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Impinj, Inc. (NASDAQ:PI)
Q2 2020 Earnings Call
Jul 29, 2020, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Impinj Inc. Second Quarter 2020 Earnings Conference Call. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. I would now like to turn the conference over to Ellen Hayes-Roth, Investor Relations. Please go ahead.

Ellen Hayes-Roth -- Investor Relations

Thank you, Operator. Good afternoon, and thank you all for joining us to discuss Impinj's Second Quarter 2020 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 2020 financial results and third quarter 2020 commentary. We will then open the call for questions.

Jeff Dossett, Impinj's Chief Revenue Officer, is also on the call and will join Chris and Cary in the Q&A session. Management's prepared remarks, along with trended financial data are available on the Investor Relations section of Impinj's website. Before we start the call, please note that we will make certain statements during the call that are not historical facts, including those regarding our plans, objectives or expected performance. The expected or potential impact of COVID-19 on our business, operating results, financial condition or prospects and the expected or potential responses of government authorities, customers, partners and the Company to COVID-19.

To the extent we make such statements, they are forward-looking within the meaning of the Private Securities Litigation Reform Act from 1995. Any such forward-looking statements represent our outlook only as of the date of this conference call. While we believe any forward-looking statements we make, including concerning COVID-19, are reasonable, our actual results could differ materially because any statements based on current expectations are subject to risks and uncertainties. Please see the risk factors in the annual and quarterly reports we file with the SEC and risk factors in the Form 10-Q for more information about these risks.

We do not undertake and expressly disclaim any objection to update or alter our forward-looking statements whether as a result of new information, future events or otherwise, except as required by applicable law. During today's call, all financial numbers we discuss, except for revenue or where we explicitly state otherwise, are non-GAAP financial measures. Balance sheet and cash flow metrics are on a GAAP basis. Free cash flow is a non-GAAP measure.

Before turning to our results and outlook, I'd like to note that the Company will virtually attend the 9th Annual Needham Industrial Technologies Conference on August 6th, the Oppenheimer 23rd Annual Technology, Internet & Communications Conference on August 11th, Canaccord Genuity's 40th Annual Growth Conference on August 13th, and Colliers Securities' Conference on September 10th. We look forward to connecting with many of you at these upcoming events.

I will now turn the call to Chris Diorio, Impinj's Co-Founder and Chief Executive Officer. Chris?

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Thank you, Ellen. Thank you all for joining our call. I hope you and your loved ones are, and remain safe and well. COVID-19 has significantly affected Impinj and our customers in the short term, causing unprecedented volatility in the first, second and third quarters of 2020. Looking further out, we believe COVID-19 will accelerate our secular opportunities in the mid to long terms and advance our thesis of connecting and giving digital life to everything.

Starting with the short term, COVID-19 severely impacted retail apparel, our leading endpoint IC market with non-essential stores mostly closed. In other markets, COVID-19's impact varied by opportunity and geography, but the overall impact was negative. Our inlay partners adjusting to the volatile demand environment, first expedited endpoint IC shipments from second quarter to first, then rescheduled backlog from second quarter to second half, while also slowing second quarter bookings. As a consequence, our second quarter revenue contracted quarter-over-quarter and year-over-year.

The rescheduling requests peaked in May, with bookings improving notably in July. Our Inlay partners are today consuming inventory they accumulated in the first quarter, and we expect that inventory to normalize by the end of the third quarter. On the brighter side, demand for those endpoint ICs used in industrial, supply chain and specialty applications, which are smaller, but still meaningful opportunities for us, remain steady in second quarter in generating a richer-than-typical products mix and higher margins.

On the systems side of the business, second quarter revenue also declined quarter-over-quarter and year-over-year driven by the North American systems project transitioning to its operational phase and capex pullbacks at other end-user projects. The former did bring a bright spot with the customer ordering more gateways, despite the project transition, generating modest second quarter revenue. The latter, tight capex manifested in lower deal count and smaller deal size, with many consumer-facing use cases like race timing and airline baggage tracking, delayed or put on hold. Also, pilots or deployments that require non-essential on-site personnel were similarly put on hold.

