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

Great. Well, good afternoon, everyone. My name is Craig Hettenbach. I'm one of the semiconductor analysts at Morgan Stanley. Before I kick things off, I do want to advise important disclosures can be found on the Morgan Stanley research disclosure website, that's at www.morganstanley.com/researchdisclosures. So with that, we're very pleased to have with us today Impinj, Chris Diorio, Founder and CEO; as well as CFO, Cary Baker. So welcome, gentlemen.

Thank you, Craig. Thank you very much for having us today.

Thank you.

Great. Chris, maybe I thought we could kick off at a high level for Impinj. Just what are the key technology, the importance of RAIN RFID and some of the long-term growth drivers that will kind of shape this discussion today?

Sure. Thanks, Craig. I'm happy to kick us off that way. So our vision as a company is to connect everything, to extend the reach of the Internet by a factor of 1,000 from today's powered electronic devices to connecting everything. It is a technology that's a type of RFID called RAIN for radio identification, and we believe it's the only technology that can wirelessly connect and provide a unique identifier for everyday items at up to 1,000 items per second read speed without a battery, the radio chips absorb their operating energy from radiowaves, without line of sight and for pennies per item. We can put a miniature radio chip, smaller than a grain of sand on an -- attach it to a small antenna, apply it to an individual item. That radio chip has a unique identifier for the item and can wirelessly communicate information about the item. And we can connect anything. Today, it's retail apparel. We talked a lot, and we'll talk a little bit more on this call about supply chain and logistics opportunities, items being shipped, moved, transported, sold. But if you should really think about everything, connecting all retail items, all automotive parts, all beauty products, all pharmaceutical items, all biospecimens, all blood draws, all food items, literally trillions of items per year. We have the technology, the spectrum, the know-how, the standards and Impinj is in a leadership position to make it happen. So we're really excited about the opportunity in front of us. It is a -- not just a multiyear technology evolution. It's a multi-decade technology evolution, but the real vision here is to extend the reach of the Internet to everything.

That's great. Perhaps before we dig into some of those drivers, I do want to touch on near-term business conditions and supply chain backdrop. The company had meaningful upside in Q4. You guided well above for Q1. At the same time, you talked about there's some moving pieces to think about for Q2 and potential dampened the seasonality around endpoints. And so maybe you can just talk about some of that transition and starting with endpoints, what you're seeing in the business?

Yes, Craig, I can take that one. So let me back up first a little bit into the latter part of 2020. Q2 was our COVID trough. And really as we rounded Q2 and got into July, we started to see an uptick in our bookings pace. And that continued through the fourth quarter to a point where we exited Q4 with greater backlog than we exited Q3. We beat our Q4 guidance on better-than-expected turns assumption. The holiday season was better than we thought. And the spring inventory season was better than we thought. We were concerned that there could be some items that were tagged and sitting on a shelf when COVID hit that got warehoused and then brought back out this coming spring inventory. And neither of those turned out to be the case. And then really, once we got into November, we saw another uptick in our bookings, and that carried us through Q4 and into the strong guide in Q1. We've seen that pace continue through the quarter. We're seeing our customers book further into the future than we would have otherwise anticipated or what is otherwise normal for our business. And as we're looking into Q2, we really haven't had normal seasonality since COVID hit. And coming out of a strong Q4, it's better than seasonal, and a better than seasonal Q1 from what our vantage point is right now, we said, you know what, maybe Q2 is not going to have the normal seasonal lift just because we're in an unnatural seasonal period right now. So that was really the genesis of the commentary around our Q2 endpoint ICs. Then backing down to the systems business, there's a couple of factors that play. In Q1, we are experiencing packaging delays with our reader IC business. And as a result, we won't be able to meet the demand we have on the books for reader ICs in the first quarter. We sized that impact at north of $1 million of revenue, which is baked into our Q1 guidance, of course, and then north of 100 basis point gross margin impact because reader ICs are, in fact, our highest gross margin product. We expect to get back to kind of normal levels in Q2 based on where we are right now and the visibility that we have right now. And then the other factor that plays into Q2 is we won a large loss prevention engine contract with a European-based global retailer in Q4. We received a $6 million prepayment for that. We will finish out the loss prevention engine in Q1, which will take up our non wage engineering OpEx a little bit. And then we expect to substantially shift that project in Q2 and recognizing the bulk of the $6 million that sits on our deferred revenue balance right now. So those are a couple of unusual factors to consider on the systems side of the house as we look from Q1 into Q2.

