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Edited Transcript of KRNT earnings conference call or presentation 9-Nov-16 10:00pm GMT

Thomson Reuters StreetEvents

Q3 2016 Kornit Digital Ltd Earnings Call

Rosh- Ha Ayin Dec 7, 2016 (Thomson StreetEvents) -- Edited Transcript of Kornit Digital Ltd earnings conference call or presentation Wednesday, November 9, 2016 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gabi Seligsohn

Kornit Digital Ltd. - CEO

* Guy Avidan

Kornit Digital Ltd. - CFO

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Conference Call Participants

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* Joseph Wolf

Barclays - Analyst

* John Michael

Stifel - Analyst

* Kenneth Wong

Citigroup - Analyst

* Brian Drab

William Blair & Company - Analyst

* Jim Ricchiuti

Needham & Company - Analyst

* Jon DeCourcey

Canaccord Genuity - Analyst

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Presentation

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Operator [1]

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Good day, everyone and welcome to Kornit Digital Limited Third Quarter 2016 Earnings Conference Call. As a reminder, today's conference call is being recorded. After prepared remarks, we will provide instructions to conduct a question-and-answer.

At this time, I'd like to turn the conference over to [Tom Cook]. Please go ahead, sir.

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Tom Cook [2]

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Thank you, operator and good afternoon, everyone and welcome to Kornit Digital's third quarter 2016 earnings conference call.

Before we begin, I would like to remind you that forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other U.S. Securities laws will be made on this call. These forward-looking statements include, but are not limited to, statements relating to the Company's objectives, plans, strategies, statements of preliminary or projected results of operations or of financial condition; and all statements that address activities, events or developments that the Company intends, expects, projects, believes or anticipates will or may occur in the future.

Forward-looking statements are subject to known and unknown risks and uncertainties and are based potentially on inaccurate assumptions that could cause results to differ materially from those expected or implied by the forward-looking statements. The Company's actual results could differ materially from those anticipated for many reasons and I encourage you to review the Company's filings with the Securities and Exchange Commission, including the Company's Annual Report on Form 20-F filed March 17, 2016 which identifies specific risk factors that may cause actual results or events to differ materially.

Any forward-looking statements are made as of the date hereof and the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future event or otherwise, except as required by law. Additionally, the Company will be making reference to certain non-GAAP financial measures on this call. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the Company's earnings press release published today which is posted on the Company's Investor Relations site.

On the call today, we have Gabi Seligsohn, Kornit's Chief Executive Officer; and Guy Avidan, Kornit's Chief Financial Officer.

At this time, I would like to turn the call over to Gabi. Please go ahead.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [3]

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Thank you, Tom and hello, everyone and welcome to our third quarter of 2016 earnings conference call. During today's call, I will review aspects of our performance, then provide an update on market conditions and our view on the remainder of the year. Guy will then walk you through the full financial details for the third quarter, as well as state our guidance for the fourth quarter of 2016.

Q3 2016 was another record quarter for Kornit, exceeding the high end of our revenue and profitability guidance and delivering year-over-year revenue growth of 40% is an extremely exciting result to report. Revenues during the quarter came in at $30.9 million and non-GAAP operating margins came in at 12.5%. Non-GAAP gross margins came close to 50%.

Strengths in the quarter was predominantly driven by sales to large accounts, including another round of systems for the major customer mentioned previously. The ramp-up program with this customer has been extremely successful and is expected to continue well into next year.

The third quarter did not include Vulcan revenue, but we expect initial revenues to provide a contribution to the fourth quarter.

I'm also happy to report that we recently received an order for a fourth Vulcan system from a new customer and we are currently at advanced stages of multiple negotiations of sales for more Vulcans to new customers beyond the initial three who are early adopters of the system. All three evaluation sites have been running production, one of them has even then running two shifts, seven days a week for the past several weeks to meet their high season demand.

Looking forward to the fourth quarter, and as Guy will detail in our guidance, we expect our momentum to continue as a result of different drivers. The bulk system order with a large customer was completed during the third quarter and we expect subsequent deliveries to take place in early 2017. However, we ended the quarter with a strong order book, which we expect to support these higher revenue levels. This includes a higher number of deliveries of Allegro systems and initial deliveries of the Vulcan.

