Impinj: Looming Demand Concerns (NASDAQ:PI)


We believe future demand for Impinj’s (PI) products is weakening and will continue to do so for longer than management projects. With the company trading at 3X Price/Sales and growing GAAP-losses, we see further downside.

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Demand

In Q120 Impinj had a record quarter with sales of $47.82m, and management communicated that 6.2 of these were attributed to customers expediting their requests. From the Q120 earnings call, we get the following statement:

All told, COVID-19’s impacts on our endpoint IC and systems opportunities and new products, combined with headwinds from the North American project, the $6.2 million first quarter expedites and significant order pushouts from second quarter to third [emphasis added], all conspire to a second quarter challenge. – Q120 earnings call

This indiates that demand will be low during Q220 and will pick up in Q320 with significant orders pushed outwards. In the Q220 earnings call, management’s language had significantly shifted and we get the following:

Today, retail stores are reopening in many geographies, particularly in Asia, but productivity remains low, particularly in North America. While the pandemic’s apparent resurgence tempers our third [emphasis added] quarter endpoint IC expectations, some large retail deployments continue expanding worldwide, including at a notable North American end user. – Q220 earnings call

and:

On the systems side, tightened end-user CapEx budgets and ongoing slowness in consumer-facing opportunities likewise temper our third [emphasis added] quarter systems expectations. Today’s vantage point also suggests that the fourth quarter [emphasis added] may not follow typical seasonality. – Q220 earnings call

They are less optimistic about demand in both Q320 and Q420. We believe the channel is still stuffed from the expedited requests and Impinj’s customers will continue to be more cautious moving forward. This all points to a challenging third and fourth quarter and questions the long-term prospect of Impinj.

Deteriorating Fundamentals

The DSO increased from 49 days in Q120 to 75 days in Q220, an increase of 52% quarter-over-quarter and an increase of 60% year-over-year, indicating demand problems and more generous payment terms during Q220. In Q220 earnings call management refers to customers building inventory to reduce supply risk. If this were true, then demand should have been pulled forward but there should have been no effect on DSO or gross margin. We are skeptical of this statement but to note here is that accounts receivables fell 27% year-over-year, in line with a revenue decline of 31% year-over-year and a stable gross margin. From the Q220 earnings call, management is communicating that a better than usual product mix was responsible for boosting the gross margin.

We see the same trend in inventory with DIO jumping from 144 in Q120 to 233 in Q220, a 105% increase quarter-over-quarter and 27% year-over-year. When asked about Impinj’s inventory build, management responded with the following:

And wafer buys in the period can take as long as five months to turn into to finished goods. So the quarter-over-quarter increase was really driven by the sudden demand drop more so than anything other than what we have done in terms of managing our inventory – Q220 Earnings call

We think that Impinj’s lead times are for the most part faster than five months and in Q120 should have had the foresight of Q220 demand. In the same quarter 10-Q report, the following is stated:

Due to shorter lead times for our endpoint ICs in 2018 and 2019 relative to prior years, we were, prior to Covid-19, increasingly receiving orders and shipping the ordered products within the same quarter. – Q220 10-Q p.32

and:

Some components of our products have longer lead times and we place orders with some [emphasis added] of our suppliers five or more months before our anticipated product delivery dates to our customers. – Q220 10-Q p.34

Breaking down the inventory, we get that finished goods increased by almost twice the amount of work in progress. For this to happen the products must be bought and turned into finished goods within the same quarter and our conclusion is that at least half of the inventory build was produced in the quarter. It impresses us that an inventory management company is managing its own inventory so poorly.

The continued manufacturing of new products when it should have been obvious to management that demand will be low in Q220 could be due to a different product mix as management alluded to, or it might indicate that Impinj has some obsolete inventory that should be written off.

In the Q220 earnings call, management tells us that the channel is stuffed and their customers will manage down this inventory in Q320 and be back on normal levels in Q420. Management has a history of being overly optimistic: simply compare Q120 to Q220 earnings call in the “demand” section. Management is not alone though, as industry sources are also constantly overestimating demand for Impinj’s products (p.4 10-K). We do not believe the inventory is a one-quarter event that management can blame on COVID. We think both excessively high inventory levels and COVID will linger for longer.

Third, in the second quarter, we generated positive free cash flow from strong underlying product mix boosting gross margins and the team effectively managing operating expense, working capital and capital expenditures. Looking into third quarter, those benefits will reverse. Operating expenses will increase, working capital will consume cash, capital expenditures will increase and underlying product mix will be less favorable. – Q220 Earnings call

In addition, Impinj has a non-cancellable agreement to purchase inventory for 10.1m (p.11 10-Q). With our forecast of lower demand for Impinj’s products in the future, this commitment will increase working capital needs and inventory further with potential write-downs needed in the future. Further pressure will be put on Impinj with the positive effects from Q220 reversing in Q320.

Peers

Management is blaming recent developments on COVID. We do not believe the latter is solely responsible for the recent development in sales and inventory. Comparing Impinj with two peers, NXP Semiconductors (NXPI) and Zebra Technologies (ZBRA), Impinj clearly stands out negatively.

The slowdown in revenue and building of inventory paired with the company’s commitment to buy inventory does not bode well for Impinj’s stockholders.

NXP’s IoT segment is the division in direct competition with Impinj. Year to date, the IoT segment is the only one developing revenue positively for NXP.

[Year to date] Revenues decreased by 19.3% in our largest end market, Automotive, 6.7% in the Mobile end market, and 9.6% in the Communications & Infrastructure end market, which were slightly offset by an increase of 7.0% in our Industrial and IOT end market – NXPI Q220 p.16

Revenue from NXP’s IoT segment grew 11.5% while the remaining segments were down during Q220. The developments seen at Impinj should be mirrored by the industry if it is in fact due to an industry-wide event such as COVID. We affirm recent developments are due to poor management and not COVID.

Customer concentration and demand concerns

Impinj has a high revenue concentration with the top five customers being responsible for 45% of revenue. Two out of the five companies are Avery Dennison (AVY) and Smartrac, accounting for 19% and 12% of revenue respectively. In Q120, Avery Dennison acquired Smartrac. The combined company is now responsible for 31% of Impinj’s total revenue, based on the 2019 10-K report (p.8). In Avery Dennison’s second-quarter report management is guiding down revenue with 5-7%.

Avery Dennisson Q220 guidance

(Source: Link)

As Impinj’s management stated in its Q220 earnings call, their customers are stuffed with inventory, a statement confirmed with Avery Dennison’s small build in inventory with DSO building from 51 days in Q120 to 57.6 days in Q220. The buildup in inventory will affect Impinj to a higher degree than the guided sales decline suggests, putting additional pressure on Impinj’s Q320 revenue.

Risks

Days to cover: 9.5 days

Short ratio: 20%

The biggest risk we see with Impinj is the high short ratio and days to cover. A positive surprise during Q320 or Q420 could leave the share jumping and result in a short squeeze. Depending on options prices, it might be advisable to buy insurance in the form of call options around Q320 and Q420 announcements.

Conclusion

Impinj is losing share to its competitor and is blaming poor developments on COVID rather than poor management. The guidance of Avery Dennison and buildup in both DSO and DIO puts additional pressures on Impinj. We can not understand the expensive price tag of 3x price/sales when the only thing growing is GAAP-losses.

Disclosure: I am/we are short PI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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