Finally, our systems distributors are today reducing their inventory levels on lower sell-through and only placing new orders for products or quantities not currently in inventory. 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 quarter endpoint IC expectations, some large retail deployments continue expanding worldwide, including at a notable North American end user.

On the systems side, tightened end-user capex budgets and ongoing slowness in consumer-facing opportunities likewise temper our third quarter systems expectations. Today's vantage point also suggests that the fourth quarter may not follow typical seasonality. Turning to the medium term, we see COVID-19 accentuating our opportunity. We saw and felt it even in the depths of the crisis. Visionary RAIN-enabled retailers with better visibility into their inventories, were able to quickly pivot to online sales and omnichannel fulfillment. Many of those retailers are today accelerating plans to modernize their in-store experience, improve customer satisfaction and reduce vectors for virus transmission.

For example, COVID-19 is driving a transition away from traditional loss prevention and toward RAIN-enabled loss prevention, touch-free self-checkout and seamless returns, offering large projects with leading loss-prevention partners and retail end users. In the supply chain, as shipment volumes ramped to traditionally short-lived holiday peaks and stayed there, end users accelerated their plans to modernize their operations. We are today seeing traction not only reading items passing through dock doors, which we have discussed on prior calls, but also on conveyor belts, to reduce manual touch and improve shipment accuracy.

Notably, a second large North American supply chain and logistics provider is commencing a deployment with a scale and at a pace that are difficult to forecast, but we believe will be significant by most any measure. We expect these accelerating retail and supply chain and logistics opportunities to not only drive long-term systems revenue, but also significant endpoint IC volumes as deployments transition to operations, mostly in 2021 and beyond. With our strong balance sheet and staying power, we will not only weather the impacts of COVID-19, but we will invest in these opportunities and exit the other side of COVID-19 stronger. Looking to the long term, we believe COVID-19 will accelerate our vision of connecting and giving digital life to every thing.

Leading businesses are investing in modernizing their operation to address structural inefficiencies and deliver the seamless e-commerce, online and in-store experiences their partners and customers demand. To do so, they want and need the visibility, insights, virtualization and customer experience that RAIN brings. Our pipeline of large systems opportunities and end-user engagements is richer than, and deeper than, at any time in our history.

Leading end users are pushing us to expedite innovations and solutions, not delay them. They are also asking for more and better capabilities, not less. Our engagements with top-tier OEMs, ISVs, SIs and IoT providers are also advancing, as they feel the same pull we do from those large, visionary end users. The gamechanging products we have introduced, like the Impinj M700 endpoint IC, and the IoT vision we have advanced resonate in a world forever changed by COVID-19.

We are energized by the pace toward realizing our vision and the partners and end users we are driving it with. Turning to new products, our production ramps were a bright spot in the quarter as we delivered production volumes of our M700 endpoint IC and R700 reader product families. We believe the M700 will fundamentally change the RAIN landscape by proving our ability to migrate an endpoint IC aggressively down Moore's Law, improving performance while at the same time adding new functionalities that were previously out-of-reach.

Our partners and end users are excited by both the performance and the first key new functionality, protected mode, which enables embedded tagging for retail self-checkout, loss prevention and seamless returns. We see both the M700 and R700 as growth drivers, affirming our position as the leading RAIN innovator and product supplier now, and in the future. The R700 also received recognition for its creative design in the 2020 Core77 Design

Awards. The Impinj M700 and R700 are centerpieces of our platform and powerful growth drivers for our business. We remain committed to further innovation across all our product lines. On the organizational side, second quarter brought both excitement and introspection. Excitement in Jeff Dossett's promotion to Chief Revenue Officer. Jeff brings tremendous insights and leadership running our go-to-market organization. He has been instrumental in our sales, partner and product successes and we foresee continued excellence. Congratulations, Jeff, on your well-deserved promotion. We are also happy that, from a team perspective, we adapted well to our virtual work environment and have maintained our productivity.

Employee retention was high and we added talent to a few targeted areas. But second quarter also brought deep introspection. George Floyd's murder on the evening of the United States' Memorial Day, May 25th, 2020, exposed those of us, me included, who were silent on racism as part of the problem. Today, we can be silent no more. The next day I wrote a letter to all Impinj employees, closing with these words, together we can commit to not let today's events fade from our memories, as has happened so often in the past. To strive instead for the better, and to dedicate ourselves in doing so.

