Impinj, Inc. (PI) Earnings Call Transcript & Summary

All right. Well, good afternoon, everyone. My name is Craig Hettenbach, one of the semi analysts here at Morgan Stanley. Very pleased to have with us Impinj today, CEO and Founder, Chris Diorio. Welcome.

Thank you. Thank you.

Before we kick off, I do need to read this disclosures, including personal disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website, www.morganstanley.com/researchdisclosures, or at the registration desk.

So with that, you're fresh off of an earnings report this week. For every company this week, obviously, the topic everyone is focused on, coronavirus and just supply chain and things like that. So if we can just kind of touch on that first in terms of any type of impacts on your business before we dig in.

Sure, happy to. Thanks for the question. So for us, at least what we said on our earnings call, and I can reiterate here, and we can dive a little bit deeper, if you want to, is we see only a modest impact in first quarter. And we guided the first quarter with that modest impact. We did widen our guidance range based on the uncertainty that's risen as a consequence of the coronavirus, but modest impact in first quarter. We did say that the coronavirus has impacted the transition from our production ramp to full production of our new endpoint IC, the Impinj M700, primarily as a consequence of the fact that of our partners, our inlay partners, as they're -- some of their factories have gone into furloughs or delays and then ramp back up. Understandably, they are prioritizing production over preproduction parts. They've got production orders. They want to deliver against those first. And as a consequence, that has set back the timing for the transition from that ramp and for their qualification of Impinj M700 based inlays at their direct end customers. So we do see a delay. Our revenue expectations for the first half of the year for the Impinj M700 were very modest. So us raising that point is simply as a consequence of the fact that we had set some guideposts for our investors in terms of the timing of that ramp, and that timing's delayed. For us, for second quarter, there's a lot of puts and takes. And so we -- as of right now, with the situation evolving so rapidly, we don't have good visibility. And so we would just keep an eye on the situation on a daily basis. And when the time is right, we'll provide what updates we need to.

Sure. And you're certainly not alone there. There's no -- we've seen a lot of kind of updates to guidance this week from many companies, and fluid is what the situation is right now. So everyone's kind of watching closely. I'd love to -- with that out of the way, kind of -- there's been some management changes recently. CFO -- new CFO sitting here with us, Cary Baker. You've had Eric, who's going to be departing. And so maybe just talk about as the company matures, if you will, and the opportunity in front of you, what these management changes mean.

Well, we've been looking to bring on a CFO for a good period of time, right, and I am incredibly happy that Cary joined us. And we look forward to -- I look forward to working with him super closely, and he's already off to a running start. In terms of our team, I feel now that our team, our management team and our senior leadership team, the executive team and the senior leadership team are really, really strong. They're strongest in the company's history. Eric has helped -- Eric, who -- he's our President and COO, and who will be departing on Friday, really helped build that team, strengthen the organization. He is departing at a time where the team really has stepped up and can step up and assume the responsibilities that he was shouldering. He's going to go off and take some time off with family and then go pursue another big thing in Seattle. And the team is -- we will not be backfilling the President and COO role. And the team is going to step up and take those responsibilities. And I'm really excited about what the team is going to be able to deliver this year and in the future.

Perfect. Maybe we can start just kind of big picture on RFID, and we'll certainly drill down to some of the specific growth drivers. But just give us an update on how you see the market, kind of adoption levels, key trends, things we should be watching for.

So our particular type of RFID, RAIN for radio identification, continues to grow nicely. Retail apparel is still the primary endpoint IC volume driver. Probably consumes about 2/3 of the endpoint ICs would be our best estimate. The RAIN Alliance made its announcement a couple of weeks ago that the endpoint IC volumes for 2019 were 18.5 billion units, which is a nice growth number over the 15.4 billion units from the prior year 2018. And they are projecting north of 20 billion units for 2020. We still see growth opportunities in the market. We believe retail is roughly 15% penetrated. Retail apparel is 15% penetrated, not all of retail. And we see growth opportunities in that retail apparel space as well as in many other spaces. They include supply chain and logistics, automotive, industrial and manufacturing, aviation with the IATA announcement in airlines moving forward. So growth opportunities in multiple verticals not only for the endpoint ICs but also for the systems business as well.

Got it. And what do you -- what would you say in terms of as you see this market unfolding, like what are some of the accelerants to growth? And then on the flip side, what are some of the deterrents or things that customers are kind of evaluating in terms of do they go forward or not with RFID?

