CUE HEALTH INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)

You should read the following discussion and analysis of our financial condition
and results of operations together with the financial statements and the related
notes included elsewhere in this Annual Report on Form 10-K. This discussion and
other parts of this Annual Report on Form 10-K contain forward-looking
statements that involve risks and uncertainties, such as statements of our
plans, objectives, expectations and intentions, that are based on the beliefs of
our management, as well as assumptions made by, and information currently
available to, our management. Our actual results could differ materially from
those discussed in or implied by these forward-looking statements. Factors that
could cause or contribute to such differences include, but are not limited to,
those discussed in the section of this Annual Report on Form 10-K titled "Risk
Factors." For a discussion related to the results of operations for 2020
compared to 2019, refer to "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in our 2021 S-1 filed with the Securities
and Exchange Commission on September 23, 2021.


Overview

We are a health technology company, and our mission is to enable personalized,
proactive and informed healthcare that empowers people to live their healthiest
lives. Our proprietary platform, the Cue Integrated Care Platform, which is
comprised of our Cue Health Monitoring System, Cue Data and Innovation Layer,
Cue Virtual Care Delivery Apps, and Cue Ecosystem Integrations and Apps, enables
lab-quality diagnostics-led care at home, at work or at the point of care. Our
platform is designed to empower stakeholders across the healthcare ecosystem,
including consumers, providers, enterprises and payors with paradigm-shifting
access to diagnostic and health data to inform care decisions. We are helping
pioneer a new continuous care model that we believe has the potential to
significantly improve the user experience, provide measurable and actionable
clinical insights, and increase efficiency within the healthcare ecosystem. We
believe this model, powered by our platform, will allow users to actively manage
their health, which we believe will lead to improved health outcomes and a more
resilient, connected, and efficient healthcare ecosystem for all stakeholders.

The Cue Integrated Care Platform consists of the following hardware and software
components: (1) our revolutionary Cue Health Monitoring System, made up of a
portable, durable and reusable reader, or Cue Reader, a single-use test
cartridge, or Cue Cartridge, and a sample collection wand, or Cue Wand, (2) our
Cue Data and Innovation Layer, with cloud-based data and analytics capability,
(3) our Cue Virtual Care Delivery Apps, including our consumer-friendly App and
our Cue Enterprise Dashboard, and (4) our Cue Ecosystem Integrations and Apps,
which allow for integrations with third party applications and sensors.

Our Cue Health Monitoring System is designed to deliver a broad menu of tests
through one system, enabling two major testing modalities, NAAT, and
immunoassays, in one device. Our system is designed to handle different sample
types, including saliva, blood, urine and swabs, and can detect nucleic acids,
small molecules, proteins and cells. We believe this will enable us to address
many of the diagnostic tests conducted in clinical laboratories, such as tests
addressing indications in respiratory health, sexual health, cardiac and
metabolic health, women's health, men's health, and chronic disease management.

Initial public offering

The Company's registration statement related to its initial public offering
("IPO") was declared effective on September 23, 2021, and the Company's common
stock began trading on the Nasdaq Global Select Market ("Nasdaq") on September
24, 2021. On September 28, 2021, the Company completed its IPO of 14,375,000
shares of the Company common stock at an offering price of $16.00 per share,
including 1,875,000 shares purchased by the IPO underwriters. The Company
received aggregate net proceeds of approximately $206.0 million after deducting
underwriting commissions and legal, accounting, and consulting fees related to
the IPO.

Upon completion of the IPO, Convertible Notes outstanding in the principal
amount of $235.5 million and accrued interest of $2.8 million were automatically
converted into 18,611,914 shares of common stock. All outstanding shares of the
Company's redeemable convertible preferred stock were converted into 83,605,947
shares of common stock. Immediately prior to the IPO, all of the Company's
outstanding warrants to purchase redeemable convertible preferred stock were
converted into the redeemable convertible preferred stock and the related
warrant liabilities were reclassified to additional paid-in capital.

Impact of COVID-19

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While the ongoing global COVID-19 pandemic has adversely impacted global
commercial activity, it served as a catalyst to accelerate our product pipeline
and commercialization of our platform. We began selling and recording total
revenue for our COVID-19 test in August 2020 after obtaining our first FDA EUA
in June 2020. Currently, all of our revenue is related to sales of our Cue
COVID-19 test.

In December 2020, the FDA issued EUA for two COVID-19 vaccines and in February
2021, the FDA issued a third EUA for a COVID-19 vaccine. The widely-administered
use of an efficacious vaccine or the availability of therapeutic treatments for
COVID-19 may reduce the demand for our COVID-19 test and could cause the
COVID-19 diagnostic testing market to fail to grow or to decline. However, we
believe the need for ongoing detection and monitoring will continue to be high
even after effective vaccines have been widely distributed and administered. We
also believe COVID-19 will remain endemic for the foreseeable future and people
suspected of having COVID-19 will want to obtain a fast and accurate COVID-19
test to confirm a diagnosis in order to receive timely and appropriate
treatment. Even while vaccine efforts are underway, public health measures, like
testing, will likely need to stay in effect to protect against COVID-19.
However, given the unpredictable nature of the COVID-19 pandemic, the
development and potential size of the COVID-19 diagnostic testing market is
highly uncertain.