In response, so many of our employees committed to making our Company a model of diversity and inclusion that I am confident that they, and we, will make it so. And we, all of us, will not forget. In closing, second quarter was challenging, and COVID-19's immediate impact will extend into the third quarter. Regardless, we remain focused on emerging from COVID-19 a stronger Company in a stronger market position than when we entered it. As I said last quarter, we have not lost sight of the big picture, of the benefits we bring to retailers and of the improvements we can drive in supply chain and logistics.

And we see brightness ahead, with adoption accelerating as leading end users leverage the visibility, insights, virtualization and customer experience that RAIN brings. With a strong balance sheet, game-changing new products and a compelling platform and vision that sit squarely in the center of end-user business transformations, our future is bright.

We will continue focusing on leading apparel retailers and on leading supply chain and logistics companies, investing in operational improvements for them and business opportunities for us. We will do so with a fierce determination to win, keeping a close eye on expenses as we leverage our resources to increase our competitiveness and chart a path to adjusted EBITDA breakeven on the other side of COVID-19. Be safe and be well.

I will now turn the call over to Cary for our detailed financial review and second quarter commentary. Cary?

Cary Baker -- Chief Financial Officer

Thank you, Chris, and good afternoon everyone. Today, I will cover both the metrics we typically discuss on earnings calls as well as additional, more detailed metrics, which we believe are appropriate given the market uncertainties.

Second quarter revenue was $26.5 million, declining 30.7% year-over-year and 44.7% quarter-over-quarter, compared with $38.2 million in second quarter 2019 and $47.8 million in first quarter 2020. Second quarter endpoint IC revenue was $18.5 million, declining 21.8% year-over-year and 44.9% quarter-over-quarter, compared with $23.7 million in second quarter 2019 and $33.7 million in first quarter 2020. Second quarter endpoint IC bookings declined significantly year-over-year and quarter-over-quarter, driven by inlay partners rescheduling backlog and managing inventory levels in this new demand environment. We expect our inlay partners to take advantage of the recovering retail demand environment in the third quarter to reduce the inventory they built in first quarter 2020.

While that dynamic, coupled with customer-specific adjustments, will limit our third-quarter revenue recovery, we see positive momentum in our bookings pace. As of July 24th, July bookings have improved significantly over June and are higher than any month in the second quarter, and we still have a week of July to go. We expect our customers to complete their supply chain inventory adjustments in the third quarter and that our fourth quarter endpoint IC revenue will be more indicative of end-user demand.

Second quarter systems revenue was $7.9 million, declining 45.4% year-over-year and 44.1% quarter-over-quarter, compared with $14.5 million in second quarter 2019 and $14.1 million in first quarter 2020. Gateway revenue declined both year-over-year and quarter-over-quarter, led by the large North American project transitioning to an operational phase, with modest revenue from that customer in the second quarter. Reader revenue declined year-over-year and quarter-over quarter, impacted by COVID-related project delays and tight customer capex budgets.

Reader IC revenue grew year-over-year and quarter-over-quarter due, in part, to modest partner inventory builds to reduce supply risk. We expect third quarter systems revenue to remain constrained by continued tight capex budgets, our distribution partners rationalizing their inventory levels for lower sell-through, and by lower reader IC revenue, the latter due, in part, to reduced demand for retail handhelds.

Second quarter gross margin was 51.4%, compared with 50% a year ago and 46.1% last quarter. On a year-over-year basis, gross margin improved 140 basis points, driven by underlying product margins partially offset by leverage on lower revenue. On a quarter-over-quarter basis, gross margin improved 530 basis points, driven by lower E&O charges and improved underlying product gross margins, partially offset by leverage on lower revenue. Total second quarter operating expense was $18.8 million, compared with $18.3 million in second quarter 2019 and $19.0 million in first quarter 2020. Research and development expense was $8.7 million. Sales and marketing expense was $4.8 million. General and administrative expense was $5.4 million.