Moving to some business highlights. During the third quarter, we attended the SGIA show in Las Vegas, where we showcased the Vulcan, Allegro and Storm Hexa systems. For Vulcan, we showed a full workflow with a Duplex dryer, which is able to meet the high throughput offered by the system. For Allegro, we showcased the ability to quickly and seamlessly transition to multiple fabric types, we generated a lot of interest from custom home decor manufacturers, a market which we believe can be meaningfully addressed with Allegro. And finally, the Strom Hexa demonstrated the benefit of an expanded color gamut offered by a six-color mid-level system. The team walked away with multiple orders and many new customer leads.

Today's results provide us with a great sense of achievement, as we see our strategy of making digital printing into a large scale textile decoration technology unfolding. More and more of our customers have reached daily production volumes of tens of thousands of garments with several working two and three shifts, seven days a week.

This is a result of a combination of several important factors. Online apparel shopping has become a way of life, the maturity of the technology we now offer, the lucrative business model, improving manufacturing costs combined with high ASPs for garment sold, the level of expertise our larger customers have reached and the operational excellence achieved by these customers, whether they are B2B or B2C, which allows them to produce and perform same-day delivery of tens of thousands of one-offs, in many cases.

To help investors understand the strength of the online trend, I would like to share a few data points about the US market. As I'm sure you are aware, instant gratification in this day and age is a huge driver. Data published by CIRP shows that the number of US Amazon shoppers willing to spend more to get faster delivery more than doubled from 2013 to 2015 and reached a staggering $55 million. Social Intelligence reports that over 74% of people buying decisions are made based on social media. These and several other factors have led to a situation whereby online apparel CAGR in the US has reached 20%, according to a report written by [TechGlobe] and already commenced close to 20% of overall apparel sales in the US. Specifically to our market, we actually see many of our customers growing twice and three times that number. For example, Redbubble, a long time Kornit customer focused on merchandising artistic designs with fulfillment centers in the US and Europe, which recently went public on the Australian Stock Exchange grew a staggering 62% last year, with customized apparel representing 68% of its revenues.

To try and understand the proportions of digital printing by Kornit customers, we recently made a calculation showing there our ten largest customers currently have capacity to manufacture 5 million garments a month, while we believe our overall installed base actually produces 70 million to 80 million garments per year. With billions of garments being produced annually, we believe we are still at the early innings of a digital transformation. As you know, most of our revenues in recent years have come from specialty printers, who decided to write this trend, which essentially takes garment manufacturing from a regime of supply and demand to demand and supply. These companies continuously expand their customer base, with several of them already starting to deliver a solution for the fast retail needs of major brands.

When referring to the concept of fast retail, what we actually mean is that relatively short production runs of up to 300 units to 500 units are ordered by major retailers to satisfy discrete market opportunities such as capsule collections, special limited offers, or sports events and the like. The introduction of the Vulcan allows Kornit to provide an optimal solution for such demand. The work we have done in the past 10 months with our selected few evaluation sites has demonstrated an ability to meet the required production cost and productivity relevant for this market, and we are enthusiastic about the opportunity it represents going forward.

Today, we filed a new investor deck, which we believe provides incremental information to allow investors to better understand our offering, addressable market and business KPIs. Some of the data included will be updated annually, such that our next major milestone will be our fourth quarter and annual conference call, which will take place during the first quarter of 2017. I'd like to use today's call to walk you through some of the data points, which are included in this presentation and which amplify some of the market data I just shared with you.

To start with, I'd like to point out to a sign of maturity and market adoption of our technology. Revenues from recurring customers during the first half of the year grew to 71% from 66% in 2014. As I have been reporting, more and more of our customers have multiple Kornit systems and continue to expand their business. Another area we have been talking about has been revenues from services. While in 2013 no revenue came from servicing our installed base, in 2015 already 12% of our installed base had service contracts in place and that number continues to grow.