Certain key factors affecting our performance

manufacturing capacity

We manufacture all of our Cue Cartridges in our vertically integrated facilities
in San Diego, California. We also produce all of our biochemistry in-house,
including critical enzymes, antibodies and primers for our Cue Cartridges.
Production of our Cue Readers is performed for us by third-party contract
manufacturers and production of our Cue Wands is performed by both us and by
third-party contract manufacturers. We continue to optimize our manufacturing
capabilities, including our fully automated production pods. A production pod is
a free standing, modular environmentally controlled structure containing an
automated cartridge production line.

Investments in our growth

We expect to make continued significant investments in our business to drive
growth, and therefore we expect our expenses to increase going forward. We
expect to invest significant resources in sales and marketing to drive demand
for our products and services as well as research and development to enhance our
platform and bring additional tests to market. We also intend to continue
investing in our supply chain and logistics operations. As we continue to scale
our business, we expect to hire additional personnel and incur additional
expenses, including those expenses in connection with our becoming a public
company.

Expand our customer base

Following the completion of our obligations under the U.S. DoD Agreement, the
future commercial success of our diagnostic products is dependent on our ability
to broaden our customer base beyond the U.S. government and public sector to
include enterprise employers, healthcare providers and direct-to-consumer. As a
result, our long term growth depends on our ability to renew and acquire new
customers. Current key strategic relationships include BARDA, Google LLC, or
Google, the Mayo Clinic, the National Basketball Association, and Henry Schein,
Inc. We intend to leverage our success with our COVID-19 test and the expansion
of our manufacturing capabilities to enable broad distribution of our Cue
Readers and awareness of our platform across different groups of customers and
to enhance pull-through of our future tests. For the year ended December 31,
2021, we sold over 155,000 readers and have sold over 160,000 readers since our
first FDA EUA in June 2020.

Improve and expand our menu of testing and software capabilities

Currently, our only commercially available test is our molecular COVID-19 test.
A key part of our growth strategy is to expand our menu of tests to include
other diseases, ailments and general health markers, which we expect will
support our growth and continue to contribute to the utility of our platform,
including the Cue Health Monitoring System. We are currently developing tests in
the fields of respiratory health, sexual health, cardiac and metabolic health,
women's health, men's health, and chronic disease management. As we continue to
develop and expand our menu of tests, we have made, and will continue to make,
significant investments in our business, particularly in research and
development, sales and marketing and the hiring of additional personnel.
Investing in research and development will allow us to develop new tests as well
as enhance our current product offerings and our Cue Integrated Care Platform.
To build out our menu of tests and bring additional products to market, we will
need to hire additional personnel, such as engineers and researchers, as well as
develop robust sales and marketing and customer support teams to be able to sell
our products.

Regulatory clearance of our diagnostic products

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Our commercial success will depend upon a number of factors, some of which are
beyond our control, including the receipt of regulatory clearances, approvals or
authorizations for existing or new product offerings by us, product
enhancements, or additions to our proprietary intellectual property portfolio.
While we have received two EUAs for our COVID-19 test, a CE mark in the European
Union, an Interim Order authorization from Health Canada, and regulatory
approval from CDSCO, our COVID-19 test has not been FDA cleared or approved and
is only authorized for emergency use during the declaration that circumstances
exist justifying the authorization of emergency use, and this declaration could
be terminated, or our authorization could be revoked in the future. We will need
to seek additional regulatory approval for our COVID-19 test if the EUA
declaration or Interim Order is terminated or otherwise revised or revoked, and
we will need to seek regulatory authorization, clearance or approval for our
other diagnostic products in development. In addition, we will not be able to
commercialize any other tests for our platform unless we obtain required
regulatory clearances or other necessary approvals or authorizations. As such,
our ability to navigate, obtain and maintain the required regulatory clearances,
approvals or authorizations, as well as comply with other regulatory
requirements, for our products will in part drive our results of operations and
impact our business.

Reimbursement and insurance coverage

We have been granted two EUAs by the FDA for our COVID-19 test for point-of-care
and at-home and over-the-counter indications. The commercial success of our
COVID-19 test, and any of our subsequently developed tests, is dependent on a
customer's ability to be able to pay for or otherwise be reimbursed for the
purchase of a test, whether out-of-pocket, by insurance or from a governmental
or other third-party payor. We believe payment for our products, including our
Cue COVID-19 Test Kits, will be billable by a physician, reimbursable by
government payors or insurance companies, paid for by a self-insured employer,
or eligible under FSA and HSA guidelines. For example, most of our contemplated
future tests that are currently offered by others through central labs are
reimbursable by health plans and governmental payors if properly ordered by a
physician. These third-party payors decide which products will be covered and
establish reimbursement levels for those products. Coverage criteria and
reimbursement rates for clinical laboratory tests are subject to adjustment by
payors, and current reimbursement rates could be reduced, or coverage criteria
restricted in the future. If the Cue Health Monitoring System, including any of
our current or future tests, are not reimbursable or covered by insurance, our
business may be materially and adversely impacted.