Second quarter adjusted EBITDA was a loss of $5.2 million, compared with a profit of $800,000 in second quarter 2019 and a profit of $3 million in first quarter 2020. We have excluded costs of $5.4 million associated with an expected settlement of our shareholder class action lawsuits from second quarter non-GAAP general and administrative expense, adjusted EBITDA and non-GAAP net loss. Second quarter GAAP net loss was $17.5 million. Second quarter non-GAAP net loss was $5.7 million, or $0.25 per share, using a weighted-average diluted share count of 22.7 million shares.

Turning to the balance sheet, we ended the second quarter with cash, cash equivalents and short-term investments of $120.9 million, compared with $59.8 million in second quarter 2019 and $119.2 million in first quarter 2020. Inventory totaled $37.1 million, down $800,000 from second quarter 2019 and increasing $5.3 million from first quarter 2020. The quarter-over-quarter inventory increase was driven by lower demand due to COVID-19 as well as the production ramp of the Impinj M700.

In second half 2020, we will maintain adequate supply of our 200 millimeter endpoint ICs as we set the stage for our transition to the 300 millimeter M700 family. In the second quarter, net cash provided by operating activities was $1 million and property and equipment purchases totaled $100,000. Free cash flow was $800,000. I will now highlight a few items impacting our business.

First, our suppliers that operated at reduced capacity or were closed due to temporary government mandates have recovered. They are today operating at nearly 100% capacity, but we continue to be vigilant around component availability in a dynamic demand environment.

Second, we have an agreement to settle all outstanding shareholder litigation. We recorded a $5.4 million settlement-related expense in our second quarter GAAP general and administrative expense and we expect a corresponding cash outflow during third-quarter 2020. After considering a number of factors, including the significant expense of protracted litigation of this type, in time and money, we determined that it was in Company's and its shareholders' best interests to settle the suits.

As Chris noted, we have significant opportunities ahead of us and we look forward to focusing on enabling digital life for everything. 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 the 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. While we will use our balance sheet in the third quarter to fund our business, we remain confident in our plan to return to adjusted EBITDA breakeven on the other side of COVID-19.

Turning to our outlook, considering the ongoing impact of COVID-19 on our partners and end users, we feel it is prudent to not give quantitative third quarter guidance. Instead, we will share additional metrics about our business that we do not intend to share on an ongoing basis. As of July 1st, third quarter backlog scheduled to ship in quarter was $16.2 million. In addition as of July 24th, third quarter bookings scheduled to ship in quarter were $7.0 million, up 20% quarter-over-quarter and down 17% year-over-year.

Further third quarter upside is limited both by continuing demand volatility and by our partners rationalizing their endpoint IC and systems inventory levels. Despite the third quarter uncertainty, we see encouraging signs as our partners and end users recover in the new demand environment. We remain focused on emerging on the other side of COVID-19 a stronger and more competitive Company, delivering against the new opportunities that COVID-19 is creating. In closing, I want to thank our Impinj team, our customers, our suppliers and you, our investors, for your ongoing support in these uncertain times.

I will now turn the call to the operator to open the question-and-answer session.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions]. And our first question today will come from Jim Ricchiuti with Needham & Company. Please go ahead.

James Ricchiuti -- Needham & Company -- Analyst

Hi, thanks. Good afternoon. Yeah, I'm wondering if there's a way to look at the business and look at some of the areas of the markets that you address that have opened. And maybe give us some perspective as to the trajectory of the recovery you're seeing. Is there any way that you can -- we've seen, obviously, parts of Europe opening up. We've seen parts of the U.S. that opened on the retail side. And of course, there are other issues now with the pandemic spreading. But I'm wondering if there is anything you can share with us that might give us some sense as to how we might see the recovery?

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Thanks, Jim, and good afternoon to you as well.

James Ricchiuti -- Needham & Company -- Analyst

Hi, Chris.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

We can -- I think I'm going to tag team this one with Jeff. But just -- and our answer, of course, will be very qualitative here. Some of the words I said in my prepared remarks associated with the rescheduling request peaking in May and some return to orders in July and to comments Cary made about July being a stronger month. We're seeing a return. I can't use the word normalcy in that return because there is so much uncertainty out there associated with COVID-19.

