our convertible notes.

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Other income (expense), net increased by approximately $1.7 million during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019 due primarily to a change in the fair value of an earn-out liability incurred in connection with the S3 Semiconductors acquisition and certain other credits recognized at S3 Semiconductors.

Benefit from Income Taxes


	Three Months Ended
	March 31,				Change
	2020		2019		$		%
Benefit from income taxes	$	(103)	$	(31)	$	72	232	%

Benefit from income taxes increased by $72,000 during the three months ended March 31, 2020 as compared to the three months ended March 31, 2019. The increase was due primarily to a reduction in tax expense related to our foreign subsidiaries as well as an increase in the benefit related to deferred taxes in the United States.

Liquidity and Capital Resources

Our principal source of liquidity as of March 31, 2020 consisted of cash and cash equivalents and restricted cash of $10.5 million. Our outstanding borrowings as of March 31, 2020 were $80.5 million. Substantially all of our cash and cash equivalents are held in the United States.

We believe our existing cash and cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs over the next 12 months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of our spending to support research and development activities, the timing and cost of establishing additional sales and marketing capabilities, the introduction of new and enhanced products and our costs to implement new manufacturing technologies. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. Any additional debt financing obtained by us in the future could also involve restrictive covenants relating to our capital-raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. Additionally, if we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new equity securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to grow or support our business and to respond to business challenges could be significantly limited.

The following table summarizes our cash flows for the periods indicated:


	Three Months Ended
	March 31,
	2020		2019
Cash flows used in operating activities	$	(11,132)	$	(631)
Cash flows used in investing activities		(1,226)		(604)
Cash flows provided by financing activities		1,703		48

Cash Flows from Operating Activities

Our primary source of cash from operating activities has been from cash collections from our customers. We expect cash inflows from operating activities to be affected by increases in sales and timing of collections. Our primary uses of cash from operating activities have been for personnel costs, investments in research and development and sales and marketing, and procurement of inventory. Net cash used in operating activities for the periods presented consisted of net losses adjusted for certain noncash items and changes in working capital. Within changes in working capital, changes in accounts receivable, inventory and accounts payable generally account for the largest adjustments, as we typically use more cash to fund accounts receivable and build inventory as our business grows. Increases in accounts payable typically

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provides more cash as we do more business with our contract foundries and other third parties, depending on the timing of payments.

During the three months ended March 31, 2020, cash used in operating activities was approximately $11.1 million and was due primarily to a net loss of $11.0 million, partially offset by non-cash charges of $1.9 million related to stock-based compensation expense, $1.0 million related to depreciation and amortization, $1.8 million related to the amortization of intangible assets, $0.7 million related to amortization of debt discount, offset by the change in fair value of our earn-out liability of $0.9 million, and an increase in our net assets and liabilities of $4.6 million. The increase in net assets and liabilities is due primarily to an decrease in accounts receivable of $2.4, an increase in inventories of $2.2 million, an increase in prepaids and other current and non-current assets of $0.7 million, a decrease in accounts payable, accrued compensation and other accrued expenses of $3.5 million, and a decrease in price adjustments and other non-current liabilities of $0.6 million.

During the three months ended March 31, 2019, cash used in operating activities was approximately $0.6 million and was due primarily to a net loss of $7.1 million, partially offset by non-cash charges of $1.1 million related to stock-based compensation expense, $0.6 million related to depreciation and amortization, $1.8 million related to the amortization of intangible assets, $0.4 million related to amortization of debt discount, offset by the change in fair value of our earn-out liability of $0.3 million, and a decrease in our net assets and liabilities of $2.9 million. The decrease in net assets and liabilities is due primarily to an increase in accounts receivable of $9,000, a decrease in inventories of $2.0 million, a decrease in deferred rent of $0.3 million, an increase in accounts payable, accrued compensation and other accrued expenses of $1.3 million, and an increase in prepaid expenses and other current assets of $0.1 million.

Cash Flows from Investing Activities

During the three months ended March 31, 2020, cash used in investing activities was $1.2 million, primarily due to purchases of equipment for our operations and research and development functions along with investments in unconsolidated affiliates.

During the three months ended March 31, 2019, cash used in investing activities was $0.6 million, primarily due to purchases of equipment for our operations and research and development functions.

Cash Flows from Financing Activities

During the three months ended March 31, 2020, cash provided by financing activities was $1.7 million and was due primarily to proceeds of $1.7 million from the exercise of stock options and purchases of stock associated with our employee stock purchase plan net of withholdings related to the net settlement of restricted stock units.

During the three months ended March 31, 2019, cash provided by financing activities was $48,000 and was due primarily to proceeds of $0.5 million from the exercise of stock options and purchases of stock associated with our employee stock purchase plan net of withholdings related to the net settlement of restricted units offset by a $0.4 million paydown of our term loan.

Off Balance Sheet Arrangements

During the periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off balance sheet arrangements or other contractually narrow or limited purpose.

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Credit Facility

Tennenbaum Capital Partners, LLC Term Loan.

On May 8, 2018, we entered into a credit agreement with Tennenbaum (“Credit Agreement”). The Credit Agreement provided for a first lien senior secured term loan of $35.0 million (“Term Loan”). The Term Loan bore interest at a rate per annum equal to the sum of the Libor Rate plus 8.75% and was payable in consecutive quarterly installments starting December 31, 2018. The Term Loan was scheduled to mature on May 8, 2022. The Credit Agreement provided that any indebtedness we incurred thereunder was collateralized by substantially all assets of the Company and any domestic subsidiaries, subject to certain customary exceptions.