Seasonality

We anticipate that fluctuations in customer and user demand for our COVID-19
test may be similar to those related to influenza, which typically increases
during the fall and winter seasons. Although our products will be available
throughout the year, we anticipate that we may experience higher sales during
the fall and winter seasons, relative to the spring and summer seasons. However,
as our portfolio of diagnostic offerings increases beyond our COVID-19 test, we
expect the impact of this seasonality on our results to decrease.

Summary of the 2021 financial year (for comparative purposes)

Selected GAAP financial results for the year ended December 31, 2021 were as follows compared to the year ended December 31, 2020:

•Revenues increased to $618.1 million from $23.0 million;
•Product gross margin was 55% compared to 3%;
•Net income increased to $86.4 million from $47.4 million net loss and;
•Earnings per diluted share increased to $0.59 from a $2.90 loss per diluted
share.

Key Non-GAAP Financial Results for the Year Ended December 31, 2021 were as follows compared to the year ended December 31, 2020:

•Non-GAAP adjusted net income increased to $164.5 million from $47.4 net loss;
and
•Non-GAAP adjusted earnings per diluted share increased to $1.21 from a $2.90
loss per diluted share.

Please see a description in the Non-GAAP Financial Measures section below.

Components of our operating results

Income

Our product revenue currently primarily relates to sales of our COVID-19 test,
which began in August 2020 after we obtained our initial EUA in June 2020. With
respect to the U.S. DoD Agreement, the transaction price was fixed and did
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not include variable consideration. The U.S. DoD Advance of $184.6 million was
recorded as deferred revenue and will be recognized upon satisfaction of
performance obligations, such as the delivery of Cue Cartridges, Cue Readers,
Cue Wands and Cue Control Swab Packs to the U.S. government. Significant
judgment is applied in determining how deferred revenue will be recognized,
including estimating future quantities, delivery schedules, pricing and contract
duration from the U.S. government, which can have a significant impact on
revenue recognition. Deferred revenue related to the U.S. DoD Advance as of
December 31, 2021 is $92.4 million. Of this amount, $82.2 million was classified
as current as of December 31, 2021, based on amounts expected to be realized
within the next twelve months. Deferred revenue related to the U.S. DoD Advance
as of December 31, 2020, was $182.3 million. Of this amount, $114.9 million was
classified as current at December 31, 2020, based on amounts expected to be
realized during 2021. The remaining $92.4 million of contract value under the
U.S. DoD Agreement, that had not been recognized by us as of December 31, 2021,
is expected to be recognized by us as revenue upon satisfaction of performance
obligations by reference to the total products expected to be provided under the
U.S. DoD Agreement, including an estimate of future performance obligations
under expected contract renewals, and the corresponding expected consideration.
Commercial customers outside of the U.S. government accounted for approximately
37.7% of our total revenue for the year ended December 31, 2021.

Grant and Other Revenue. Our grant and other revenue primarily relate to our
cost reimbursement research and development agreement with BARDA, which, as
amended, is effective through January 2023. The objective of the contract is to
accelerate the development, validation and FDA clearance of our influenza and
COVID-19 diagnostic products. We have received $36.3 million in contracts and
awards, $21.8 million for phase one and $14.5 million for phase two, from BARDA
from June 2018 to December 31, 2021. Income derived from reimbursement of direct
out-of-pocket expenses, overhead allocations and fringe benefits for research
costs associated with U.S. government contracts are recorded as grant revenue.
We recognize revenue from our contracts and awards with BARDA at the gross
amount of the reimbursement in the period during which the related costs are
incurred, provided that the conditions under which the grants and contracts were
provided have been met and only perfunctory performance obligations are
outstanding. Grant and other revenue in 2019 also included $0.4 million related
to our collaboration agreement with Janssen Pharmaceuticals, Inc, or the Janssen
Contract. We did not recognize any revenue related to the Janssen Contract in
2020 or 2021. The direct costs associated with both contracts are reflected as a
component of research and development expense in our statements of operations.
BARDA revenue recognized for the year ended December 31, 2021 was $2.2 million.

Operating costs and expenses

Cost of Product Revenue. Our cost of product revenue includes the cost of
materials, direct labor, and manufacturing overhead costs used in the
manufacture of our Cue Cartridges as well as contract manufacturing costs
associated with production of our Cue Readers, Cue Wands and Cue Control Swab
Packs. Prior to August 2020, we had not commenced sales of our diagnostic
products and as such, did not record any cost of product revenue. We expect our
costs as a percentage of revenue to vary from period to period depending on the
number of units produced to satisfy demand.

Sales and Marketing Expense. Our sales and marketing expense consists primarily
of salaries, commissions, and other related costs for personnel in sales and
marketing, customer support and business development functions as well as
advertising and marketing costs. We expect that our sales and marketing expense
will increase on an absolute dollar basis and vary from period to period as a
percentage of revenue for the foreseeable future as we focus on building out our
customer facing organization and expand our brand.

Research and development costs. Research and development expenses include external and internal costs associated with our research and development activities, including costs associated with the development of our platform, the individual tests we offer on our platform, and clinical and regulatory costs associated with the development of our platform. obtaining regulatory approval for these tests.