And what we wanted to do here was really to give a picture of a little bit less about the short-term and a little bit more about the mid -- or the medium and long terms. And the fact that we see transformations happening in our two key focus markets, those being retail and supply chain and logistics. And then we're broadly out in the market as end users really adapt their businesses for COVID-19. So we see return coming out this year. Of course, depending on what happens in the fourth quarter, it's hard to say with COVID-19. But we do see tailwinds now from these large end customers, that are striving to change their organizations. And I know I didn't directly answer your question. Maybe Jeff can help me out a little bit here with a little bit work in size around some other points.

Jeff Dossett -- Chief Revenue Officer

Jim, this is Jeff Dossett. Just a couple of things I'll add to Chris' comments. First of all, I'd reinforce that I think the supply chain and logistics, there are bright spots in supply chain and logistics around the globe. And then I think I would add that, of course, the timing and pace of recovery in different geographies and in different industry sectors varies around the globe. We are seeing some moderate recovery earlier in Asia as it recovers and returns to a new normal. So we're seeing retail reemerging. We're seeing business in general, reemerging as non-essential team members are able to return to work and return to either existing deployments and/or testing new proofs of concept or proofs of value, which are bright spots in terms of longer-term opportunity. So I think there is geographic variance in terms of the recovery, but bright spots that we're seeing around the globe.

James Ricchiuti -- Needham & Company -- Analyst

Okay. The follow-up question I had is just one of the other players in the RFID market has talked about the fact that in some cases, it's difficult to get even into certain locations because of the pandemic to carry out installations. And I'm wondering how much of that you're seeing whether it's on the tag IC side of the business or more directly on the system side of the business. You alluded to another -- it sounds like another potentially nice win with an American logistics customer. Is there any visibility as to how that -- it sounds like you don't have much visibility in how that's deployed. But to what extent is the pandemic impacting your ability to really see some of these programs carried out in the near-term?

Jeff Dossett -- Chief Revenue Officer

Jim, it's Jeff again. And I would say that the inability for non-essential team members to return to the workplace does impact some systems projects in terms of timing and pace. There are other examples where larger organizations have been able to continue testing and preparation for deployments. So I do think it's impacting the systems business differently from the endpoint IC business, whereas the endpoint IC business is more directly impacted by the enclosures in retail. So not so much a worker access to the workplace, but rather shoppers returning in person to in-store experiences. That being said, a bright spot that Chris noted in his opening remarks, is that visionary leading retailers have leveraged their RAIN investments to support improved supply chain, inventory visibility to support omnichannel, shopping experiences, whether it's buy online pickup in store, buy online pickup at curbside or importantly to buy online and ship from closest available inventory to maximize customer satisfaction and to minimize shipping costs.

So we're seeing -- I would say we're seeing amazing resilience and creativity around the globe to adapt to a very changing environment, but the inability for non-essential workers to return to work is impacting some systems projects, timing and pace.

James Ricchiuti -- Needham & Company -- Analyst

Thanks. I'll jump back in the queue. Thank you.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Okay, thank you Jim.

Operator

[Operator Instructions]. And our next question will come from Charlie Anderson with Colliers Security. Please go ahead.

Charles L Anderson -- Colliers Securities -- Analyst

Yeah. Thank you for taking my questions and good afternoon. I wanted to start on supply chain logistics. Sounds like a lot of interesting traction there. So firstly, on the existing customer where you did get more orders, is that just the tail of the prior project? Or would that be a movement into a new project with them? And then on the new customer, it sounded like that has a lot of opportunity. I wonder if you could maybe just layer in any more context there in terms of how it looks relative to the first project you executed with a customer in that end market? And then I've got a follow-up.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Okay. Charlie, thank you for joining us. Appreciate it. To answer your first question, there are some existing opportunities in the existing deployments at that North American supply chain and logistics customer. And of course, that being a very large customer, there are also other opportunities that we foresee for the future. So we continue to prioritize that customer, support them as best we can. And as we said, we had a modest gateway sale in the second quarter, and we look forward to future opportunities.