The Credit Agreement, as amended, contained customary representations and warranties and affirmative and negative covenants, including maximum consolidated leverage ratios and minimum liquidity. Upon an occurrence of an event of default, under the Credit Facility we could have been required to pay interest on all outstanding obligations under the agreement at a rate of 2% above the otherwise applicable interest rate, and the lender could have accelerated our obligations under the agreement.

In connection with the Credit Agreement, Tennenbaum received a warrant to purchase 850,000 shares of common stock at an exercise price of $8.62 and a term of six years. We paid financing costs of $1.4 million. The financing costs and the value of the warrant, $4.8 million, were recorded as a debt discount and were being amortized over the life of the agreement. Amortization of debt discount was $1.2 million prior to the loan payoff with the remaining $3.6 million of unamortized debt discount being recognized as interest expense for the year ended December 31, 2019. Borrowings of $33.8 million under this term loan were repaid in full on September 23, 2019 along with a contractual prepayment premium of $0.7 million which represented 2% of the outstanding loan balance.

Senior Convertible Notes

On September 23, 2019, we completed offering of $80.5 million aggregate principal amount of the Notes. The Notes were sold pursuant to an indenture, dated September 23, 2019, between the Company and U.S. Bank National Association. The Notes are senior, unsecured obligations of the Company. The Notes pay interest at a rate equal to 4.25% per year. Interest on the Notes is payable semiannually in arrears on March 15 and September 15 of each year, beginning March 15, 2020. Interest accrues on the Notes from the last date to which interest has been paid or duly provided for or, if no interest has been paid or duly provided for, from September 23, 2019. Unless earlier converted, redeemed or repurchased, the Notes mature on September 15, 2024. In connection with the pricing of the Notes, we entered into privately negotiated capped call transactions with each of Credit Suisse Capital LLC and Société Générale.

In accounting for the issuance of the Notes, we separated the Notes into liability and equity components. The carrying amounts of the liability components of the Notes were calculated by measuring the fair value of similar debt instruments that do not have an associated convertible feature. The carrying amount of the equity component represents the conversion option and was determined by deducting the fair value of the liability component from the par value of the respective Notes. This difference represents the debt discount that is amortized to interest expense over the respective term of the Notes using the effective interest rate method. The carrying amount of the equity component that represents the conversion option was $22.6 million gross and $21.6 million net of issuance costs. The equity component is recorded in additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification.

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Contractual Obligations and Commitments

The following is a summary of our contractual obligations and commitments as of March 31, 2020:


			Payments due by period
Contractual Obligations	Total		Less than 1 Year		1 - 3 Years		4 - 5 Years		More than 5 Years
	(in thousands)
Operating leases (1)	$	7,945	$	1,512	$	4,258	$	2,175	$	—
Inventory-related commitments (2)		9,088		9,088		—		—		—
Financing arrangements (3)		80,500		—		—		80,500		—
Interest obligation on convertible senior notes		16,137		2,566		10,264		3,307
Total contractual cash obligations	$	113,670	$	13,166	$	14,522	$	85,982	$	—

(1)	Operating leases primarily relate to our leases of office space with terms expiring through July 31, 2023.

(2)	Represents outstanding purchase orders for wafer commitments that we have placed with our suppliers as of March 31, 2020.

(3)	Financing arrangements represent debt maturities under our senior convertible notes.

As of March 31, 2020, we had a liability of $274,000 for uncertain tax positions.

Item 3.Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risks in the ordinary course of our business. These risks primarily include foreign exchange rate and interest rate sensitivities as follows:

Foreign Currency Risk

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates.

The majority of our revenue is denominated in U.S. dollars. Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the United States and to a lesser extent in Europe, Middle East and Africa (“EMEA”) and APAC. Our results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates. The effect of a hypothetical 10% change in foreign currency exchanges rates applicable to our business would not have a material impact on our historical consolidated financial statements.

We have not hedged exposures denominated in foreign currencies or used any other derivative financial instruments. Although we transact the substantial majority of our business in U.S. dollars, future fluctuations in the value of the U.S. dollar may affect the competitiveness of our products and thus may impact our results of operations and cash flows.

Interest Rate Sensitivity

We had cash and cash equivalents of $10.5 million as of March 31, 2020, consisting of bank deposits, money market funds and U.S. government securities. Such interest-earning instruments carry a degree of interest rate risk. To date, fluctuations in interest income have not been significant. We also had total outstanding gross debt of $80.5 million offset by $21.7 million related to the conversion option recorded in equity and $2.3 million of issuance costs as of March 31, 2020. The outstanding debt relates to our 4.25% Convertible Senior Notes due 2024. See Note 8, Convertible Notes, of the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information.

We do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate risk exposure. We have not been exposed to, nor do we anticipate being exposed

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to, material risks due to changes in interest rates. Our exposure to interest rates relates to the change in the amounts of interest we must pay on our variable rate borrowings. A hypothetical 10% increase in our borrowing rates would result in a $0.3 million increase in annual interest expense on our gross principal balance of $80.5 million.

Item 4.Controls and Procedures.

(a)

Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.

Our management is responsible for establishing and maintaining our disclosure controls and procedures. Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our disclosure controls and procedures as of March 31, 2020. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of March 31, 2020.

(b)

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Internal control over financial reporting means a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.

PART II: OTHER INFORMATION

ITEM 1.Legal Proceedings

We are not currently a party to any legal proceedings which, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our business, operating results, financial condition or cash flows. We may, from time to time, become involved in legal proceedings arising in the ordinary course of our business and as our business grows, we may become a party to an increasing number of legal proceedings.

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ITEM 1A.Risk Factors

Large accelerated filer ☐

Accelerated filer

Non-accelerated filer ☐

Smaller reporting company

Emerging growth company

ADESTO TECHNOLOGIES Corp 10-Q