Our internal resources, employees and infrastructure are not directly tied to
any one program or test and there is often significant overlap in research and
development efforts between different programs and tests and we are often able
to leverage the research and development of one test or program to help advance
one or more other programs or tests. As such, we do not track internal costs on
a test-by-test basis. The following table summarizes our external and internal
costs for the periods presented:

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                                                     Year Ended
                                                    December 31,
(dollars in thousands)                    2021          2020          2019
External costs                         $  3,612      $  4,441      $  1,534
Internal costs
Salaries and benefits                    19,766         7,607         8,366
Facilities and supplies                  19,451        16,430        11,505
Total internal costs                     39,217        24,037        19,871

Total research and development costs $42,829 $28,478 $21,405



We expect that our research and development expense will increase significantly
on an absolute dollar basis and vary from period to period as a percentage of
revenue for the foreseeable future as we continue to invest in development
activities related to our technology platform and our current and future test
menus and continuing to expand our portfolio of diagnostic testing offerings.

General and Administrative Expense. Our general and administrative expense
consists primarily of salaries and other related costs, including stock-based
compensation, for personnel in our executive, finance, corporate development and
administrative functions. General and administrative expense also includes
professional fees for legal, patent, accounting, information technology,
auditing, tax and consulting services, travel expenses and facility-related
expenses, which include direct depreciation costs and allocated expenses for
rent and maintenance of facilities and other operating costs. We expect that our
general and administrative expense will increase on an absolute dollar basis and
vary from period to period as a percentage of revenue for the foreseeable future
as we focus on processes, systems and controls to enable our internal support
functions to scale with the growth of our business. We expect to incur increased
expenses associated with being a public company, including costs of accounting,
audit, legal, regulatory and tax compliance services, costs related to
compliance with the rules and regulations of the Securities and Exchange
Commission and exchange listing standards, higher director and officer insurance
costs, and investor and public relations costs.

Interest Expense. Our interest expense prior to February 2021 primarily consists
of expense related to our prior loan and security agreement with Comerica Bank.
In February 2021, we entered into a new loan and security agreement with East
West Bank and the other lenders party thereto. In May 2021, we repaid $63.2
million outstanding under the Revolving Credit Agreement with a portion of the
net proceeds from the issuance and sale of the Convertible Notes. In June 2021,
we terminated the Revolving Credit Agreement. Upon agreement with East West Bank
and the other lenders to the Revolving Credit Agreement, we are keeping in place
our outstanding letter of credit in the amount of $12.0 million, which will be
cash collateralized. All other obligations under the Revolving Credit Agreement
have otherwise been terminated. See "Liquidity and Capital Resources" below.

Change in Fair Value of Redeemable Convertible Preferred Stock Warrants. Change
in fair value of redeemable convertible preferred stock warrants relates to our
liability-classified redeemable convertible preferred stock warrants which are
recorded on the balance sheets at their fair values on the date of issuance and
are revalued on each subsequent balance sheet date, with fair value changes
recognized as increases or reductions in the statements of operations.

Change in Fair Value of Convertible Notes. Change in fair value of convertible
notes relates to our liability-classified convertible notes which are recorded
on the balance sheets at their fair values on the date of issuance and are
revalued on each subsequent balance sheet date, with fair value changes
recognized as increases or reductions in the statements of operations.
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Operating results

Comparison of the years ended December 31, 2021 and 2020

The following table provides a summary of our results of operations for the years ended December 31, 2021 and 2020, and variations between periods:

Year ended the 31st of December,

                                                     2021                      2020                      $ Change                  % Change
(dollars in thousands)
Revenue:
Product revenue                               $           615,796       $            15,391       $              600,405                 3,901%
Grant and other revenue                                     2,311                     7,562                      (5,251)                  (69%)
Total revenue                                             618,107                    22,953                      595,154                 2,593%
Operating costs and expenses:
Cost of product revenue(1)(2)                             276,542                    14,951                      261,591                 1,750%
Sales and marketing(1)                                     28,729                       714                       28,015                 3,924%
Research and development(1)                                42,829                    28,478                       14,351                    50%
General and administrative(1)                              79,788                    23,936                       55,852                   233%
Total operating costs and expenses                        427,888                    68,079                      359,809                   529%
Income (loss) from operations                             190,219                  (45,126)                      235,345                 (522%)
Interest expense                                          (9,809)                     (374)                      (9,435)                 2,523%
Change in fair value of redeemable
convertible preferred stock warrants                           53                   (1,289)                        1,342                 (104%)
Change in fair value of convertible notes              (59,560)                     -                      (59,560)                         n.m
Loss on extinguishment of debt                            (1,998)                     (610)                      (1,388)                   228%
Other income (expense), net                                   272                        47                          225                   479%
Net income (loss) before income taxes                  119,177                (47,352)                     166,529                       (352%)
Income tax expense                                      32,759                      -                       32,759                          n.m
Net income (loss)                             $            86,418       $          (47,352)       $              133,770                 (283%)
Net income (loss) per share attributable to
common stockholders - diluted                 $              0.59       $            (2.90)       $                 3.49                 (120%)


n.m. = not meaningful

(1)Includes stock-based compensation expense as follows:

                                                 Year Ended December 31,
                                                    2021                2020
(dollars in thousands)
Cost of product revenue                    $       1,979              $     -
Sales and marketing                                2,634                    1
Research and development                           6,889                   98
General and administrative                        31,477                3,064
Total stock-based compensation expense     $      42,979              $ 

3,163

(2)Includes $27.9 million and $2.1 million the amortization expense for the years ended December 31, 2021 and 2020, respectively.