So I think the -- if I was to pick one of the key accelerants for growth, I guess it would be that RAIN RFID, at least in the retail space, doesn't appear to be optional anymore. There's so many companies that have deployed, that are getting positive ROI in terms of same-store sales uplift, reduction in inventory, just significant benefits that the growth is happening in the retail space. If I look at aviation, the Delta Air Lines deployment was an impetus for IATA to make their announcement last year, that all 385 member airlines would be going forward with RAIN RFID for tracking airline baggage. And so what you're seeing right now, I think, is that industries led by a couple of leading companies -- in the case of the apparel space, it was the Decathlon and Macy's and Marks & Spencer back many years ago. In the case of the aviation space, it was Delta Air Lines, led by a large visionary end user, has shown the benefits of the technology, the benefits of what RAIN RFID can do. And then you see entire industry is following along. We see that same opportunity playing out in multiple other industries. So the impetus for growth is simply that the ROI is positive in so many use cases, in so many areas. And when one large end customer proves it out, others follow. So that's a positive sign. The primary impediment, I would say, for adoption is still that adoption takes time in any particular vertical for any particular customer. And the fundamental reason is that we are transforming. When I say we, I'm using the we broadly. We and our partners introducing RAIN RFID into a business are transforming how that business does its operations. So you can take any business, take the airline industry, for example, transforming how they track bags, how they optimize their baggage handling and loading onto airplanes and transforming the back end software that they need to do to track things, transforming the applications they need to deliver to you as a customer, Track My Bags app. And that transformation is not a small transformation for a company. It's a large transformation. And fundamentally transforming a business takes time. It does not happen overnight.

Sure.

The good thing is that once end customers roll out, they don't go back. We almost never see any company stopping and going back because the transformation is positive, the ROI is positive, and the businesses go forward. And the opportunities, at least, especially at the endpoint IC layer, keep layering on top because endpoint ICs are essentially consumable silicon. But the time frame for a deployment is often measured in a year to several years for a company to fully transform their operations. And so people say, well, why does RAIN RFID takes so long to roll out? And the answer is we're not just making a small change to a large end customer. We're transforming how they run their business. And in so doing, they have the opportunity to track every item they manufacture, transport and sell and thereby fundamentally improve their operations for the long term. They're pulling themselves into the 20th century -- the 21st century.

Great. From a technology perspective, in the last year or 2, there's been a lot of interest in kind of a concept store. And there's different ways you can approach, be it RAIN RFID, machine vision and things. Do these technologies kind of coexist? Is it one or the other? Or how does this kind of play out going forward?

I think my view, my personal view is that in most instances, the technologies will be complementary. So let me just use a very specific example. Let's say we're going to do loss prevention at retail stores. Well, if somebody is going to steal an item, they're generally going to try and hide it. If they're going to steal items by buying a couple and taking more than the ones that they bought, they're going to put them in the same bag. So you need a technology that can read several items and read through a bag or read an item that's on a person that hasn't been properly sold. And so for example, a vision technology is not going to work there. But at the same time, if you've got a loss prevention systems that's detecting theft, when you detect the item, you want the vision system to actually track the person. So you have some visibility in terms of who's doing the stealing. So you're going to be blending a vision technology with a RAIN RFID technology. You need some other technologies to detect other ways theft happen. For example, wrapping stuff in metallic shielding, so there's going to be other detection technologies. And then you need to have the backhaul. The backhaul today is probably the Ethernet, and going forward in the future, the information may just be relayed via, for example, a 5G network or some other kind of wireless connectivity. So my view is these technologies are very complementary. From my point of view, RAIN RFID is unique in that we can connect every day item for pennies, reading up to 1,000 items per second without line of sight through boxes and packaging and literally get information about those items, which includes the items' expiration date, which includes detailed information at the item, tracking through the supply chain. I don't see any other technology that can offer the capabilities that RAIN RFID delivers in the area that it does that. We do it without batteries at cost measured in pennies.

Yes. The topic of loss prevention, I know that's something that's come up in your earnings calls the last couple of quarters. And so how has that evolved in terms of how customers are looking at this technology and how it could help them?