We have also made significant progress with Allegro in recent months. By the end of this year, we expect to have about 20 customers coming from all four of our regions, two of which already have multiple systems. More recognition for the quality and differentiation of our Allegro offering was gained through our participation in the recent episode of project runway, a style and fashion reality show led by ex-supermodel Heidi Klum. In that episode, participants had to design prints, cut and sew swimwear in less than 24 hours and have their products showcased on the runway by models. Successfully printing high quality swimwear with pigment as a unique capability offered by the Allegro. The hand feel and durability requirements of stretchable fabric used for swimwear are very tough to meet.

On several occasions, I mentioned the importance of selling upgrades to our existing customers. This direction has been very well received by our customers as a means to protect their previous investments and extend the usable life time of their equipment. I'm happy to report that we have recently begun upgrading Storm II systems with Storm Hexa functionality. With an installed base of several hundred units, we expect this to become a more meaningful part of our business in 2017 with initial revenues expected during the fourth quarter of this year. In the coming months, we will also begin to roll out more upgrade kits for other parts of our installed base.

I will now turn the call over to Guy for a closer look at the numbers. Guy?

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Guy Avidan, Kornit Digital Ltd. - CFO [4]

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Thanks, Gabi, and good evening, everyone. Before beginning the financial overview, I would like to remind you that the following discussion will include GAAP financial measures as well as non-GAAP pro forma results. Our third quarter non-GAAP pro forma results reflect adjustment for the following non-cash items: stock-based compensation expenses, which totaled $618,000; depreciation and amortization expenses relating to the acquisitions of intangible assets in the previous year in the amount of [$106,000] and $147,000 for the assets of SPSI; non-cash inventory adjustment of $1.4 million related to the acquisition of SPSI's asset and acquisition cost and other costs of [$922,000]. a full reconciliation of our results on a GAAP and non-GAAP basis is available in the earnings press release issued earlier today and on the Investor section of our website.

Third quarter revenue increased by 40.3%] to $30.9 million versus $22 million in the prior year and increased 29.1% versus the prior quarter. Higher revenue versus the prior year was driven by several items in the quarter, predominantly higher sales to our key accounts, including a major customer that accounted for 28% of our revenue this quarter.

By geography, 75% of our sales were from the Americas, 17% from Europe, the Middle East and Africa and 8% from the Asia Pacific region. As in previous quarters, the Americas remain our largest territory. Our Asia-Pacific business in the third quarter continue to be weak although as Gabi mentioned, we are seeing improvement in the fourth quarter.

Moving to customer concentration. Our US distributor contributed 25.9% of our overall revenues and as stated, one of our global customers contributed 28% of our overall revenue. Our top 10 customers accounted for 71% of our overall revenue compared to 70% or 47% if without SPSI in the third quarter of 2015.

Moving to profitability. Non-GAAP gross margin in the quarter reached 49.2% versus 49.5% in the previous quarter and 48.3% in the prior year. On a GAAP basis, gross margin was 44.1%. The decrease in our GAAP gross margin is attributed to a non-cash $1.4 million inventory adjustment related predominantly to the SPSI asset purchase transaction. We expect to sell the majority of the remaining acquired inventory in the fourth quarter.

Moving to our OpEx items. I'll discuss this item on a non-GAAP basis, which exclude non-operating charges previously mentioned and highlighted in our GAAP to non-GAAP reconciliation, including in our today's press release. Adjusted research and development was 14.2% of sales or $4.4 million compared to 13.3% of sales or $2.9 million in the prior year. The increase in R&D expense as a percentage of sales, primarily reflect an increase in headcount, as well as expenses related to (inaudible) to support the accelerated release of the Vulcan and several other development projects, which are underway.

Sales and marketing expenses in the quarter were $4.6 million or 14.8% of sales compared to $3.1 million or 14% in the prior year. Higher sales and marketing expenses were the result of increase in headcount in the sales department to support the growth in sales and increased market coverage.

General and administrative expenses in the third quarter were $2.4 million or 7.8% of sales compared to $1.7 million or 7.8% in 2015. Higher G&A in the quarter results predominantly from the management headcount addition and incremental expenses as a public company.

Headcount as of September 30 was 388 employees. The increase in personnel was primarily attributed to additions of R&D and sales and marketing personnel. Given the size of company we have become an in-line of challenges and opportunities we currently face, we expect a significant slowdown in the pace of headcount increase in the coming quarter. In the long-term, we may require additional investment phases as our end market and product portfolio evolve.