Revenue increased to $618.1 million for the year ended December 31, 2021, from
$23.0 million for the year ended December 31, 2020. The increase was primarily
due to the commencement of product sales in August 2020 and continued expansion
of our customer base. Revenue during the year ended December 31, 2021 was driven
by sales to public sector clients, primarily from our U.S. DoD Agreement, where
we recognized $383.0 million of revenue along with sales to private sector
customers of $232.8 million.
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Cost of Product Revenue increased to $276.5 million for the year ended December
31, 2021, from $15.0 million for the year ended December 31, 2020. This increase
was primarily due to the fact that we did not incur cost of product revenue
until we began to generate product revenue in August 2020 after receiving our
first FDA EUA in June 2020. Our product gross profit margin, or product gross
profit as a percentage of product revenue was approximately 55% in the year
ended December 31, 2021 compared to approximately 3%, in the year ended December
31, 2020. The increase in gross profit margin was driven by scaling up
production and related efficiencies that resulted in more favorable absorption
of fixed costs on a per unit basis in 2021.

Sales and Marketing Expense increased to $28.7 million for the year ended
December 31, 2021 from $0.7 million for the year ended December 31, 2020. This
increase was due to the launch of our COVID-19 test in August 2020 and increased
sales and marketing personnel costs to support the expected growth and demand
for our products, higher expenses related to digital marketing services and
increased headcount to support the growth of our business.

Research and Development Expense increased to $42.8 million for the year ended
December 31, 2021, from $28.5 million for the year ended December 31, 2020. This
increase was primarily driven by higher research and development spend
associated new product development and early costs related to upcoming clinical
studies for 510(k) approval of our COVID-19 and influenza tests. Our research
and development expenses primarily consist of engineering and research expenses
related to our continuous COVID-19 and influenza technology, clinical trials,
regulatory expenses, quality assurance programs, materials and products for
clinical trials. We also incur significant expenses to operate our clinical
trials including clinical site reimbursement, clinical trial product and
associated travel expenses.

General and Administrative Expense increased to $79.8 million for the year ended
December 31, 2021 from $23.9 million for the year ended December 31, 2020. This
increase was primarily related to an increase in stock-based compensation
expenses, legal, banking, headcount growth to build out central team, accounting
and other consulting-related costs to support our growing business and prepare
us to operate as a public company after our IPO in September 2021.

Interest Expense increased to $9.8 million for the year ended December 31, 2021
from $0.4 million for the year ended December 31, 2020. The increase was
primarily driven by $6.0 million of issuance costs related to our Convertible
Notes in May 2021 and subsequent write-off of additional issuance costs of $0.7
million upon conversion of the Convertible Notes at the time of the IPO in
September 2021. Additionally, we incurred $2.8 million of interest expense
during the period the Convertible Notes were outstanding. The termination of our
revolving credit agreement required us to pay a fee of $1.3 million.

Change in Fair Value of Convertible Notes was $59.6 million and $0 for the years
ended December 31, 2021 and 2020, respectively, reflecting fair value
adjustments associated with the Convertible Notes issued by us in May 2021. We
did not incur any gains or losses associated with changes in fair value of the
Convertible Notes during the year ended December 31, 2020 as the Convertible
Notes were not outstanding during that period.

Income Tax Expense increased to $32.8 million for the year ended December 31,
2021 from $0 for the year ended December 31, 2020, and our effective tax rate
was 27.5% in the year ended December 31, 2021, compared to 0% for the year ended
December 31, 2020. The increase in our provision and effective tax rate was
primarily due to the current tax liability arising from an increase in income
from operations which exceeded available net operating loss carryforwards. The
California Competes Tax Credit will be reflected as a benefit when certified
annually which did not occur during the year ended December 31, 2021.
Substantially all of our deferred tax assets continue to maintain a valuation
allowance.

Non-GAAP Financial Measures

We supplement the reporting of our financial information determined under
accounting principles generally accepted in the United States, or GAAP, with
certain non-GAAP financial measures, adjusted net income and adjusted net income
per diluted share, or adjusted diluted EPS. We believe these non-GAAP financial
measures provide meaningful information to assist investors and shareholders in
understanding our financial results and assessing our prospects for future
performance. Management believes the adjusted measures described above are
important indicators of our operations because they exclude items that may not
be indicative of or are unrelated to our core operating results and provide a
baseline for analyzing trends in our underlying businesses. Management uses
these non-GAAP financial measures for reviewing the operating results and
analyzing potential future business trends in connection with our budget process
on these non-GAAP financial measures. To measure earnings performance on a
consistent and comparable basis, we exclude certain items that affect the
comparability of operating results and the trend of earnings. These adjustments
are irregular in timing and may not be indicative of our past and future
performance.
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For the years ended December 31, 2021 and 2020

Because non-GAAP financial measures are not standardized, it may not be possible
to compare these financial measures with other companies' non-GAAP financial
measures having the same or similar names. These adjusted financial measures
should not be considered in isolation or as a substitute for reported net income
and net income per diluted share, the most directly comparable GAAP financial
measures. Our non-GAAP financial measures are an additional way of viewing
aspects of our operations when viewed with our GAAP results and the
reconciliations to corresponding GAAP financial measures below.