Got it. I appreciate all the detail there, Cary. Perhaps -- I just want to come back to the supply chain, the tightness. And anything else you'd call out in terms of things you're trying to kind of navigate because it's a broader industry issue that we hear more and more about in terms of what's impact from semiconductors. And anything to be mindful in terms of how you're trying to kind of manage through this period?

So I'll take that one, Craig. So for us right now, kind of all aspects of semiconductors are tight, wafers, post processing, testing, as Cary just mentioned, packaging. And so we're navigating all aspects of that situation. We predicted some of the semiconductor tightness, especially in the 200-millimeter wafers and built inventory during the pandemic. So we do have inventory that we're able to ship this year even as we get additional wafers, but still, wafers are tight, especially 200-millimeter wafers. I am guardedly optimistic that the industry may see a little bit of breathing space in the second half of this year, but it's still too early to tell. So just expect us to keep talking about the challenges as to the rest of the industry is the challenges kind of across the board for semis. And we will provide updates as we get -- as we see some of that breathing space come forward.

Got it. I think that's a good segue into just the transition you're seeing for the M700. And so maybe perhaps talk about the 200-millimeter in terms of going to 300-millimeter and how that's going? And bigger picture, what do you see as kind of the financial impact and growth impact for M700?

Cary, you want to start with that one?

Yes, I'll start, and I'll start with the financial impact. So there are a couple of key structural advantages with the M700 chip. First, as you noted, Craig, we moved from 200-millimeter wafer to 300 millimeter wafer. So that gives us a little bit of a cost advantage. But the bigger structural advantage comes from the jump down Moore's law that we took. And that's allowed us to increase the number of die per wafer on -- for the M700 chip. So from a comparison point, we get 4x as many die per wafer with the M700 on a 300-millimeter wafer than we do with our prior generation Monza 6 on a 200-millimeter wafer. And when compared to our competitor, who's also on 300-millimeter wafer size, we get about twice as many die per wafer. So that gives us a great deal of flexibility when it comes to pricing, to be aggressive on price point, to drive adoption of RAIN. But it also gives us the flexibility to be that aggressive on price point, but also drive accretion to gross margin. So as M700 becomes a greater portion of our sales mix, I expect improvement in accretion in gross margin.

Got it. And maybe, Chris, you can talk about just kind of the ramp that you anticipate for this product launch and maybe give some history as to other product launches and what people should expect as this really gets going?

Sure. So as historically, if I go back in time, historically, as we have introduced new products, they have layered on top of existing products. When we introduce a new endpoint, I see, we typically -- previous ICs would continue shipping into accounts. The new opportunities would take the newer IC and we would layer on top. And the reason is that the existing ICs were previously qualified in the old accounts, they worked. There wasn't a lot of incentive for the end customers to switch over. Given the current situation in the semiconductor industry, where we have more availability on the 300-millimeter wafers than on 200, we are pushing a fairly accelerated ramp associated with the M700, both layering in new opportunities and getting our inlay partners and our end customers to qualify and replace the existing 200-millimeter products with the 300-millimeter products or the newer M700 die on the 300-millimeter wafers. So we talked a little bit on our prior earnings call about the need to make that ramp happen and to transition over to the M700. Even as our supply of 200-millimeter wafer is declining, and we keep pushing on that transition. We think there's a lot of goodness in the M700, not just in the smaller die size, but better performance, advanced functionalities. We'll talk a little bit maybe coming up about protected mode and how we can actually make a tag invisible at point-of-sale and thereby enable loss prevention in self-checkout. So there's a lot of goodness in the M700, and we want to push that, but it is a faster and kind of a little bit less traditional ramp than we have historically gone through in our prior new product introductions.

Got it. And any customer feedback you can share in terms of -- you touched on performance is better, which is great from an adoption curve, but anything else you'd share in terms of how customers are viewing the product initially?

I'd say the overall customer feedback is positive. We've got a new product that has better performance for our inlay partners, a lot of smaller inlays. So we gave better performance and specifically gave better sensitivity. Our inlay partners can turn that better sensitivity either into a longer-range inlay or to a smaller inlay, that smaller inlay being a smaller antenna to reduce some of their costs. So in fact, we see high-performing smaller inlays that pass a wide variety of certifications at end customers. And so the overall adoption has been positive. Of course, we are pushing a fairly fast ramp. And I'm not trying to -- want to in any way minimize the difficulties that places in some of our inlay partners, we need them to move quickly. We're supporting them to move quickly. We are guardedly optimistic that, that ramp will happen quickly and that we will not only be able to deliver a superior product into the market, but that will have really delighted inlay partners and end customers.