Non-GAAP net income for the third quarter was $3.6 million or $0.11 per diluted share, an increase of $640,000 versus the year-ago quarter. GAAP net profit was $361,000 or $0.01 per share on a diluted basis, compared with net income of $2.1 million or $0.07 per share for the year-ago quarter.

Cash balances included long-term marketable securities at quarter-end were $56.7 million compared to $74.2 million as of September 30, 2015. Net cash provided by operating activities was $2.5 million this quarter compared to $3.7 million net cash used in the prior quarter and net cash used in operating activities of $4.9 million in the year-ago quarter. The increase in cash from operation was mainly a result of net income and the increase in (inaudible) versus the prior-year period. The decrease of cash balances included $9.2 million in connection with the acquisition of SPSI's assets, which include a significant amount for inventory and future services to be provided by SPSI.

In the fourth quarter, we will continue to execute a leasehold improvements program to our facilities in Israel. This project will increase space for research and development labs and accommodate our large team in Israel. We expect CapEx related to this project in the fourth quarter to approximate $2 million and be completed in 2016.

Turning to our guidance for the fourth quarter of 2016, we expect revenue to be in the range of $31 million to $34 million and non-GAAP operating income to be in the range of 12% of revenues to 16% of revenues.

I'll now transfer the call to Gabi.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [5]

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Thank you, Guy. And with that operator, we'd be happy to take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Joseph Wolf, Barclays.

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Joseph Wolf, Barclays - Analyst [2]

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Thank you. First, I just wanted a review of the comment. You said that Top 10 customers were 71%, 47% without SPSI and compared to 70% with SPSI, can you just review that? I don't think I heard that properly.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [3]

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So as we already said, 71% this quarter for Top 10, obviously without SPSI. And the previous year, we were at 70% with SPSI. SPSI accounted for 23% last year.

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Joseph Wolf, Barclays - Analyst [4]

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Okay, thank you. And then, I guess, the commentary on the large customer ramping into 2017 and the comments on, I guess, a big order in 3Q. Does that mean that they are not taking much product in the fourth quarter? And how should we be -- and so that mix of customers will be slightly different in the fourth quarter?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [5]

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So, I'll say very clearly, first of all, most important thing, this project has been going extremely well, running at very large scale capacity. I visited their facility very recently. It's an amazing project. It's progressing extremely well. It's running 24/7. And as is the case with capital equipment and this has been what I've seen my entire career manufacturing capital equipment, you do a significant intake of equipment and then basically you absorb that equipment and ramp it up. Ink consumption has been huge as well because they're running at the highest productivity possible on the Avalanche 1000.

And Q4 guidance does not include revenues from systems from that customer, which I think demonstrates how strong the business has become, right, because, let's say, so they were a 28% customer in 3Q. We will see obviously ink revenues from them in the fourth quarter, but no system revenues. And then my commentary also said that we see their investments in new systems continuing well into 2017. To finalize that, it's a pause in system intake from them in the fourth quarter, but continued ramp up with other customers is allowing us to provide very good guidance of $31 million to $34 million despite that.

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Joseph Wolf, Barclays - Analyst [6]

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Okay, that's very helpful. And then just a question on margin and mix? And there were no Vulcan sales in the quarter, a lot of Allegro sales, and a little bit it sounds like extra ink. Can you kind of triangulate that in terms of -- you did give the operating margin, but how do you see the fourth quarter shaping up in terms of those three elements? Does initial sales of Vulcan help or hurt the product margin?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [7]

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I mean, initial sales of Vulcan should start showing up in the fourth quarter. It's positioned in pretty good margin, I have to say. As far as system breakdown, you made a comment about Q3, so there were some Allegro revenues in Q3, much stronger Allegro revenues expected in Q4 because you asked about that specifically. And basically what we see in the fourth quarter is continued growth. So there are economies of scale implications that will demonstrate themselves also in the gross margin side. As far as product mix is concerned, we don't provide that on a quarterly basis as you know, but it's robust, it's within the model that we've described, and let's remember this is peak season, so fourth quarter is a very strong quarter always for ink consumption as well. So, to sum all that up, stronger Allegro sales in Q4, initial revenues from Vulcan expected in Q4, and continued growth of the high throughput DTG systems, which represents the largest part of our business still.