Banking and finance-related items consist of (i) banking and finance fees
associated with the issuance of Convertible Notes; (ii) early extinguishment of
debt costs; and (iii) fees associated with our termination of our Revolving
Credit Agreement. Since such fees and costs can be material, are irregular and
often mask underlying operating performance, we excluded such amounts for
purposes of calculating adjusted net income and adjusted diluted EPS for the
year ended December 31, 2021, as they may not be indicative of our past and
future performance and we believe excluding such amounts may assist investors in
their evaluation of our current operating performance.

The Convertible Notes issued by us in May 2021 were recorded at fair value. We
excluded the impact of fair value changes to arrive at adjusted net income
(loss) as it is valued based on probability weighted assumptions regarding
potential future financing scenarios that may not be indicative of our past and
future performance and to assist in the evaluation of our current operating
performance.

In September 2021our board of directors has approved the cancellation of certain promissory notes with our founders.

The reconciliations of net income (loss) (GAAP) and diluted EPS to adjusted net
income (loss) (non-GAAP) and adjusted diluted EPS were calculated as follows for
the years ended December 31, 2021 and 2020:

                                                                                   Year Ended December 31,
                                                                       2021                                       2020
                                                                                Per Diluted                               Per Diluted
                                                          Dollar Amount            Share            Dollar Amount            Share

Net income (loss)/diluted EPS                           $       86,418              0.59          $      (47,352)             (2.90)
Fair value adjustments of convertible notes                     59,560              0.47                       -                  -
Banking and financing-related items                              7,998              0.07                       -                  -
Forgiveness of promissory notes(1)                              12,880              0.10                       -                  -
Tax effects(2)                                                  (2,315)            (0.02)                      -                  -

Adjusted net income (loss)/adjusted diluted EPS $164,541

$1.21 ($47,352) $(2.90)


(1)Represents stock-based compensation expense related to the forgiveness of
promissory notes subject to restricted stock purchase agreements with certain
executives. The forgiveness of the promissory notes resulted in the modification
of the stock option accounting applied to the shares underlying these
agreements. See Note 12, Stock-Based Compensation, to our audited financial
statements included elsewhere in this annual report.
(2)Represents the tax impact with respect to the adjustments noted above. We
applied the effective tax rate of 27.5% to amounts deductible for tax purposes
to quantify the tax effects. The charges related to the convertible notes and
the portion of the forgiveness of promissory notes limited by Internal Revenue
Code Section 162(m) were not deductible for income tax purposes and were
excluded from the tax effects above. Also includes additional tax effects
related to banking and financing-related items that became deductible upon the
IPO during the year ended December 31, 2021.

Cash and capital resources

Overview

As of December 31, 2021, we held $409.9 million of cash and cash equivalents as
a result of our IPO proceeds and other financing activities. Our primary cash
needs are for the funding of day-to-day operations, financing capital
investments and to address our working capital needs. Our largest source of
operating cash generation is from sales to our customers. Our primary uses of
cash from operating activities are for personnel-related expenses, material and
supply costs
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for manufacturing, direct costs to deliver our products, and sales and marketing
expenses and research and development initiatives.

Based on our current business plan, we believe our anticipated operating cash
flows, together with our existing cash and cash equivalents, will be sufficient
to meet our working capital and capital expenditure requirements for at least
the next 12 months.

We expect that our near and longer-term liquidity requirements will consist of
working capital and general corporate expenses associated with the growth of our
business, including, without limitation, expenses associated with scaling up our
operations and continuing to increase our manufacturing capacity, sales and
marketing expense associated with rollout of our over-the-counter, at home
COVID-19 test to commercial customers, including directly to consumers,
increasing market awareness of our platform and brand generally to individual
consumers, enterprises and other target customers, additional research and
development expenses associated with expanding our care offerings, expenses
associated with continuing to build out our corporate infrastructure and
expenses associated with being a public company. Our short-term capital
expenditure needs relate primarily to the expansion of our research and
development capabilities, expanding production capacity and optimization of
existing business processes.

Revolving line of credit

In February 2021, we entered into the Revolving Credit Agreement. In connection
with our entering into the Revolving Credit Agreement, we repaid outstanding
amounts of $5.4 million and terminated our prior loan and security agreement
with Comerica Bank, or the 2015 Credit Agreement, that we initially entered into
in May 2015. The 2015 Credit Agreement, as amended, provided for a revolving
line with a credit extension of up to $4.0 million and a Growth Capital A Line
with a credit extension of up to $6.0 million. The Revolving Credit Agreement
provided for a revolving credit facility with an aggregate maximum principal
amount of $130.0 million and a letter of credit subfacility of $20.0 million. In
June 2021, we terminated the Revolving Credit Agreement and we were required to
pay a fee equal to 1.00% of the amount of the outstanding revolving commitment.
Upon agreement with East West Bank and the other lenders to the Revolving Credit
Agreement, we are keeping in place our outstanding letter of credit in the
amount of $12.0 million, which will be cash collateralized. In November 2021,
East West Bank increased the letter of credit by $0.5 million. All other
obligations under the Revolving Credit Agreement have otherwise been terminated.

