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Edited Transcript of KRNT earnings conference call or presentation 18-Nov-19 10:00pm GMT

Q3 2019 Kornit Digital Ltd Earnings Call

Rosh- Ha Ayin Nov 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Kornit Digital Ltd earnings conference call or presentation Monday, November 18, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Guy Avidan

Kornit Digital Ltd. - CFO

* Ronen Samuel

Kornit Digital Ltd. - CEO & Director

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Conference Call Participants

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* Brian Paul Drab

William Blair & Company L.L.C., Research Division - Partner & Analyst

* Christopher Paul Moore

CJS Securities, Inc. - Senior Research Analyst

* Danny James Eggerichs

Craig-Hallum Capital Group LLC, Research Division - Research Analyst

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Jim Suva

Citigroup Inc, Research Division - Director

* Peter A. Zdebski

Barclays Bank PLC, Research Division - Research Analyst

* Thomas Cook

ICR, LLC - VP of IR

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Presentation

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Operator [1]

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Greetings, and welcome to the Kornit Digital Ltd. Third Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Tom Cook. Please go ahead, sir.

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Thomas Cook, ICR, LLC - VP of IR [2]

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Thank you, operator. Good afternoon, everyone, and welcome to Kornit Digital's Third Quarter 2019 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 our 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 26, 2019, which identify specific risk factors that may cause actual results or events to differ materially. Any forward-looking statements are made as of this call hereof, and the company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events 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 release published today, which is posted on the company's Investor Relations site. On the call today, we have Ronen Samuel, Kornit's Chief Executive Officer; and Guy Avidan, Kornit's Chief Financial Officer. At this time, I would now like to turn the call over to Ronen. Ronen?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [3]

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Thank you, Tom. Good evening, and thank you for joining our third quarter 2019 earning conference call. Today, I will provide a brief summary of our strong performance in the quarter, followed by some key business updates as we continue to execute on our short- and long-term strategy. I will then hand over the call to Guy to cover our financials.

We are excited to report our third quarter results marked a record quarter for Kornit in industrial system sales and continuation of the strong momentum we have demonstrated all year. We continue to revolutionize the fashion, apparel and home décor markets by fueling the transition to on-demand and sustainable digital manufacturing, and I'm very pleased with the progress we are making with our sports strategy.

Revenue in the quarter was $44.6 million, net of $5.1 million of warrants related to a global strategic account. As a reminder, our guidance policy assumes 0 impact from warrants. This period, we experienced a significantly larger warrants impact of $5.1 million compared to $1.7 million in the prior year, resulting from an increase in business volume with a global strategic account and a higher share price.

Overall, our third quarter business volume grew 26.7% during the period, driven by strong adoption of our recently introduced Atlas, Polypro and Presto systems and continued adoption of our HD platforms.

During the quarter, we sold multiple Atlas and Polypro system, as our strategic customer adopt these new platforms in preparation for the peak holiday season, positioning us well for a peak consumable revenue as these systems ramping up for full capacity. We see new strategic customer, including leading brands, increasing their focus on partnering with us as they transition to digital production. This led, for example, to new wins with the key players in the athleisure market and the beginning of partnership with one of the largest specialty use apparel retail brands in North America. I'm particularly proud to report on the phenomenal feedback we continue to receive from customers on our next-generation DTF system, the Presto. The Presto is a market-leading single-step solution, which features our best-in-class ink and the ability to print at high quality on wide range of fabrics. We recently announced an important win with OnPoint Manufacturing, an innovative leader in on-demand personalized apparel manufacturing, which adopted the Presto, and we believe we will be able to disclose important new adoption of the Presto in both fashion and home décor environment in the quarters to come.

Last month, we held a live showcase of the Presto, together with an ecosystem of partners, where we demonstrated end-to-end microfactory in an unique industry event in New York City. This milestone event is the first time we brought the microfactory concept from vision to reality. We believe textile manufacturing will adopt Industry 4.0 principle and commits technology is an essential component to the feasibility of automation, while the microfactory enhances the economies of proximity manufacturing.