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Operator [8]

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Kenneth Wong, Citi.

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Kenneth Wong, Citigroup - Analyst [9]

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Hey, Gabi. So focusing again on large customers, if we were to exclude that one really large customer, any of the other large customers you guys are looking at kind of approaching sort of a 10% of revenue type of a benchmark where -- I think on a normal quarter, they'd be viewed as significant?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [10]

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I wouldn't say that any of them have that level on a sustainable basis as much as this customer, because this customer has a multi-year program in place and the others have quarters where they order quite a few tools and then quarters where they pause a little bit more. So, you will see, with the other larger acconuts, lumpiness, more lumpiness than with this specific larger account? And so it's important that investors understand investment in capital equipment happens in cycles, right. And I think, for me, this is a great sign of maturity that we're starting to see investment cycle. If you remember on maybe some of the previous call we spoke about what's the stage of maturity of our industry? And coming from a different industry as I did, investment cycles had everything to do with technology and people would do a replacement cycle. What we're starting to see here is that the capacity growth -- the need of more and more capacity is very significant, we see people on the one hand increasing capacity, on the other hand many of them also replacing existing older technology with newer systems. So I would say these larger accounts always consume a lot more ink. We said in the past, they consume up to five times more than the normal account, equipment is lumpier.

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Kenneth Wong, Citigroup - Analyst [11]

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And then as we look to Q4, the margins are looking better than I think most were expecting. How much of that is due to gross margins with perhaps less systems flowing through and a lot more ink as customers print products, is that the way we're thinking about it?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [12]

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You're asking -- well, we're not going -- again as I said, we do this on an annual basis. I will say as a qualitative statement rather than as a quantitative one, the fourth quarter is always a very strong ink quarter. I have to say though that I'm extremely impressed by the system ramp up that's taking place at the same time. And I did mention Allegro, we do expect some Vulcan sales and the amount of high throughput DTG systems we're selling now, it's quite significant. In the fourth quarter we have a few very significant customer orders for multiple -- many, many AVK systems. So I think, I would say, business is progressing well on all fronts. And as I mentioned, very importantly, and I've been talking about this for quite a while, we were going to start seeing upgrade revenues in Q4 that I've been talking about for quite a while and it's going to be a lot more meaningful in 2017.

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Kenneth Wong, Citigroup - Analyst [13]

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And then last thing from me, you mentioned the services attached into 12%, can you maybe update us on where we are on that gross margin breakeven and then kind of roughly, what kind of attached do you think we would need to get there to achieve that breakeven?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [14]

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Yes. Service businesses is a function of a variety of things, right, there's service contract, there is time and material, there is part sales, there is training and knowledge transfer and there are upgrades. By far the most lucrative part of the business is selling upgrades simply because the value proposition is very clear, it always will deal with productivity improvement as well as many times much higher quality. Case in point, for instance, going from a Storm II to a Storm Hexa is night and day as far printing capability and also night and day as far as throughput and capacity output.

The implication for the service business is such that we continuously grow the number of service contracts, in our Q4 call, you'll hear another nice significant increase in the amount of service contract versus our installed base, that plays an important part, but I think what's going to be most meaningful to get to breakeven, and I have to say we're not there yet, it's taking a little bit longer, is the transition that we're making out to significant number of our systems being upgradable. So the first round is with the Storm II, you're going to see in the next few months other very meaningful systems that have hundreds of units in the field becoming upgradable as well. I think that will be a significant turning point.

For profitability, in the background as you know, we continue to invest heavily in headcount and infrastructure for service, which turned out to be the right decision, obviously, it increased the breakeven point for service, but at the same time, has allowed us to be the chosen partner for all these big projects, which I have a feeling would be very difficult to do without the infrastructure that we now have.

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Operator [15]

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Patrick Newton, Stifel.