Got it. And you mentioned implications potentially for loss prevention. I know you guys have talked about a program you won. And I know for a number of quarters, you've been excited about this opportunity, and it's great to see it's happening now. Can you just talk about the opportunity? And what does this mean for the business as we go forward?

So retail apparel was the early adopter for RAIN RFID. And there's a set of reasons why that was the case. But historically, retail apparel tagging started, gosh, probably 8 years ago now, maybe 9 years ago now because the inventory visibility was relatively poor in retail stores, need for better inventory visibility. The value of the items was such that they could absorb a tag that, back in the older days, was a bit more expensive, and you had a human being in the loop with a handheld reader that could actually overcome some of the technology limitations back in the old days. So retail apparel was the first early adopter. And today is still the #1 consumer of the endpoint ICs. So we see that adoption continuing to happen focused on inventory visibility. However, once you get to the point where you've got 100% of the items in your store tagged, then you, as a retailer can start thinking of where do you go next? And especially with COVID-19, coming out the other side of COVID-19, retailers are thinking about how they want to change the dynamics for their stores, basically move -- drive forward into the future. And an obvious area, an obvious opportunity is to do self-checkout. So we see significant demand for self-checkout from retailers. But most retail stores have loss prevention. And if you're going to do self-checkout without loss prevention, you're risking increasing theft. The loss prevention they have typically is with those hard tags with a pin that goes through the garment. So in order to enable loss prevention, you need to get rid of that existing hard tag that goes wa, wa, wa at the store exit. The right thing to replace it with is with the RAIN RFID tag, where you can identify for a person that -- for an item that's being stolen exactly what that item is. So our focus as a company has been to drive RAIN-based loss prevention so that we can identify sold or unsold items leaving the store. And then once we can deliver that capability, that loss prevention capability, that enables consumer self-checkout in the stores, which allows store employees to spend more time with the customers about -- around the things that matter rather than at checkout. Furthermore, as we deliver a loss prevention at self-checkout use case, it further induces retailers to get to 100% tagging of items in their stores because it doesn't make sense to do self-checkout until you're 100% tagged. So it's all goodness for us. It's all goodness for the retailers and that we will continue to push on that loss prevention and self-checkout opportunity. We announced the first large European retailer, as Cary mentioned, just a little while ago, are rolling out with the first deployment for a solution. And we expect more to come, and it's a core focus area for us.

Got it. Is there anything you learned through this process in terms of the technology? And then I guess, just as important, that one kind of customer, how does this market evolve in the next number of years?

So I will say that we have learned a lot by focusing on loss prevention and self-checkout, although the learning started many years ago. It was -- I'm going to have to say around the 2010 time frame that retailers identified loss prevention and self -- or specifically loss prevention, but driving self-checkout as the #1 use case after inventory visibility. So we've learned a lot. And one of the things that we learned specifically is that you want to embed the endpoint IC as part of the garment. Because if you don't embed it as part of the garment, a bad actor can cut the tag off and just steal the item. So we want to embed the IC as part of the garment. But in order to do so, we need to address consumer privacy. In order to address consumer privacy, you need to put something on the IC to do it. And you want to do so in a cost-effective process node such that adding that functionality under the IC doesn't increase the IC cost that much. So for us, what that meant over time was, first, advancing down Moore's law to get a much more cost-effective platform on which we could introduce digital logic. Then introducing what we call protected mode where you can make the tag invisible at point-of-sale to protect consumer privacy. And then the exit gates, don't see the items leaving the store. And then that protective mode enables the loss prevention opportunity because now all the exit gates need to do is just see the items that are unsold leaving the store and the sold items are invisible and consumer privacy is protected. So it's a win all around. It opens up an opportunity that we think retailers have wanted for a long time and has high hopes for the future.

That's great. Maybe we could talk about in terms of some of the impacts of the pandemic, and from a retailing perspective, omnichannel in terms of the increased importance and just how big of a factor is that for you guys today in terms of what you're seeing in the business?