So what we see is that retailers, as they get to 100% tagging, where all the items in their stores have RAIN RFID tags on them and get the benefits of improved inventory visibility, they then start looking at additional use cases. And one of the use cases they want to go forward with is consumer self-checkout. But when you do consumer self-checkout, generally, the needs for your loss prevention system increase. For retail apparel items, the primary loss prevention mechanism today is the hard tags with a little pin that goes through and is attached to the item. But you're not going to have the consumer do consumer self-checkout and then remove that hard tag. So what retailers want is they want a consumer self-checkout and then a loss prevention system that uses the same RAIN tag for loss prevention. And once you do the self-checkout on the loss prevention, then you need a returns desk that uses that same tag for returns. And if you're going to build a loss prevention system where the tag is an embedded part of the item because you're using it at the point of sale at the exit of the store and for returns, you need to address GDPR. And so we recently introduced the Impinj M700, which has something in it called Protected Mode where a retailer can make the tag invisible at point of sale. The exit gate doesn't see it. The item is invisible while the consumer has it or the tag is invisible. At the point of return, the consumer needs 2 things. They need the item itself and some way to look up the pin to recover and make the tag visible again. So it's essentially dual-factor authentication for returns, which inhibits fraudulent returns. We're just introducing that capability now. It hasn't been rolled out, but the reception from retailers has been really positive. And we see that Protected Mode as a key capability that will enable embedded tagging that's safe for consumers, enables loss prevention, self-checkout and seamless returns and inhibits fraud.

Got it. I certainly want to dig into the M700. And maybe just before we get there, just curious to get your thoughts, just competitive landscape, right? Because it seems like a very unique capability that should help you in the market. But just any changes in the last year or 2 in terms of what you're seeing from competitors?

The competitive environment remains roughly unchanged for what it has been for the past couple of years.

Okay. So on the M700 -- and again, you mentioned before that may be a little bit of a slower start. But as we get through the year and this starts to ramp, any parallels you can kind of give us in terms of other product launches previously and what it's going to mean to the business, both from a revenue and margin perspective?

Sure. So if I look at the -- if I look at past history, when we've introduced new products, they tend to layer on to existing deployments. Most end customers, once they've qualified one of our endpoint ICs and an inlay, they tend not to change very frequently because the product is qualified and it works. And so we tend to see the new products layering on existing -- onto existing business and addressing newer opportunities more than it displaces prior opportunities. We see -- typically see a ramp. I can't project exactly what's going to happen with Impinj M700, but if it follows prior trends, we typically see a ramp that lasts several years and the volumes continue to ramp for an extended period of time. If I look at our history, we introduced our Monza 4 IC in 2010, and volumes were still ramping in 2017. It's very unusual for semiconductor's volumes. We're still ramping 7 years later, and we're still selling significant volumes of Monza 4 in 2020. Monza R6 followed the same trajectory. We introduced it in 2014, and we saw significant ramps for many years. And in fact, it continues growing. I expect the same to happen with the Impinj M700. Volumes are bigger now. So it's even more exciting. I have said that for Impinj, I think it's the biggest innovation we've introduced since we did Monza 1 a while back, a long time ago.

Yes.

And so I have very high expectations for the chip, including the new features we introduced. And so I'm really excited about it. We should see a positive impact to our business in second quarter of this year. Significant growth we expect in 2021. And I would expect the ramp to go for years.

Is it -- how does it help now that you're so established in the market, right? So if I think if you try to go back to kind of all these launches, and you're kind of trying to develop the market, you're there, right? So now you have these new features and capabilities, how much does that help in terms of hitting the ground running in customer awareness or their willingness to kind of adopt and move forward?

So the technology is -- I won't say mature because there's so much more that we can do, but it's mature enough so that major industries can adopt. First, we had retail. And then when the aviation industry moved forward, that's a big deal because aviation is a marquee customer. They don't adopt nascent technologies. The fact that aviation adopted was a big deal. And we now see opportunities, as I said, in so many other verticals, supply chain and logistics, automotive, industrial and manufacturing, so many others. Retail continues to lead -- retail apparel continues to lead. The others are essentially relatively new. And so there's enormous growth opportunities in these other industries. So that's exciting for us, point number one. And point number two is, as retailers, we said, gets to 100% tagging of all the items in the store, retailers are looking to expand their deployments and transition from handheld-driven inventory counting, or a person who's doing a handheld inventory, to more fixed reading. Initially, probably starting with self-checkout, loss prevention and returns and then improving the supply chain visibility and many other use cases in the retail environment. So retail is actually a very good opportunity for us going forward, not just the endpoint IC volumes with retail apparel only being roughly 15% penetrated, but on the system side now, where there's some great opportunity for fixed infrastructure into which we have been investing for many, many years, anticipating this time. And we see it happening now.

Yes. No, that's a great segue because it's a success story. If I look back to 2019, tremendous growth, right? You grew over 45%. And so can you give us a feel in terms of where you are in that next wave of adoption as you go from, like you said, handheld to kind of fixed infrastructure?