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John Michael, Stifel - Analyst [16]

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Hey, this is John Michael on for Patrick, how is it going?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [17]

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Good. Thank you.

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John Michael, Stifel - Analyst [18]

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So just going back with the large customer, if we normalize the rest of business and backing out that revenue, it seems like growth is decelerated there. So our question there is just what's going on, is there -- is this customer (inaudible) accelerates this issues with providing volumes for other customers, just could you offer color there?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [19]

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Well, order entry during the third quarter was strong and the base business absolutely grew and enabled us to have a good backlog at the beginning of the fourth quarter. But if -- looking at our P&L for the third quarter, our production timing was such that the fulfillment of the large customer order represented most of the quarterly revenue growth. Also as indicated my prepared remarks, the guidance we have provided today included no system revenues from that large customer in Q4 and still, we're able to deliver strong growth.

So the message here is, we're not capacity constrained, order timing obviously influences when you ship systems, meaning is it intra-quarter or do they roll into the next quarter. The backlog that we enjoy now coming into the fourth quarter is meaningful. So there is momentum in the business. So while you could maybe come to that conclusion that the business is not growing because you're judging it by the numbers in the Q3 revenues, actually if I include in that order intake, we are growing and growing nicely beyond that specific customer.

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John Michael, Stifel - Analyst [20]

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And then thinking kind of longer term, if we're looking at kind of Vulcan revenue, how should we think about how Vulcan's contribution should kind of layer onto the model in 2017?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [21]

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We're not yet in a position to say how much. I'll say the following. This is a big investment. Customers are paying over $800,000 for a system, some of them are buying it with multiple years of service contract at a large amount even above that amount of money. Buying decisions are made as a result of an analysis of cost per print and productivity. What we're seeing, which is very encouraging, is that we're already in discussions with one of the three first accounts on a second system order, which demonstrates how excited they are by this.

Other customers in discussions with us are clearly talking about -- this has been a dream, by the way, of displacing screen printing. And so we think that there is a very big potential here, but we also know that given the size of the investment is not going to be available for everyone. It's going to be players that need those more meaningful volumes. So I believe, over the next several quarters, we're going to see an increase in Vulcan sales. Those people that decide to go for Vulcan, it would be hard for me to envision them buy only a single system, simply because this is a transformative way of producing.

But again, it's too early for us to say how much of the revenue but I'm extremely encouraged and remind investors that we are way ahead of the schedule that was actually described in the IPO. So it is progressing well but too early to say how much of our revenue. It does open the fast retail market opportunities that I said, which is no longer just theoretical in a sense that we already see some of our customers fulfilling orders for several brands right now much more than they did before using the Vulcan already, definitely using the Avalanche 1000, but the Vulcan just seems to fit that model so much better.

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Operator [22]

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Jon DeCourcey, Canaccord.

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Jon DeCourcey, Canaccord Genuity - Analyst [23]

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I'm on for Bobby this evening. In light of the SPSI acquisition from earlier this summer, I just wanted to touch on relations that you've had with the other important North American distributors, specifically Hirsch. Have you seen (multiple speakers) relationship?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [24]

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Actually, I have to say for the better and if they're listening, it's a good opportunity to complement them. They're doing a great job, very collaborative, working hard. They represented 25% of our revenues. And think about the revenue base that it now represents, it just shows that they're poised to continue to grow. Also, our new leadership with Gilad Yron as Executive VP coming with many, many years of channel management experience is developing our relationship and making it stronger, as well as relatively newly appointment President of the US Subsidiary, all of which has really contributed to even strengthening the relationship. So I'm actually positively surprised and impressed by how well things are going with them.

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Operator [25]

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Brian Drab, William Blair.

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Brian Drab, William Blair & Company - Analyst [26]

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I just wanted to first clarify going back two callers. I think the comment that has been made, if I heard you correctly, is that if you removed the impact of a large customer, that revenue growth in the underlying business excluding that customer wasn't there -- there wasn't growth. I just wanted to clarify, in the second quarter, that customer accounted for 35% of revenues, is that correct?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [27]

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That's correct.

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Brian Drab, William Blair & Company - Analyst [28]

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And the third quarter is 28%?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [29]

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Correct.

