Q2 2023 Impinj Inc Earnings Call
Participants
Andy Cobb
Cary L. Baker; CFO; Impinj, Inc.
Chris Diorio; Co-Founder, Vice Chairman & CEO; Impinj, Inc.
Jeffrey Dossett; Chief Revenue Officer; Impinj, Inc.
Harsh V. Kumar; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
James Andrew Ricchiuti; Senior Analyst; Needham & Company, LLC, Research Division
Mark John Lipacis; MD & Senior Equity Research Analyst; Jefferies LLC, Research Division
Scott Wallace Searle; MD & Senior Research Analyst; ROTH MKM Partners, LLC, Research Division
Thomas Michael Walkley; MD & Senior Equity Analyst; Canaccord Genuity Corp., Research Division
Presentation
Operator
Welcome to the Impinj Second Quarter 2023 Earnings Conference Call and Webcast. All participants will be in listen-only mode. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Mr. Andy Cobb, Vice President, Strategic Finance. Please go ahead.
Andy Cobb
Thank you, MJ. Good afternoon, and thank you all for joining us to discuss Impinj's Second Quarter 2023 results. On today's call, Chris Diorio, Impinj's Co-Founder and CEO, will provide a brief overview of our market opportunity and performance. Cary Baker, Impinj's CFO, will follow with a detailed review of our second quarter 2023 financial results and third quarter outlook. We will then open the call for questions. Jeff Dossett, Impinj's COO will join us for the Q&A. You can find management's prepared remarks plus trended financial data on the company's Investor Relations website.
We will make statements in this call about financial performance and future expectations that are based on our outlook as of today. Any such statements are forward-looking under the Private Securities Litigation Reform Act of 1995. While we believe we have a reasonable basis for making these forward-looking statements, our actual results could differ materially because any such statements are subject to risks and uncertainties. We describe these risks and uncertainties in the annual and quarterly reports we file with the SEC. We do not undertake and expressly disclaim any obligation to update or alter our forward-looking statements, except as required by law.
On today's call of financial metrics, except for revenue or where we explicitly state otherwise are non-GAAP. Balance sheet and cash flow metrics or GAAP. Please refer to our earnings release for a reconciliation of the non-GAAP financial metrics to the most comparable GAAP metrics. Before turning to our results and outlook, note that we will participate in the 12th Annual Needham Virtual Industrial Tech, robotics and Clean Tech one-on-one conference on August 4, the Oppenheimer 26th Annual Technology Internet and Communications Conference on August 8; the Canaccord Genuity 43rd Annual Growth Conference on August 10 in Boston, the Jefferies Semiconductor, IT Hardware and Communications Technology Summit on August 29 and 30 in Chicago. The Goldman Sachs Communacopia in Technology Conference on September 6 in San Francisco, the Piper Sandler Growth Frontiers Conference on September 12 in Nashville and Lake Street 7 Conference on September 14 in New York. We look forward to connecting with many of you at those events.
I will now turn the call over to Chris.
Chris Diorio
Thank you, Andy, and thank you all for joining the call. Second quarter revenue set a new record with record systems revenue more than offsetting weaker than anticipated endpoint IC revenue. The primary driver of the system's revenue strength was the loss prevention deployment at the visionary European retailer. The primary driver of the endpoint IC weakness was larger than anticipated retail apparel inventory destocking. We expect the impacts of that inventory destocking to persist at least through the third quarter. Focusing first on endpoint IC's Second quarter revenue declined sequentially, coming in slightly below our expectations.
The magnitude of the retail inventory destocking became apparent late in the quarter, not just to us but also to our inlay partners, some of whom had requested upside ICs as recently as April. That destocking more than offset sequential IC growth at our second large North American supply chain and logistics enterprise customer and us seeding several hundred million Impinj 775 ICs into multiple authentication applications.
Looking to the third quarter, our endpoint IC share at our enterprise customers remains strong. At the same time, we and our inlay partners now anticipate softer-than-expected third quarter retail demand recovery. Those partners build IC safety stock, anticipating a stronger recovery. And as our wafer supply has grown, they are burning down roughly a month's worth of ICs primarily in the third quarter, but with a tail into the fourth. Also, the curve of new program launches shifted to the right by the 2022 product shortfalls, created an adoption air pocket that the industry is still working through.