Turning to our regional performance. Our business grew year-over-year in all 3 of our geographies. In Americas, we posted a record quarter as the result of a new customer acquisition and expansions within existing strategic accounts, including very strong volume from a global strategic account. In EMEA, we continue to see good demand as we convert pipeline associated with ITMA Barcelona last June. And our performance in the Asia Pacific region was primarily driven by good momentum with key accounts in Japan. To that end, we announced the installation of 2 Polypro systems at a Tokyo-based customer, Image Magic. This is an existing customer that serves a mix of corporate clients, including some of Japan's leading apparel brands and general consumer via an e-com sales model. The installation of the Polypro expands Image Magic's DTG capabilities to print on polyester and polyblends fabrics and significantly improves the efficiency of the operations.

During the third quarter, we attended over 20 regional and specialized shows across the globe, resulting in an impressive increase in leads and opportunities. We also continued our successful roadshows activities across North America, where we bring our technology to centralize and accessible location for prospective customers to experience.

Last month, we participated in PRINTING United, which took place in Dallas this year. While some industry peers reported low overall traffic at the show, our booth was busy, and it was one of our most successful PRINTING United shows, which translated to orders and letter of intent received for our wide range of systems. At this event, we showcased Kornit Konnect, our powerful cloud-based softwares analytics platform, which was introduced last June. This was the first time we showcased the software in a large North American show, and our customer and prospect were excited to learn about the productivity benefit that can be delivered to their operations.

At the event, we also showcased the Presto, Polypro, Atlas and Storm HD systems and exhibited another live production in collaboration with Adidas. During the quarter, we were very active in strengthening our global workforce, adding 31 new team members, many of which are in customer-facing functions. In addition, today, we are also formally announcing some exciting enhancements to our corporate structure around 2 main themes: customer success and scalability. First, we are strategically realigning our business with all regional presidents reporting directly to me, and now parts of the company's executive management team. This brings the voice of the customer across region closer to the day-to-day focus of the entire executive management team and will improve cross-functional alignments as we continue to scale the business. Second, we are also increasing our go-to-market focus by adding dedicated teams across fashion, sports and online customized design. We believe this will be a boost to our business as we continue to shift from equipment provider to a strategic solution provider and partner with the world's leading brands. As part of this organization alignment, after almost 4 successful years with Kornit, Gilad Yron, our EVP Global Business, will be leaving Kornit. The strong business and go-to-market infrastructures that we are now scaling is a product of his hard work in the last few years, together with the very strong teams he has built, and we are grateful for his contribution and leadership. Gilad will be transitioning his current day-to-day responsibilities by December 31, 2019, to assume a few strategic initiatives for Kornit until his final departure in April next year. As we focus on scalability, we are creating a new Chief Commercial Officer function, and a few days ago, we welcomed a seasoned executive for our team, Mrs. Jecka Glasman, will assume responsibility for all our customer success function, including service, support, pre- and post- sales. Jecka will also assume responsibility for managing our global strategic accounts team and will be responsible for global sales operation with scalability in mind. Jecka's vast international experience in operations, sales, product distribution and customer service across multiple industries will be a huge asset to Kornit. As part of this important alignment, I am also pleased to announce that we have elevated Kobi Mann, our VP of Consumable and Application, to the newly created position of Chief Technology Officer, alongside his current responsibilities. As 1 of the first employees of Kornit, and an industry guru, Kobi is uniquely qualified to lead this effort, and we are grateful for his years of service and expertise. In total, we believe these alignments will strengthen our company as we continue to focus on customer success and scaling our business and operations.

To summarize, with just a couple of months left in 2019, we are in a very strong position to deliver on all the goals we laid out last fall. We are growing in line with our long-term goals, our new product introduction are enjoying widespread of adoption. We are penetrating new markets and leading brands. And have enhanced our managerial go-to-market and operational platform to scale the business. We are also making progress on adding adjacent products, services and software solutions like the Kornit Konnect, and have been very active in identifying a pipeline of M&A opportunities that can expand our value proposition. The combination of all these factors leaves us well positioned to deliver on our business goal of being a $500 million run rate business by the end of 2023.

I want to thank all our customers and investors for the confidence and loyalty to Kornit and our global workforce for their hard work and dedication to our collective success. Now I will turn the call over to Guy for a closer look to the numbers and our guidance.