So right now, RAIN -- I'm going to say it this way. I perceive RAIN RFID as being the life raft for omnichannel retail. Retailers have had the transition omnichannel associated with the pandemic. They can't sell items from either their stores or their warehouses or their fulfillment centers unless they know they've got it. And if you got a RAIN RFID tag on an item and you actually can send and employ it with a handout or a fixed reading that actually reads the item and gets the unique number of the item. You know you have it and you know where you have it. And so you can ship from store, you can ship from fulfillment center. And I've actually had -- had several of our partners and end customers basically say, RAIN RFID is the life raft for omnichannel retail. And we expect that life raft to persist into the future. Omni-channel is not going back. It's not going to go away even as stores reopen. So we will continue to drive that visibility that retailers need. We have seen that the retailers that had previously deployed RAIN RFID before the pandemic hit have been better able in general to weather COVID-19. And they also tend to be the ones who are driving forward and looking for the advanced use cases like loss prevention and self-checkout as a further differentiation going forward.

Got it. So understanding this is going to be an important driver as we go forward. At the same time, how should people think about just the reopening of economies in retail, physical store, presence? And any thoughts there in terms of that potentially over the next number of quarters, given a bit of a lift as well?

That was a little tougher for me. I'm going to say the future is going to -- the future will tell. I do believe that not only in retail, but also in supply chain and logistics that COVID-19 has kind of laid bare the opportunities for RAIN RFID and for -- specifically for our products to provide visibility into, like I said before, the items that enterprises, manufacture, transport and sell. We can provide that visibility and enterprises need that visibility from -- everything from retailers who want to ship omnichannel to think supply chain and logistics to improve the efficiency in terms of which they can route packages, reduce their -- reduce or increase their throughput while maintaining accuracy or not sacrifice throughput for accuracy. Basically give whatever the enterprise gives, visibility into the items as the items are moving through the supply chain or are in a store and allow them to better manage their organizations. And we believe that, that opportunity that we deliver is really going to be key to the successful future of many, many companies.

Got it. Maybe we could shift to supply chain and logistics. I know it's been an important driver for the systems business. You have talked about 2 customers in supply chain and logistics. Can you just give us a sense of just an update on kind of where business stands with these customers?

So we've announced 2 large North American supply chain and logistics customers. The first, which we engage with significantly or had significant sales to in 2019, but those sales date back to the third quarter of 2018, has been deploying for an extended period of time. And as we said on a prior call, is transitioning to its operational phase, and we continue to support them as they transition to the operational phase. We're excited about the -- not only the transition and supporting the customer, but future opportunities with that customer. The second one is just getting going. And its focus. The first was focused on pallets, on tracking pallets. The second is focused on parcels and cartons, items moving at conveyor belts. And the second is just getting going. We see it's a very large opportunity with great promise for the future, but it's also such a large opportunity that the pace and the timing of the deployment remain uncertain to us. That said, the -- our M700 -- I mean, I'm sorry, our R700 reader, which we believe is key to the readability required by that deployment we think is performing very well. And so we have high hopes for the future for that deployment. Both of them -- both of those deployments are either focused on improving the throughput of a facility while maintaining existing accuracy or not sacrificing throughput and improving the accuracy with which the company can manage the shipment or route the shipment.

Got it. And I know in retail, early on, one of the big things was kind of return on investment, right, in terms of deploying RFID. How do we look at that in supply chain and logistics in terms of what type of returns are they seeing to kind of say, okay, we're going to go forward with this technology?

I think it's fairly early to speak about the return on investment. We have other case studies and other smaller deployments. Neither of these large end customers have cited anything in terms of their ROI. And in fact, just one of them is just starting to go live right now. What I would focus on, however, is to think about they've got existing facilities and RAIN RFID and the products and technology and the capabilities that we bring to bear should allow them to improve the efficiencies of their operations and/or improve the accuracy of their operations, which I believe are essential for these types of companies going forward, especially with the accentuated shipment volumes that we're seeing now due to COVID-19.

Got it. And maybe we can look out a little further in terms of growth in any application. So we've kind of walked through retail and supply chain logistics, driving business today. On a longer-term basis, are there any applications kind of catching your eye in terms of end markets or things that you feel like could be on the verge in the coming years of embracing RAIN RFID?