Our enterprise wins are insufficient to overcome these headwinds. And as a result, our third quarter endpoint IC revenue will decline sequentially. Importantly, despite these headwinds, we do not know of a single end user who has pulled back from RAIN RFIB. Said another way, our long-term opportunity remains strong, and we expect growing adoption to drive demand after these corrections are behind us. We also expect greater than 25% 2023 endpoint IC unit volume growth.
Turning to systems. Second quarter reader and gateway revenue exceeded our expectations, driven by better-than-anticipated component availability. The additional supply allowed us to deliver more gateways into the visionary European retailers self-checkout and loss prevention deployment than we had expected as well as fulfill our prior period reader backlog. It also allows our team to shift their focus to new opportunities for our solutions offerings. Regardless, for the third quarter, we expect a sequential decline in reader and gateway revenue due to delivery timing to the visionary European retailer and our return to typical reader and gateway backlog entering the quarter the latter after nearly 2 years of component supply constraints.
Our second quarter reader IC revenue remained healthy with robust demand for printer encoders in North America, offsetting weak macro demand in China. Looking to third quarter, we see the printer and coder demand mostly fulfilled while China remains soft. Our Chinese reader partners built Indi reader IC inventory ahead of our planned end of life and are today focused on selling Ind-based product inventory rather than ramping Impinj e-family-based designs. That Indi focus will drive a sequential decline in third quarter reader IC revenue. Like for readers and gateways, our reader IC supply is normalized and we entered the third quarter with typical reader IC backlog.
Turning to new products. Last week, we launched the Impinj M800 Series RAINRFID endpoint IC's, the first ICs in the series, the Impinj MA30 and MA50 are the most advanced in the market with performance and features designed to help enterprises read the right tag at the right place at the right time. In addition to 25% more die per wafer than the Impinj M700, the M800 has 30% lower power consumption, allowing businesses to use a single small tag across a broad range of items. With enhanced tag reliability, manufacturer ability and drop in compatibility with M700 antennas, we expect the M800 to drive additional rent adoption. It is also a key component of our long-term growth and margin targets.
Turning to intellectual property. We are the innovation leader in our industry with more than 300 issued and allowed patents. I am pleased to say we successfully defended our leadership position by prevailing in 2 separate trials. In June, a federal jury in Washington found that Impinj endpoint ICs do not infringe an NXP patent. In July, a federal jury in California found that NXP endpoint ICs do infringe on Impinj patents, one willfully. The California jury awarded Impinj approximately $18.9 billion in damages and lost profits, and we have asked the court for injunctive relief. We now turn our attention to the upcoming Texas trials against NXP.
In closing, from today's vantage point, we see several headwinds driving lower third quarter revenue. At the same time, our long-term opportunity remains strong, and we see some green shoots in retail apparel. We, as a company, have been through industry cycles before and have come through those cycles stronger. With confidence in our growing opportunity and our leading position in it, I have no doubt we will do so again.
Before I turn the call over to Cary for our financial review and third quarter outlook, I'd like to again thank every member of the Impinj team for your constant effort driving our bold vision. I feel honored by my incredible good fortune to work with you. Cary?
Cary L. Baker
Thank you, Chris, and good afternoon, everyone. On today's call, I will review our second quarter financial results and third quarter financial outlook. Second quarter revenue was $86 million, up slightly sequentially compared with $85.9 million in first quarter 2023 and up 44% year-over-year from $59.8 million in second quarter 2022. Second quarter endpoint IC revenue was $64.9 million, down 3% sequentially compared with $67 million in first quarter 2023 and up 51% year-over-year from $42.9 million in second quarter 2022.
Looking to the third quarter, we expect a sequential decline in endpoint IC revenue driven by Inlay partners safety stock reductions and weak retail apparel demand more than offsetting growth from our platform wins. Second quarter systems revenue was $21.1 million, up 12% sequentially compared with $18.8 million in first quarter 2023 and up 24% year-over-year from $16.9 million in second quarter 2022. Second quarter systems revenue exceeded our expectations, driven by better-than-anticipated component availability, allowing us to service reader and gateway demand.