Cash flow

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

                                                                            Year Ended
                                                                           December 31,
                                                                     2021                2020

(in thousands of dollars) Net cash, cash equivalents and restricted (used in) provided by operating activities

                                             $   

(9,449) $92,655
Net cash, cash equivalents and restricted cash used in investing activities

                                                         (115,717)            (78,148)

Net cash, cash equivalents and restricted cash provided by financing activities

                                                419,621             100,243

Net increase in cash, cash equivalents and restricted cash $294,455

$114,750

Cash flows used in operating activities

Net cash, cash equivalents and restricted cash used in operating activities was
$9.4 million for the year ended December 31, 2021, primarily due to increases in
accounts receivable and inventory of $100.4 million, and $51.5 million
respectively. Non-cash deferred revenue of $90.6 million was recognized during
the period. The timing of our revenue, timing of our collections, and an
increase in private sector customers increased our accounts receivable. The
expected increase in demand for our products drove the increase in inventory.
These outflows were offset by non-cash cost adjustments, primarily driven by the
change in fair value of the Convertible Notes of $59.6 million, depreciation and
amortization expenses of $32.5 million and stock-based compensation expense of
$43.0 million.

Net cash, cash equivalents and restricted cash provided by operating activities
was $92.7 million for the year ended December 31, 2020, primarily due to an
increase in government funding of $183.1 million. The increase was primarily
offset by the use of cash in inventory and prepaid expenses and other current
assets of $36.8 million, and $31.0 million, respectively, related to the
commencement of product manufacturing and expansion of production facilities and
manufacturing capacity.
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Cash flows used in investing activities

Net cash, cash equivalents and restricted cash used in investing activities was
$115.7 million for the year ended December 31, 2021, reflecting purchases of
property and equipment of $108.8 million. The purchases of property and
equipment were used to expand our production capabilities of our Cue COVID-19
Test Kits in relation to the U.S. DoD Agreement and our commercial customers. We
also invested $6.9 million in the development of software related to COVID-19
Testing apps for commercial customers.

Net cash, cash equivalents and restricted cash used in investing activities was
$78.1 million for the year ended December 31, 2020, reflecting purchases of
property and equipment of $76.0 million to expand our production capabilities of
Cue COVID-19 Test Kits in relation to the U.S. DoD agreement. We also invested
$2.1 million in the development of internal-use software related to COVID-19
Testing apps for commercial customers.

Cash flows generated by financing activities

Net cash provided by financing activities for the year ended December 31, 2021
of $419.6 million was primarily driven by $206.0 million in net proceeds from
our IPO and $235.5 million in gross proceeds from the issuance and sale of
Convertible Notes.

Net cash, cash equivalents and restricted cash provided by financing activities
was $100.2 million for the year ended December 31, 2020, primarily reflecting
proceeds received from our issuance of Series C redeemable convertible preferred
stock in June 2020.

Commitments and Contingencies

See Note 15, Commitments and Contingencies, to our audited financial statements
included elsewhere in this annual report for a summary of our commitments as of
December 31, 2021. Our material cash commitments at December 31, 2021 related to
finance leases of manufacturing equipment totaling $6.0 million, real estate
leases under non-cancelable operating lease agreements in the amount of $68.8
million, that expire at various dates through 2031 and a legal settlement of a
contract dispute totaling $9.0 million, of which $4.5 million has not been paid.
We expect to fund these commitments using our existing cash on hand.

As of December 31, 2020, the Company was party to certain letters of credit,
primarily related to a letter of credit with Comerica Bank as collateral
required by one of the Company's vendors. During the year ended December 31,
2021, the Company entered into a Revolving Credit Agreement with a capacity of
$130.0 million and all but one of the letters of credit were no longer required
by the counterparties. The one letter of credit, totaling $6.0 million, has been
re-issued under the Revolving Credit Agreement.

In May 2021, the Company repaid the debt outstanding under the Revolving Credit
Agreement and terminated the agreement in June 2021. Upon agreement with East
West Bank and the other lenders to the Revolving Credit Agreement, the Company
kept in place its outstanding letter of credit in the amount of $6.0 million.
The letter of credit was increased to $12.0 million in July 2021. In November
2021 East West Bank increased the letter of credit by $0.5 million. All other
obligations under the Revolving Credit Agreement have otherwise been terminated.
In November 2021, $0.8 million of cash was restricted in relation to a customs
surety on international imports. The Company also has outstanding, letters of
credit with Comerica Bank related to its real estate leases totaling $0.5
million as of December 31, 2021. All letters of credit are collateralized.

Significant Accounting Policies and Estimates

Our management's discussion and analysis of our financial condition and results
of operations is based on our financial statements included elsewhere in this
Form 10-K that have been prepared in accordance with U.S. GAAP. The preparation
of these financial statements requires us to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements, as
well as the reported income generated and expenses incurred during the reporting
periods. Our estimates are based on our historical experience and on various
other factors that we believe are reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions and any such differences may be material. While our significant
accounting policies are more fully described in Note 2 to our audited financial
statements, included elsewhere in this Form 10-K, we believe that the accounting
policies discussed below are critical to
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understand our historical and future performance, as these policies relate to the most significant areas involving management’s judgments and estimates.