It is still early days, just even in retail, which is the furthest along. The transition to fixed infrastructure is still very early days. There are retailers that have rolled out self-checkout systems. I was just in a Decathlon store in France, and I observed the self-checkout, multiple self-checkout terminals. And the thing works and it works brilliantly. People came in. They have a handful of items, there are pile of items. They drop them on the checkout bin, up on the screen tops -- up on the screen pops items they need to buy or they're buying. They swipe their credit card, take the items and leave the store. It worked brilliantly. But they are the leading adopters. And there's a couple of others that have rolled out this self-checkout. But the entire volume of the retail industry rolling out are still behind us. So again, we're in the point where leading adopters are moving forward, paving the way. And I foresee the rest of the industry saying that's what we want, too, and following. That's what I foresee. I can't predict the future. But when I saw how efficiently that self-checkout worked, I was very excited about it. So that's why I said, we're still in the early days in so many things. And I guess the way to measure that, you think about -- so our industry delivered 18.5 billion endpoint ICs. It seems like we're so far along and so mature. But by our estimates, we're probably only 0.2% penetrated in the total number of connectible items per year. And so any industry that's only 0.2% connected -- or penetrated, I'm sorry, has a long way to go.

Open ended.

Open ended, essentially.

Yes. Got it. Great. How about just from a geographic perspective, if you can touch on kind of -- are there any discernible trends in terms of the pace of adoption and kind of use cases that you see in a certain geography and then maybe it broadens out to other geos?

Sure. So there are significant opportunities across Europe, North America and Asia. Asia specifically being Japan, China and South Korea. There are budding opportunities in South America as well. Universal Postal Union has been focusing on Brazil for the rollout for using RAIN RFID for tracking postal items. So we see broad growth across all the geographies you would expect. Historically, Europe has led in terms of adoption and led the U.S. because many years ago, a nonpracticing entity set the U.S. back by a couple of years by suing the industry. What we see is kind of rapid growth occurring in the U.S. kind of making up for some lost ground. We see opportunities in automotive, which our partners significantly addressed, focused a lot in Europe, specifically in Germany. We see retail apparel tagging kind of happening worldwide. And I think the aviation opportunity will be worldwide. Those are the trends, I think I can point to. If you ask me about any particular industry, I might be able to give a little bit of guidance, but those are kind of the trends we see and feel right now. Supply chain and logistics also is worldwide.

And maybe on the aviation front, you mentioned Delta, which is a great use case. How should we think about just kind of timing in terms of other players coming on? And what does it look like over the next number of years?

So I can't -- so what I can speak to is what IATA, the International Air Transport Association, has said. They voted unanimously last year that all 385 member airlines would follow Delta's lead and use RAIN RFID for baggage tracking. They set a milestone as they wanted to be significantly rolled out by 2024, 4 years. We see pilots and initial deployments ongoing. You've heard some announcements, for example, by KLM-Air France that they're going forward. And our anticipation is that as a consequence of the IATA impetus and some airlines going, we'll be seeing more and more of those announcements in the future. But I can't predict the timing. It's the same situation here. You've got Delta moved out, show it would work. Some of the Delta partners are coming along right behind them. And then you'll anticipate seeing other airlines and airports and facilities starting to make announcements and rollout as well.

Got it. Can we talk about just kind of the -- as you grow the business and the balance between growth and profitability, I know that's something probably Cary will be looking at very closely. And I'm sure there will be more details as we go along. But just as you see it, right, you're growing the business really well. You've talked about your increasing investments in R&D, right, in terms of the confidence in that growth. How do you balance those in terms of delivering the growth and also making sure that the margins are moving the right way?

So our investment thesis hasn't changed. And Cary will have the opportunity to talk a lot more about it with our investors going forward. But that is for us to drive towards adjusted EBITDA breakeven and to take every incremental gross margin dollar and pour it back into the business. We're so early on in a gigantic opportunity. It's the time to invest in that opportunity, grow our share, grow our scale, grow the verticals that we're pursuing and really strive to win this gigantic opportunity. At the same time, we talked a little bit in the earnings call about investing some CapEx dollars in terms of streamlining our operations, increasing our inventory turns and doing a set of things that will overall increase our nimbleness. And since we did a convertible offering in December, we've got a little bit more cash now that we can actually start to invest a little bit of CapEx in those operations to kind of make us a more nimble company.

Great. We have a few minutes left before I open it up if there's any questions in the audience. I'd be curious to just get your take now as you meet with investors, like, what's kind of the biggest debate, if you will, right? As we said, it's kind of an open-ended opportunity, a lot of growth potential. But what would you say is the biggest sticking point as you talk with investors?