On a sequential basis, reader revenue increased, while reader IC and Gateway revenue decreased. On a year-over-year basis, Gateway revenue increased while Reader-IC and reader revenue decreased. Systems included Voyantic revenue starting second quarter. Looking ahead, we expect a sequential decline in third quarter systems revenue with declines in all product lines. Second quarter gross margin was 53.3% compared with 52.4% in first quarter 2023 and 54.7% in second quarter 2022. The sequential increase was driven by endpoint IC product mix. The year-over-year decrease was driven by lower endpoint IC product margins, specifically a smaller specialty and industrial IC mix and lower systems product margins driven by increased costs.
Looking to the third quarter, we expect our gross margin to decline. Total second quarter operating expense was $35.9 million compared with $36.4 million in first quarter 2023 and $28.8 million in second quarter 2022. Research and development expense was $16.8 million. Sales and marketing expense was $7.7 million. General and administrative expense was $11.3 million. Litigation expense was $4.3 million. Despite litigation expense being similar to second quarter, we expect a sequential decline in third quarter operating expense as we tighten our belt on spending.
Second quarter adjusted EBITDA was $10 million compared with $8.6 million in first quarter 2023 and $3.8 million in second quarter 2022. Second quarter adjusted EBITDA margin was 11.6%. Second quarter GAAP net loss was $8.1 million. Second quarter non-GAAP net income was $9.3 million or $0.33 per share on a fully diluted basis.
Turning to the balance sheet. We ended the second quarter with cash, cash equivalents and investments of $114.9 million compared with $164.7 million in first quarter 2023 and $183.7 million in second quarter 2022. Inventory totaled $112.3 million, up $26.5 million from the prior quarter, with wafer delivery timing and the initial M800 ramp contributing to the increase. Net cash paid for Voyantic totaled $23.4 million. Second quarter net cash used by operating activities was $22.5 million. Property and equipment purchases totaled $5.7 million. Free cash flow was negative $28.2 million, including $25.3 million for inventory growth.
Before turning to our third quarter guidance, I want to highlight a few items unique to our results and outlook. First, we anticipate third quarter gross margin to decline by approximately 300 basis points due primarily to lower revenue on fixed cost and less reader ICs. As our revenue recovers, we are confident that our gross margin will recover with it, and we remain confident in the long-term margin targets I outlined at our Investor Day.
Second, we have updated our non-GAAP net income to include estimated taxes based on statutory tax rates. Given our NOLs, we expect our cash tax payments to remain well below this estimated rate at least for the next few years. Please see our trended file for a retrospective view of our non-GAAP net income following this revised tax treatment. Third, we have reduced our wafer purchases, adjusted our wafer delivery timing and are focused on better aligning our inventory to our outlook. We expect those efforts to impact fourth quarter inventory. We currently expect third quarter inventory to be similar to second quarter.
Finally, based on our revised view of market demand, we believe our inlay partners have roughly a month's worth of excess IC safety stock. Our third quarter guidance assumes progress rightsizing that safety stock with a tail into the fourth quarter.
Turning to our outlook. We expect third quarter revenue between $63 million and $66 million compared with $68.3 million in third quarter 2022, a 6% year-over-year decline at the midpoint. We expect an adjusted EBITDA loss between $3.3 million and $1.8 million. On the bottom line, we expect non-GAAP net loss between $3.2 million and $1.7 million, reflecting non-GAAP fully diluted loss per share between $0.12 and $0.06.
In closing, I want to thank the Impinj team, our customers, our suppliers and you, our investors, for your ongoing support. I will now turn the call to the operator to open the question-and-answer session. MJ?
Question and Answer Session
Operator
Thank you very much. We will now begin the question-and-answer session.(Operator Instructions) At this time, we will pause momentarily to assemble our roster. Today's first question comes from Harsh Kumar with Piper Sandler.
Harsh V. Kumar
I had 2. Chris and Cary, one for you. So I think if I'm reading this correctly, I think we're thinking there's about a month's worth of inventory safety stock at the inlay partners -- but then today is, what, July 26. So there's a whole month or so left. I can understand this sort of tails into the third quarter. But I guess I'm trying to understand your comment about this might dovetail into the fourth quarter as well, this inventory correction. I was wondering if you could provide some color around why it might spill into the fourth quarter? And why won't the logistics uptick that you might be anticipating with that rollout not come as a positive and sort of offset this decline.