So there's -- I'm going to say RAIN RFID is deployed really broadly. I mean Impinj has delivered to date, more than 50 billion endpoint ICs, and we're just getting going. That's roughly 7 for every person on the planet. They go in everything from marathon bibs to golf balls to enhanced drivers' licenses to retail apparel to pallets to cases to automotive parts, food items, literally everything. So that's the first point I wanted to make. As I look from where we are today, for us really focusing on retail and supply chain and logistics, there is a significant opportunity on the automotive supply -- on the automotive side for just-in-time parts availability. As more and more vehicles get made custom based on the order that the customer puts in for a custom made vehicle, I expect us to see an increased need for item level visibility during automotive production. Even today, there's a good number of cars that have tens of tags in them today, just used in the manufacturing process for airbed tracking, for bumpers, for chassis, for other safety components as well as for interior color match. I expect to see automotive grow in the future. We haven't really put a time frame behind it, but you can kind of see it coming, and there's a lot of talk about RAIN RFID and the benefits it provide for -- it provides for automotive manufacturing. And then if I fast forward to the far out future and say, what's the long-term holy grail for the industry? There's a lot of things that come between automotive and the big one at the end, but the big one at the end is really food. And even a small amount of movement in the food opportunity, food traceability for freshness, recall, safety purposes, even a small movement in the food opportunity, which is many trillions of items per year could significantly impact our industry in a very positive way.

Got it. Excellent. Cary, can we talk about just margins and profitability. I mean, you touched on gross margin, some of the puts and takes, particularly through this manufacturing, 300-millimeter. But what are some things people should be mindful of gross margins as we go forward from a mix perspective and drivers?

Yes. So our corporate average gross margin has been right around 50% for the last several quarters. And that makeup is our endpoint ICs are just under that corporate average. And our systems business is north of that corporate average. As I look forward, I know that there's opportunity to improve gross margins primarily with the M700 and the cost advantages that we've already covered with that. So I do anticipate improvement in gross margin as I look into the future, it's going to be driven by our increasing sales mix of the M700.

Got it. And the company has also talked about kind of pushing towards adjusted EBITDA breakeven. What's your sense on the things that you need to kind of get there?

Yes. So for the 4 quarters prior to COVID-19, we had delivered breakeven to slightly better than breakeven adjusted EBITDA. And that was kind of where we wanted to be. We know this model has leverage in it, but we also know that the growth opportunity in front of us is massive, and we want to keep fueling our engineering and our innovation. So we were returning some of those dollars back into the business. And that's where we want to get back to on the other side of COVID-19. Now 2020 was a year of investment for us in spite of the pandemic, and we increased our cost base as a result of adding more resources into engineering primarily. So that -- the revenue threshold required to break even has increased a little bit, but we're not too far from it. And I anticipate us, as we get further past COVID-19 or once we get past I '19 and start moving beyond that, I expect us to get back into that breakeven to slightly better territory while we're delivering pretty significant topside growth.

Got it. And then once you get to breakeven, from an even longer-term perspective, as you think about the business and how it evolves, what are some of the things to keep in mind from an operating leverage perspective longer-term for this business model?

Yes. So gross margin will be the first key, improving that. You should expect us to continue investing in engineering. We have a strong partner network that helps fuel our go-to-market model. And I think there's leverage in that. And then obviously, there's a lot of leverage in G&A, in the near term. So I anticipate continued investment in R&D, but leverage elsewhere in the business.

Great. And we are coming up close to time. So last question, Chris, just kind of bringing all this together, just what you see, particularly as there's a lot of growth coming into the industry and for Impinj. Are you seeing any changes in the competitive landscape or things to kind of be mindful of in different parts of your business as we move forward?

So competitive dynamic has remained relatively stable. So that's not to say there won't be something in the future, but at least more recently, has stayed relatively stable. For us, really, we're focused on the other side of COVID-19. We see companies investing right now. We actually saw some of them investing during the pandemic. We see significant investments up right now as companies looking to transform their operations. I expect it's going to be for every industry, every company, it's going to be a bumpy ride on the other side of COVID-19. There's going to be puts and takes associated with the fact that predicting the future is especially difficult at this time. But I firmly believe that RAIN RFID and the products we bring to market and most importantly, the visibility that we deliver -- again, I'll say it again, to every item that enterprises manufacture, transport and sell, that visibility is key to enterprise digitization to allow companies to know what they've got. To analyze it, to virtualize it and to optimize their operations, I think we could deliver visibility that no other technology can bring to bear. And so I think our future is bright because that visibility will allow our enterprise customers to transform their operations that they just couldn't do in the past. And so I'm excited about the future, which we hadn't gone through COVID-19, but I think it's going to paint a picture of transformation going forward. And I think where we sit right now, it's -- we're in a very opportunistic position to help drive that business transformation.

That's great. I think that brings us right to the 30-minute mark. So Chris and Cary, thank you so much for spending the time today. It was great to kind of walk through the growth drivers of your business. And I hope you and everyone else has a great day.

Thank you. Thanks very much, Craig.

Thanks, Craig.