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Brian Drab, William Blair & Company - Analyst [30]

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Okay. If I'm doing the math correctly, then you are up -- from second quarter to third quarter, excluding that customer, you're up 43% sequentially; and from the third quarter to your guide for the fourth quarter, you're up 46% sequentially. So, I don't know if I missed the point of that, but I don't -- does it sound like I'm doing that math correctly?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [31]

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I think so. Again, I'll just reiterate what I said to the other person that asked the question, that while if you look solely at the revenue numbers of Q3, you might come to the conclusion that the business is not growing other than that account. But when I take into consideration something that I haven't presented granted, which is our backlog and our ability to give $31 million to $34 million guidance without them buying any systems, is great indication that the business is actually growing.

As I said before, you do have some lumpiness in system orders, sometimes it's because that's the way a business is set up, sometimes it because this is an extremely sizable project that this large customer is going through. And there are cycles which have to do with facility preparedness, order intake from their side, et cetera, et cetera.

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Brian Drab, William Blair & Company - Analyst [32]

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Yes, okay. I guess it's just a difference between looking at it year-over-year, sequentially. But sequentially the growth looks really good this year. Any sense for when you'll be able to or if you'll be able to talk about who this large anonymous customer is?

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Guy Avidan, Kornit Digital Ltd. - CFO [33]

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Yes. More than likely, we're going to have to mention them in our 20-F or Annual Report, which happens around March time frame.

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Brian Drab, William Blair & Company - Analyst [34]

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Okay. And then on expenses, given that you had SGIA in the third quarter, is it possible to see maybe a step down in selling and marketing dollars without going into fourth quarter?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [35]

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No, we're going to have other shows. We've shows in Asia, so we're not expecting increase in sales and marketing in the fourth quarter.

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Brian Drab, William Blair & Company - Analyst [36]

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Okay. (inaudible) fair to expect it to step-up or be relatively flat in terms of dollars, or any guidance there on that line?

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Guy Avidan, Kornit Digital Ltd. - CFO [37]

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More or less flat.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [38]

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Probably more or less flat, and again I think the important point here obviously is that we're happy to be able to give that guidance of 12% to 16% operating margin. So we think starts to show really nice leverage of what we've done so far.

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Brian Drab, William Blair & Company - Analyst [39]

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One last question, just on the Allegro, it's more just a high-level question. But what applications are you seeing people buying that machine for?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [40]

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Customized home decoration is a very interesting one, also garments and clothes. I'm not sure you noticed when I mentioned and actually I suggest investors to take a look, but that Heidi Klum show really gave us a lot of publicity following work we've been doing with FIT and there it was actually swimwear. So it's been home decoration that's been strong. There is one growing customer that's been doing military applications. There are clothing applications that are taking place. There is baby bedding and there are manufacturers that are actually selling pieces of fabric in order for people to cut and saw them and to create garment dresses or accessories. Also accessories, when I say accessories, I mean small bags and things of that nature, that if you go to some of our customers' website, you will find that they combine garments, mostly T-shirts with pretty cool accessories, sometimes it's a throw pillows and things of that nature.

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Operator [41]

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(Operator Instructions) Jim Ricchiuti, Needham & Company.

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Jim Ricchiuti, Needham & Company - Analyst [42]

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With respect to this large customer and the installed base now that they represent, would this represent one of your largest -- or largest customers from an installed base standpoint?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [43]

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It's coming close to our already existing largest that's been there for a few years and it's going to be exceeding it.

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Jim Ricchiuti, Needham & Company - Analyst [44]

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And again, Gabi, you're anticipating, it sounds like given the fact that Q4 is a very strong quarter for ink consumption, sounds like you are suggesting that this customer should be consuming quite a bit of ink even though they're not taking on new systems this quarter. Is that fair to say?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [45]

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Yes, that's the beauty of this business, you know with the recurring revenue business model as you take on more systems and production volumes are so high that they are doing 24/7, very large ink consumption and one thing again to say is that we expect system orders to resume beginning of next year, we're very much involved and engaged in this project, I'll also mention that this project includes a very significant service contract with on-site people from us that they're working really well, so it's a real textbook ramp-up, I'm very, very proud of what's going on there.