Cary L. Baker
This is Cary. I'll take that question. Looking into our third quarter, our guide assumes that Endpoint IC revenue is going to be down in the mid-20s sequentially. There are going to be a few factors driving that sequential decline. So I want to unpack each of those right now. First, in the second quarter, we shipped several hundred million higher ASP M775 authentication ICs as we seeded multiple applications ahead of their commercial launch. The timing and success of those launches will determine when more product is pulled. And then second, to your point, we're attempting to burn down as much of the excess safety stock as possible. Based on our current view of demand, we anticipate burning down roughly 2 to 3 weeks in Q3. Unfortunately, both of those factors are masking growth from the large project ramps and logistics and general merchandise.
Chris Diorio
I guess I'll add that our partners have need for specific products, not all our ICs are identical. So we're still fulfilling orders. And so the burn down of that IC inventory is -- it doesn't happen over 2 months. It's going to tail into the fourth quarter. As Cary said, we're going to take as much of it out in the third quarter as we can, but there will be a tail end at the fourth.
Harsh V. Kumar
I got you. And then one of your large customers, I guess, reported yesterday, they talked about a pretty substantial growth. So I guess kind of going back into your answer to the first question that I asked, is there -- is the logistics ramp already inventoried in some manner at some of your customers? Is that part of the safety stock that you're referring to? Or is it safety stock comments are related to sort of the debacle in retail that is basically happening in the industry due to macroeconomic factors.
Chris Diorio
So I'll try and take that and Jeff might step in. So we continue to deliver ICs into that enterprise deployment, obviously, through our partners. As that large partner of ours reported yesterday, they are also sitting on IC safety stock. So even though there is -- for them, some demand growth in the market, and I noted green shoots in my prepared remarks, our expectation is that our partners fulfill those green shoots and as well as existing demand by reducing their inventory. So the comments they made are consistent with what we are seeing and saying, which is that there's some excess inventory in the channel. -- significantly built up as a consequence of our inlay partners being worried about IC supply up until very recently and about IC tightness going forward. They build safety stock, now that we've got inventory, they're going to be focused on burning it down a bit. So that retail recovery for us at least is pushed beyond the third quarter.
Jeffrey Dossett
I would just add that we don't always line up with Avery Dennison's prints. And that's for a variety of reasons, including us selling to the broader market or probably more importantly, as we ship in front of their demand. And our shipments can proceed our partners' demand by up to 90 days, and that can be even further elongated when new programs are coming online. So you have to factor that timing in. And I would point you back to a comment that Chris made in his prepared remarks, we're anticipating greater than 25% endpoint IC unit growth in 2023 on a year-over-year basis.
Operator
The next question comes from Jim Ricchiuti with Needham & Company.
James Andrew Ricchiuti
Cary, I wanted to follow up on just that point about your expectation for 25% endpoint unit volume growth in '23. What has it been through the first 6 months. And just based on the way your expectations for Q3, what does that translate to? Because it would seem to suggest, I think, some recovery outside of the soft retail market in Q4. Maybe you could help with that.
Cary L. Baker
Jim, thanks for the question. So you will see in our 10-Q that our volume is up roughly 70% on a year-to-date basis through the first 2 quarters of the year. When you map that into our 25% year-over-year number, you'll see that yes, there is a step down in the back half of the year. We announced at our Investor Day in the middle of June that we had increased our life-to-date shipments by about 10 billion units. So you can assume that through the first half of the year, we did a little bit more than 10 billion units, called 11 billion units in the first half of the year.
James Andrew Ricchiuti
The follow-up I have is just -- I'm trying to understand how you get to your adjusted EBITDA guidance for Q3 at these low levels of revenue and lower gross margins. And maybe you could talk a little bit about how we should think about the OpEx in Q3 as it relates to the bigger areas? And then the question is, as you come out of this, are you -- is your intent to maintain these OpEx levels at lower than previous levels that perhaps we were thinking?