Recognition of deferred revenue

We recorded the U.S. DoD Advance as deferred revenue and recognize this
liability upon satisfaction of our performance obligations to the U.S. DoD by
reference to estimated future performance obligations of a follow-on agreement
with the U.S. DoD and the related expected contract consideration. Estimates of
a future contract include future pricing, quantities and the timing and duration
of future contracts. Estimates for standalone selling price are done at contract
inception and are not subsequently updated. Changes in estimates are done on a
prospective adjustment approach and the Company reassess its estimate on a
quarterly basis. Changes in the assumptions used in our estimate of the future
contract with the U.S. DoD, may have a material impact on the timing of
recognition of deferred revenue.

A 10% increase or decrease in our projection of quantities purchased by the U.S.
DoD under a follow-on agreement, holding all other assumptions constant, would
increase or decrease the deferred revenue we recognized in the quarter ended
December 31, 2021 by less than $2.5 million. A 10% increase or decrease in our
projection of future pricing under a follow-on agreement, holding all other
assumptions constant, would increase or decrease the deferred revenue we
recognized in the quarter ended December 31, 2021 by less than $4.2 million.

Deferred tax assets (and related valuation allowance)

We recognize net deferred tax assets to the extent that we believe these assets
are more likely than not to be realized. In making such a determination,
management considers all available positive and negative evidence, including
future reversals of existing taxable temporary differences, projected future
taxable income, tax-planning strategies, and results of recent operations. If we
determine that deferred tax assets may be able to be recognized in the future in
excess of their net recorded amount, the deferred tax asset valuation allowance
would be adjusted, which would reduce the provision for income taxes. We record
uncertain tax positions on the basis of a two-step process whereby (i)
management determines whether it is more likely than not that the tax positions
will be sustained on the basis of the technical merits of the position and (ii)
for those tax positions that meet the more-likely-than-not recognition
threshold, management recognizes the largest amount of tax benefit that is more
than 50% likely to be realized upon ultimate settlement with the related tax
authority.

This requires management to make judgments and estimates regarding: (i) the
timing and amount of the reversal of taxable temporary differences; (ii)
expected future taxable income; and (iii) the impact of tax planning strategies.
Future changes to tax rates would also impact the amounts of deferred tax assets
and liabilities and could adversely affect our financial statements. All of our
deferred tax assets as of December 31, 2020, were fully offset by a valuation
allowance.

As of December 31, 2021, we continue to maintain a valuation allowance against
our U.S. federal and state deferred tax assets. The valuation allowance will be
reduced at such time as management believes it is more-likely-than-not that the
deferred tax assets will be realized. The exact timing and amount of a valuation
allowance release are subject to change on the basis of the future level of
profitability and changes in tax law. Release of the valuation allowance would
result in the recognition of certain deferred tax assets and a decrease to
income tax expense for the period the release is recorded.

Product Warranty Reserve

We provide our customers with the right to receive a replacement of defective or
nonconforming Cue Readers for a period of up to twelve months from the date of
shipment. Although no explicit warranty is provided for Cue Cartridges, we may
replace Cue Cartridges that result in invalid test results. Provisions for
estimated expenses related to product warranty are made at the time products are
sold. These estimates are determined using historical information that include
testing failure rates, the frequency and probability of replacement units being
requested, and the overall cost of replacement units. We evaluate the reserve
quarterly and make adjustments when appropriate. Changes to testing failure
rates, the overall cost of replacement units and replacement rates could have a
material impact on our estimated liability. At December 31, 2021 and 2020, the
product warranty reserve was $4.9 million and $0, respectively.

A 10% increase or decrease in our failure rate estimate during 2021, holding all
other assumptions constant, would increase or decrease the product warranty
reserve by approximately $0.6 million. A 10% increase or decrease in our
replacement rate estimate during 2021, holding all other assumptions constant,
would increase or decrease the product warranty reserve by approximately $0.5
million.
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Recently Adopted and Issued Accounting Pronouncements

Recently issued and adopted accounting pronouncements are described in Note 2 to our financial statements included elsewhere in this document.

Emerging Growth Company Status

We are an "emerging growth company" (as defined in the JOBS Act). Section
102(b)(1) of the JOBS Act exempts emerging growth companies from being required
to comply with new or revised financial accounting standards until private
companies (that is, those that have not had a Securities Act registration
statement declared effective or do not have a class of securities registered
under the Exchange Act) are required to comply with the new or revised financial
accounting standards. The JOBS Act provides that an emerging growth company can
elect to opt out of the extended transition period and comply with the
requirements that apply to non-emerging growth companies but any such election
to opt out is irrevocable. We have elected to use this extended transition
period under the JOBS Act until the earlier of the date we (i) are no longer an
emerging growth company or (ii) affirmatively and irrevocably opt out of the
extended transition period provided in the JOBS Act. As a result, our financial
statements may not be comparable to companies who have adopted new or revised
accounting pronouncements.
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