In terms of other supply chain and logistics providers, moving forward, as I said -- as we noted in the script, we -- there is another opportunity out there, that have a very significant size and scope, and we're excited about that opportunity. But we really can't speak at this time to either the pace of their deployment or kind of really what it means for us, we'll be giving further updates on further calls as we learn and see more. But I think it's important to note that it is another very large opportunity. And it portends for at least for us, a future of transition and supply chain and logistics that we've been looking forward to and seeing for a long period of time.

And in some sense, COVID-19 has accentuated or accelerated it. Of course, for a committee to come online quickly, meant that they already had to have some ongoing work and the pilots had a bunch of stuff already done. But we see significant opportunities in supply chain and logistics for the future and the fact that there's another large end customer coming online is super promising for us.

Charles L Anderson -- Colliers Securities -- Analyst

Great. And then for my follow-up, a couple of questions on inventory. So number one, I wonder if you'd be willing to quantify the degree of inventory that's out there at your Inlay partners. How much needs to be worked through in the third quarter to get to that equilibrium in the fourth quarter? And then secondly, you guys did build inventory yourselves in the quarter, and it sound like there was going to be some working capital investments in the third quarter. So I'm wondering if that also means inventory goes up again? And just trying to understand the dynamics there in terms of what's driving that. Thanks.

Jeff Dossett -- Chief Revenue Officer

To your first question on inventory, this is Jeff. I don't think I'll quantify the inventories in place in our Inlay channel partners. But importantly, what I would reiterate is that we anticipate exiting third quarter with healthy, meaning appropriate Inlay channel inventories. So as our Inlay partners respond to evolving demand, they are aligning their inventories to that level of changing demand. And again, we expect to exit third quarter with healthy channel inventories.

Cary Baker -- Chief Financial Officer

And hey Charlie, this is Cary. I'll take the Impinj inventory portion of your question. We have long cycle times in our inventory cycle. And wafer buys in the period can take as long as five months to turn into 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. Looking forward, we anticipate maintaining kind of our current level of 200-millimeter inventory. We will build modestly on our production ramp side. So both on the M700 300 millimeter wafers and then also to a lesser degree on the R700. But that is really to support the product launches.

Charles L Anderson -- Colliers Securities -- Analyst

Okay, great. Thank you so much.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Thank you, Charlie.

Cary Baker -- Chief Financial Officer

Thanks Charlie.

Operator

And our next question will come from Scott Searle with ROTH Capital. Please go ahead.

Scott Searle -- ROTH Capital -- Analyst

Hi good afternoon. Thanks for taking my question. Hey, I apologize if I missed this earlier, but in regard to your systems comments, did you provide any sequential directionality? I know you had some follow-on orders for gateways from your large North American customer. It sounds like that won't be there in the third quarter. Should we be assuming initially that we're starting from a down third quarter for systems? And then to follow-up on the system side, could you talk a little bit about how that pipeline is shaping up in terms of the magnitude of the deals that are in the pipeline? Are they getting larger per site deployments? Maybe talk a little bit about how the current COVID environment is maybe pulling in larger opportunities related to efficiency, visibility, zero-touch environments.

Cary Baker -- Chief Financial Officer

Yeah. Hey, Scott, this is Cary. I'll take the first portion of that and then hand it over to Jeff. So from a systems' perspective in terms of guiding to the third quarter, we expect it to be another constrained quarter. Capex budgets are going to be tight. Stores are just now opening. So projects are going to be delayed. We did get, as Chris noted, an additional order from the first North American logistics company. There will be modest revenue from that. But I would say, overall, the systems business, we expect it to be constrained in the third quarter. Jeff?

Jeff Dossett -- Chief Revenue Officer

And in terms of the pipeline, as Chris noted in his remarks, we do feel encouraged by our pipeline of large systems opportunities, some of which, not all of which, have been positively influenced by COVID-19. But I would say as a percentage of the overall pipeline, large opportunities has increased as an overall percentage. In part, COVID-19 has had a disproportionate impact on smaller projects, which often begin in terms of testing and validation of the value and initial deployment within the quarter. So again, as non-essential team members have been unable to return to the workplace in many geographies, those smaller in-quarter opportunities have been disproportionately impacted in the short-term only though. So large opportunities [Speech Overlap]. Okay, you're welcome.