Cary L. Baker
Great question, Jim. So as I noted, we are tightening our belt on spending and OpEx is coming down in the third quarter. I also signaled that the litigation expense would be roughly flat in Q3. So Q2 was $4.3 million, so assume that same level of litigation spend. Absent that litigation spend, my guide would have been in the black for the third quarter. But yes, we are tightening our belt on spending given this lower revenue line.
Operator
The next question comes from Mike Walkley with Canaccord Genuity.
Thomas Michael Walkley
Maybe just shifting a little bit to the systems business with the strategic European retailer? Or is it a pause? Or are they pretty much done rolling out the systems? And maybe you could remind us what a more normalized system quarterly cadence is for your business?
Chris Diorio
They are not done, and I'm going to hand it over to Jeff to just tell you a little bit about the pacing.
Jeffrey Dossett
Yes. Thanks for your question, Mike. In the second quarter, we and our European visionary retailer, we're completing the second phase of their overall deployment while beginning the third phase into additional brands. So in second quarter, we had that layering effect of shipping into the end of the first phase and the beginning ramp of the third phase, whereas in the third quarter, we'll be shipping into the ramping third phase, resulting in a step down from 2Q to 3Q. But again, this customer is quite satisfied with the deployment to date and increasing its investment across its overall brand and store footprint.
Chris Diorio
Mike, this is Chris. I'll add that the size of the third quarter deployment into the third phase is larger than we did in second. So the pacing is increasing for that third phase, but we're losing the benefit of continuing to fulfill the second phase, which is essentially completed.
Thomas Michael Walkley
And maybe just a little bit into the endpoint side. I think you talked about some of the new opportunities would lead to a Q4 seasonally up from Q3, absent kind of these inventory adjustments. Is that still the case on the new opportunities, so we think about Q4 up a little bit from that and then up a little bit because it's maybe 1 to 2 weeks clearing versus 2 to 3 weeks clearing of inventory. Is that a good framework to think about Q4 endpoints?
Jeffrey Dossett
So Mike, we're not guiding Q4 at this time. We're really saying, a lot it's too early for us to predict Q4, given the dynamics that we're going through still coming after the COVID, institution supply, recovery, inventory destocking and our partners burning down inventory. When you put it all together, we're going to be watching and see where -- what on the enterprise opportunities are in fourth quarter and growth there. The overall macro retail and our partners' ability to basically rightsize their inventory and put all those pieces together. We'll have a better view of fourth quarter as we get further along. But as of right now, we're not guiding anything associated with fourth quarter.
Operator
The next question comes from Mark Lipacis with Jefferies.
Mark John Lipacis
Question on the ramp of the 2 new larger programs. Can you give us a sense like how do those ramp -- like how long before you get to what you would consider to be fully ramped at those customers and before you kind of grow more organically with your customer growth. And I'm wondering, is this like does this happen like in 1 quarter or 2 quarters it does take a year or so to ramp? And then could you give a sense of how big they could ultimately be -- could either of these be like 10% customers? Or does it not impact your top line ultimately to that degree? Any color you could give on that.
Chris Diorio
So for these large customers, the ramps take typically years. I mean they really do. When we're talking the size of some of these enterprises, for them to fully roll out even just the phases of the deployments that they've got planned, it takes a long time. And that's a positive thing. Don't think about it negatively. You've got giant customers who are rolling out across their enterprise. They're transforming -- they're digitally transforming their enterprise. And that takes time. We see systems opportunities persist over multiple quarters. We see endpoint IC volumes ramping -- both of the ones we talked about have IC volumes already ramping. They are ramping in third quarter. They will ramp again in the fourth quarter. We see that ramping sustained. And even when we've done a phase we're not done. Because as Jeff just noted, we're in the third phase of a rollout at our visionary European retailer, and that's still simply on loss prevention in self-checkout. There are other opportunities with that retailer, with other retailers, other use cases. And we see the same thing with all of our large-scale enterprise deployments as they start playing right in RFID, see the benefits of transforming their enterprises. They come up with additional opportunities and use cases and our job as Impinj is to ensure those customers are wildly successful in their deployments. And that is our focus because if they are widely successful, then we'll be wildly successful with them. And we're going to make sure they're successful.