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Jim Ricchiuti, Needham & Company - Analyst [46]

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So you're currently generating service revenue or you anticipate that in 2017 from this customer?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [47]

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2017 from this customer, yes.

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Jim Ricchiuti, Needham & Company - Analyst [48]

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And in terms of new system orders, do you anticipate it's still going to be the Avalanche 1000 or possibly if it's -- go ahead.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [49]

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Or possibly, sorry?

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Jim Ricchiuti, Needham & Company - Analyst [50]

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I was going to say possibly the next generation, I guess is what I'd suggest.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [51]

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For this customer?

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Jim Ricchiuti, Needham & Company - Analyst [52]

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Yes.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [53]

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So the Avalanche 1000 is the tool of record, continues to be.

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Jim Ricchiuti, Needham & Company - Analyst [54]

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And then just maybe turning to Vulcan for a second, is there anything that you're seeing in terms of the pipeline of opportunities, new customer opportunities? Is there any color you can give with respect to either applications or the types of customers? Are we looking at traditional screen printers or say any difference, change in the profile of the customer that you anticipate with these potential new Vulcan orders?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [55]

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Yes. As I've said in the past -- I am happy you asked that question, I've said in the past that we view Vulcan as an expansion of our SAM, our servable addressable market. So the types of customers and I think the first revaluations were a great depiction of what we have in mind, because we've got there, an existing customer who's been fulfilling for himself with few dozens of DTG systems from us, now has a Vulcan added to that because he wants to use the Vulcan for larger order quantities that he gets, a second one is one that's fulfilling for other websites and also started working with significant brands.

A third one is the proprietor of multiple very significant brands, that one is definitely looking to displace screen printing. By the way, the first and the second customer are gradually moving away from screen printing as well. The new order for a four-system we just got a few days ago is for a full screen printing facility who is just waking up to what this offers him and we are in active discussions with several other brands that as this thing moves forward, they're starting to find that this is an amazing opportunity, not just because of productivity but cost per print that we're delivering is meeting what we had said before, 40% to 50%. Cost reduction starts becoming very interesting. I mentioned that today we're filing, by a way of 6-K, a new presentation. I urge investors to take a look at that presentation, because I believe that it provides a really useful analysis of what goes on in the market. And in that presentation, we also talk about the addressable market and what's happening there, and how we're expanding the addressable market as a function of our offering. So I think, Jim, that would also provide quite a bit of information and happy to discuss that in a separate call and walk you and any other investors that are interested through the main points in that new investor presentation.

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Operator [56]

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(Operator Instructions) Joseph Wolf, Barclays.

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Joseph Wolf, Barclays - Analyst [57]

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Just one quick follow-up question. If you look at the commentary about ink consumption and the take rate from this large customer. If you go back and consider what you kind of provided about a year ago in terms of the annual ink consumption on a machine in terms of dollars of ink versus the cost of the machine. how is this customer playing out in terms of -- is that ahead of plan, or is it right in line with what you expected for the Avalanche?

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [58]

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So, if you remember, in the past, we spoke a lot about the fact that depending how mature a customer is, they will take time to ramp up ink consumption. This customer prepared themselves so well that they hit the ground running. And after a very short amount of time and this is several months ago, we're using the system already at capacity. So the amount of ink they're consuming is on the highest level than we see for many customer, simply because they do an amazing job, managing the routines, the site, the knowledge, et cetera, et cetera.

And again just to remind those investors who don't remember, on an annualized basis, our business has trended around 60% systems and services, and about 40% inks and consumables. And as we said in the past, they will oscillate in one or other direction in various quarters, right.

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Operator [59]

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And at this time, I'll turn the call back over to Gabi Seligsohn for any additional or closing remarks.

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Gabi Seligsohn, Kornit Digital Ltd. - CEO [60]

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Thank you, operator. I want to thank everyone for attending today's call. As you can hear and you understood, we're in a very exciting time in our business, business continues to grow quite robustly, a very strong second half of the year, and look forward to meeting all of you on our next conference call. Thank you.

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Operator [61]

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Thank you. And that does conclude today's conference. Thank you for your participation. You may now disconnect.