Scott Searle -- ROTH Capital -- Analyst

If I could quickly follow-up on the endpoint IC front. Could you recalibrate us just in terms of what that end market mix looks like or maybe retail, non-retail in the second quarter? I know it's an unusual set of circumstances and the numbers are not normalized, but to just calibrate us on that front. And then maybe in terms of that pipeline that's building as well, particularly around the M700. What you're seeing on that front? How the early expectation is for market share on that front? And lastly, gross margins, I think, were expected to be a little bit better as the M700 gets introduced. Is that still the expectation as that starts to ramp into more meaningful production? Thanks.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Okay. Thanks, Scott. I think we're going to tag team this one. This is Chris starting, then I'll hand off to Jeff for the middle part of the question and then Cary for the latter part. We've spoken a good bit in the past about the rough breakdown of endpoint IC volumes, and as being roughly two-thirds retail, and roughly one-third -- that's retail apparel, and roughly one-thirds other opportunities. As we said for second quarter, some of the other opportunities, the specialty opportunities were not impacted as much as some of the retail environment. So that shift -- there would have been a transient shift in the second quarter, where the retail percentage would have dropped. I don't think believe we have the data that we can quantify it for you right now. But just to expect retail to have seen a more significant decline than the other opportunities.

Our expectation is that on the other side of COVID-19, that will rebound back. And we'll probably go back to the traditional two-thirds, one-third, at least until some of those supply chain and logistics opportunities start to ramp up. And then we might see, over time, as you would expect, the retail, even though it's still increasing, but to gradually decrease as an overall percentage of the total endpoint IC volumes. Jeff?

Jeff Dossett -- Chief Revenue Officer

Yeah, in terms of market reception, I'd say our partners and end customers are very excited by the performance and capabilities of the Impinj M700 endpoint IC series. We are very appreciative of the work that we've done in close collaboration with our partners to prepare for production ramp at scale. And we anticipate market adoption will grow in the quarters to come.

Cary Baker -- Chief Financial Officer

Hey Scott, this is Cary. In regard to the margin impact from the M700. Once we get out of the production ramp, yes, we expect the M700 to be accretive to margin. So I think kind of the end of this year to the beginning of next year when we'll start to see that benefit. So we started shipping the M700 in Q2, small volumes. And it did have an impact on gross margin in Q2, but the margin was more impacted by a favorable product mix that offset both the production ramp impact of the M700 as well as leverage on lower revenue.

Scott Searle -- ROTH Capital -- Analyst

Great. Thank you.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Thank you, Scott.

Operator

And our next question will come from Craig Hettenbach with Morgan Stanley. Please go ahead.

Craig Hettenbach -- Morgan Stanley -- Analyst

Yes. Thank you. In understanding that the supply chain has been very fluid kind of around the pandemic, but can you maybe just touch on some of the signals you're looking for in terms of that inventory depletion rate? And when you think you can kind of get back to a normal seasonal trend?

Jeff Dossett -- Chief Revenue Officer

This is Jeff. I think the first thing I would say is that we expect that during the third quarter, our Inlay partners will continue to address demand with -- in part by burning down inventories that were accumulated in the first quarter. We expect to exit third quarter with healthy and appropriate channel inventories at that time.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

And then I'll just add that going forward, we see -- obviously, with the pandemic, we see atypical demand in fourth quarter. It's not really clear as typically fourth quarter is seasonally down, at least for endpoint IC. But it's not clear that that's going to be the case, given what's transpiring in the market right now. And so it's really difficult for us to call what the seasonality is going to be as we exit the year on either the system side or the endpoint IC side. Hence, the comment we made in the script that we don't expect this year to follow typical seasonality trends.

Craig Hettenbach -- Morgan Stanley -- Analyst

Got it. Thanks for that. And then just as a follow-up, you mentioned just lower capex for some on the system side, which is understandable given the environment. But just maybe, Chris, can you just speak to kind of design engagements? And I know companies are trying to kind of work through all these different external events as well. But just what the level of design engagement is? And then hopefully, as the environment stabilizes a bit, what that would translate into in terms of the momentum in the business?