The biggest question I get is how can we get it to go faster. It's always the question how can we get things to go faster. And then I explain what it takes for a large end customer to roll out. And then kind of the understanding settles in. And then I start to describe some of the things we're doing to make it easier for end customers to deploy. That includes improving our products, software algorithms on our readers and gateways, by doing more automation, focusing on some of our software back ends, our ItemSense software to facilitate deployments, us doing the things that we can do to make it easier for an end customer to deploy and working with our partners to do the same thing. That said, no matter what we do, it takes time for these end customers to transform their operations, like I said previously. And there's only so much we can do there. We're going to do what we can to facilitate those deployments.

Got it. Okay. I think someone had a hand up. Do we have a...

Go ahead.

This big customer who just finished doing their rollout, will that part of revenue be compensated by the endpoint volume? That's one question. And if that was a big project, are Impinj M700 compatible with those readers and how -- what is the replacement cycle of readers in general?

Okay. So let me try and -- so there's several questions in that. Let me try and see if I can tease them apart. So the question was about the large end project -- the large supply chain and logistics project that we said was -- would not be -- we would not be shipping gateways into that project into -- in second quarter because they transitioned from deployment to operations. So the first thing is the products that we make are forward and backwards compatible. We've introduced some new features in the M700 that required some firmware updates. But it's our goal, and it's actually the goal of everybody in our industry, to follow the industry standard. We can extend beyond it, but to follow the industry standard in the way that you're both forward and backwards compatible. So -- and we intend to continue doing so. And the -- yes, so I'll start there. That answers one of the questions. Another question you asked was what about the lifetime of readers in some of these deployments. We as a company have focused on building products that are of the highest quality, the highest reliability and the highest performance to give the longest life for our end customers. I come from a background that -- where I was involved in satellite design. And so I understand what it means to build a reliable product. We just introduced our Impinj R700 reader, the next-generation reader. And when we introduced that product, we talked about enterprise-grade reliability, performance and features with a goal of attempting to, as we can, future-proof an end customers' investment. So we're building the best products with the highest reliability, the highest performance so they're good today and they're good in the future as well. I can't talk to the replacement cycle. That depends a lot on what the end customer is. But the fact that we've got firmware -- we could do firmware updates and a lot of things, we are attempting to build those products to meet the demands of enterprise-grade customers. In terms of that specific project, what we said is that the project is transitioning from deployment to operations in the second quarter. We didn't say anything beyond the second quarter. The customer is going to be working a lot on the operational phase. And then we'll see which transpires after that. There may be opportunities in the future. We can't say there are or there aren't. A lot depends on the customer. A lot depends on their needs when they transition to the operational phase. So we don't have visibility beyond the second quarter, which is why we just cited things associated with the second quarter. We do have revenue from that project in the first quarter. If you look at some of the words we said, the revenue in the first quarter is a little less than it was in fourth quarter last year, which is a little less than the average it was in 2019. And we do see strength in endpoint ICs in the first quarter, which contributed to the guide that we gave.

Great. I think we have time for just one more there.

A couple of questions. In the case of Delta, I've been using it. It's terrific. Thank you, it's a great service. Is it actually helping? Or is there a way to tell that it's actually helping and not losing bags?

So Delta has made -- so Delta has made some specific statements in terms of their performance, what they've been able to deliver to their customers and their performance in terms of the industry overall with baggage performance. And I think you can go look at their statements. And I believe that their results are what convinced IATA to go forward with RAIN RFID for all the airlines. I can't -- I don't remember their statements well enough to be able to recite them. But Delta has made public statements about their performance. And I will say that although they use a lot of our technology, there were many partners involved in that deployment. It wasn't just Impinj. And in fact, we're kind of the technology guys behind the scenes. There are many partners who actually made that thing happen.

Fortunately, my baggage is coming with me. But in a scenario where it doesn't, through the app, am I able to track it or identify where I left -- where it's been mishandled? Or is that part of the system that I can actually see that?

I don't think I know the answer since I never check a bag. So Delta did the back-end software, I believe, significantly on their own. And they keep upgrading that application. They do alert you when their bags checked on to the airplane. And -- but I don't know the specific details. For me, the most important thing that I see from that baggage tracking application is it is, to my knowledge, the first real application where consumers are directly getting the benefit of RAIN RFID. Most people don't know how Delta's tracking your bag. But the fact is they're using RAIN RFID, and you are getting the benefit from it. And that is one of the first cases where we have direct customer engagement and -- not customer, direct consumer engagement, where the consumer is getting the befit of RAIN RFID. And that's what I see as a real promise for the future.

Okay. Perfect. I think we're down on time here. So thanks so much.

Okay. Thank you, Craig. Thank you very much.

Okay. Appreciate it.