Operator
Next question comes from Scott Searle with Roth MKM.
Scott Wallace Searle
Maybe to follow up on some of the earlier comments, I'm trying to understand what a normalized level of endpoint IC demand looks like today? It looks like it's probably in that $60 million range or so. And then you've got other systems deployments that are ongoing the European retailer, U.S. logistics provider, et cetera. So I guess on 2 questions. What is the real normalized level of that IC demand where we're starting today. And then as we get into the beginning of next year and some of these other projects start to ramp up, what is non-retail apparel look like in terms of your mix? I think – even Denison was pretty upbeat yesterday about the nonretail apparel mix growing at a 50% plus clip. I'm wondering if you could provide us with some idea of what you think your mix is excited and the growth rate looks like there?
Cary L. Baker
Yes. So first question, Scott, this is Cary. I'd highlight the transition from Q2 to Q3 on the endpoint IC growth has a couple of factors that are impacting what is the real demand in that. First, as I mentioned before, we shipped several hundred of those high ASP M775 authentication ICs in Q2. That was seeding an opportunity before the commercial launches. So we won't see that level of volume immediately following in Q3. We wait to see the rebound in the volume until those products are actually pulled through by the commercial launches. So that comes down. We also see -- we also see on the IC safety stock pulling that down, it's about a month right now. We're trying to pull it down by 2 to 3 weeks. So that's masking real demand in the quarter. What's offsetting that partially is the ramps of the big projects. And think of that as logistics. Think of that as general merchandise, the logistics is much bigger than the ramp of logistics is much bigger than general merchandise right now. Last year, the industry shipped 34 billion units in total. We won't know what the industry ships this year until early part of Q1. But as impinges right now, we're modeling greater than 25% endpoint IC unit growth on a year-over-year basis.
Scott Wallace Searle
And Cary, then just a follow-up. Is there exiting this year, given the ramp of customers into general merchandise and logistics, does that start to get to 50% of the mix at this point in time once we get back to normalized levels? And one other, just on the pricing front, typically, you have pricing negotiations going into the -- from the fourth quarter into the first quarter. That hasn't happened in the last couple of years because of wafer availability issues, does that return as we go into '24?
Chris Diorio
So Scott, I'm going to take the first part of your question and then hand over to Jeff and Cary to talk about the pricing and the negotiations. Retail apparel is still by our estimate, only about 25% penetrated. So there's still huge growth opportunities in that market. Retail general merchandise has enormous growth opportunities and then supply chain and logistics layers on top, we still see retail as being the primary driver of an volumes. We also see -- we see long-term secular growth in our industry. It's a long-term opportunity. We have confidence in that long-term opportunity. adoption has increased and will increase over time. So we're going to manage through this downturn. We're going to come out strong to the other side. We're going to be delivering into those opportunities. We're going to leverage our strengths, and we're confident in the future. But as we just noted on the call, given the dynamics that are a consequence of the inventory shortfalls, let me take that back, that are a consequence of the product shortfalls we had in 2022. We now entered an over-inventory situation at our partners as they're burning down their safety stock, now seeing that we have enough wafers, there's some gyrations that we have to work through. We're going to work through as much of them as we can in the third quarter. There will be a tail end of the fourth, and we'll report out as soon as we know more information about the fourth on our next call. and provide more visibility going forward. But the long-term opportunity in front of us remains strong. To the second part of your question, in terms of pricing and when do negotiations happen?
Jeffrey Dossett
Yes. You're absolutely correct, Scott. Historically, price negotiations have occurred late in the fourth quarter and result in low to mid-single-digit ASP declines in the first quarter. That hasn't been the case in the last couple of years as our cost has increased in order to maintain the integrity of our margin model, we pass those costs on to our customers. I don't want to project what's going to happen right now, but our goal, I would reiterate, is maintaining the integrity of the margin model. So it's tough to do that unless we see a cost decline for Impinj.
Operator
This concludes our question-and-answer session. I would like to turn the conference back over to Chris Diorio, Co-Founder and CEO, for any closing remarks.
Chris Diorio
Thank you, MJ. I'd like to thank you all for joining the call today. I hope you and your loved ones are and remain safe and well. Thank you.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