Jeff Dossett -- Chief Revenue Officer

This is Jeff. My first -- my quick response would be that there's been some impact of -- on systems projects of non-essential team members not being able to return to work. But I would say that the pace of innovation or planned deployment of RAIN, the intention has continued. But some of the testing has been impacted by COVID-19, but we expect that to be relatively short term. I think both partners and Impinj have been able to remain in close engagement and communication with end customers who are planning RAIN-based deployments. And so progress is being made, but where specific on-site deployment, configuration and optimization is necessary prior to broad scale deployment, there's been some impact. Did that answer your question, Craig?

Craig Hettenbach -- Morgan Stanley -- Analyst

It did. I appreciate the color.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Okay.

Operator

And our next question will come from Jim Ricchiuti with Needham & Company. Please go ahead.

James Ricchiuti -- Needham & Company -- Analyst

Hey, and I realize it's very difficult to forecast the top line. But Cary, I'm wondering if you can give us some indication as to how we should think about operating expense? I mean clearly, there aren't trade shows going on. Travel is virtually non-existent. So how should we be thinking about your opex levels?

Cary Baker -- Chief Financial Officer

Yes. Thanks for the question. So with regard to trade shows and travel and entertainment, you're exactly right. That started slowing at the end of the first quarter and ground to a halt in the second quarter. We expect that environment to continue throughout probably the rest of this year. Though we'd like to see it improve. We'd like to be out on the trade shows and meeting with customers face-to-face. It's just not a reality right now. Where we are investing is in R&D. And we are adding resources and adding talent in this space to bring new products to market. That was one of our investment thesis at the beginning of the year, and it continues to be so. I will say we're not hiring as quick as we had budgeted. It's just a little challenging to hire in this environment right now. But we are still adding resources in our engineering organization.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

And I guess I'm going to add to that just a little bit. We're investing in R&D for the new products. We're also investing in R&D for some of the end customer projects that we see out there. So to the point about we're seeing pull from these large end customers, we're actually putting people and resources on these projects to accelerate our ability to meet the end customer requirements and deliver against them.

James Ricchiuti -- Needham & Company -- Analyst

Got it. And one other one, if I may. I just want to make sure I'm not misinterpreting your comments about the fourth quarter, potentially not exhibiting the normal seasonality that you've experienced. I mean, it sounds like you're suggesting that the fourth quarter has the potential to be stronger than the third quarter. Is that what you're saying?

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Well, we're -- well, Jim, this is Chris. So we're obviously seeing some channel inventory burn down in the third quarter, which is -- we come through on the other side -- at the end of the third quarter. So we're seeing an opportunity there. We're also seeing an uncertain environment in the retail space in general because we haven't been buying that much stuff over the past couple of quarters. So -- and retailers are attempting to figure out, I guess -- that's not quite the right word, but basically rationalize their inventory, the products they're bringing to market and then get the -- basically, get the RAIN-enabled items into their stores.

So typically, we see fourth quarter for the endpoint IC as being seasonally down because the tagging happens in the third quarter. I think what we're expecting this time around is we will see a difference, and the difference will be driven both by that channel inventory declining as well as some rationalization that is happening at the end customers, which is difficult for us to predict right now.

James Ricchiuti -- Needham & Company -- Analyst

Okay. Thank you.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Thank you, Jim.

Operator

And this will conclude our question-and-answer session. I'd like to turn the conference back over to Chris Diorio for any closing remarks.

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Okay. Thank you all very much for joining the call today. And I hope that you and your loved ones are, and remain safe and well. Thank you again. Bye-bye.

Operator

[Operator Closing Remarks].

Duration: 47 minutes

Call participants:

Ellen Hayes-Roth -- Investor Relations

Chris Diorio -- Chief Executive Officer, Vice Chair, and Co-Founder

Cary Baker -- Chief Financial Officer

Jeff Dossett -- Chief Revenue Officer

James Ricchiuti -- Needham & Company -- Analyst

Charles L Anderson -- Colliers Securities -- Analyst

Scott Searle -- ROTH Capital -- Analyst

Craig Hettenbach -- Morgan Stanley -- Analyst

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