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

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Thanks, Ronen, 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 adjustments for the following items: stock-based compensation expenses totaled $1.8 million; total amortization expenses relating to the acquisition of intangible assets in previous years in the amount of $249,000; taxes on income related to non-GAAP adjustment in the amount of minus $62,000; and noncash deferred tax benefit in the amount of minus $347,000; amortization expenses relating to the acquisition of Hirsch's intangible assets of $78,000. The company has significant operating lease liabilities in foreign currencies, and incur foreign exchange gains or losses from the reevaluation of these liabilities. These gains and losses may vary from period to period, and do not reflect the true financial performance of the company. This quarter, foreign exchange losses associated with ASC 842 were $242,000. A full reconciliation of our results on GAAP and non-GAAP basis is available in the earnings press release issued earlier today and on the Investors section of our website.

Third quarter revenue, net of the $5.1 million warrant impact, increased by 18.6% to $44.6 million versus $37.6 million in the third quarter of 2018, and increased 1.6% sequentially. Third quarter business grew 26.7% year-over-year and 7.4% sequentially. Revenues grew to record level this quarter, driven by robust demand for our new high throughput product and strong demand from our strategic and global partners, especially in North America.

Services revenues from the third quarter were $3.9 million, net of $0.2 million warrants impact, accounting for 8.7% of total revenues. The decrease in revenues of 8.3% year-over-year and 35.6% sequentially, was predominantly driven by lower revenues from upgrade to HD technology. The noncash impact of warrants in the third quarter was $5.1 million or 10.3% of revenues, $1.7 million or 4.2% of revenues in the third quarter of 2018, and $2.4 million or 5.2% of revenues in the second quarter of 2019. The sequential increase in warrants impact was mainly attributed to higher share price, higher revenues from Amazon and accelerated vesting. Details of the warrants impact on revenues and margin for this quarter versus the prior quarter and the previous year are included in Slides #17 and 18. Additional information regarding the Amazon warrants agreement is available in Slide #19.

By geography, 61% of our sales were from the Americas, 27% from Europe, the Middle East and Africa and 12% from the Asia Pacific region. As in previous quarters, the America remain our largest territory. Asia Pacific revenue in the third quarter showed continuous impressive growth of 51% year-over-year and 60% in the 9 months of 2019 over the prior year period. EMEA revenue increased by 2% over the prior period and increased 8% sequentially.

Moving to customer concentration. We continue to diversify our customer base, driven by the success of our go-to-market transition as we go direct to our customers. This quarter, we had 2 strategic customers that exceeded 10% of revenues. A global customer contributed 15.3%, and another strategic customer contributed 12.9% of our overall revenues compared to 19.8%, and 1% in the prior year period. Our top 10 customers accounted for 53.6% of our overall revenue compared to 60.2% in the prior year period.

Moving to profitability. Non-GAAP gross margin in the quarter decreased to 44.5% from 51.1% in the prior year period and 45.9% in the second quarter of 2019. Lower margins this quarter versus the third quarter of 2018 were mainly the result of $5.1 million or 574 basis points warrant impact. On a GAAP basis, gross margin in the quarter was 43.8% versus 50.3% in the prior year period and 42.5% in the second quarter of 2019. Due to annual seasonality, we expect the fourth quarter versus third quarter product mix to lean more towards ink and consumables.

Moving to our OpEx items. I'll discuss this item on a non-GAAP basis, which exclude nonoperating charges previously mentioned and highlighted in our GAAP to non-GAAP reconciliation included in today's press release. Adjusted research and development was 11.8% of sales or $5.3 million compared to 12.8% of sales or $4.8 million in the prior year.

In the third quarter of 2019, we capitalized certain qualified software development costs related to external vendors and independent contractors in the amount of $0.2 million. We expect additional $0.3 million software development cost capitalization in the fourth quarter of 2019. Sales and marketing expenses in the quarter were $7.1 million or 16% of sales compared to $5.9 million or 15.7% in the prior year period. The increase was driven by additional headcount.

General and administrative expenses in the third quarter were $4 million or 9% of sales compared to $3.6 million or 9.6% in 2018. Headcount as of September 30 was 515 employees, 31 employees more than the previous quarter. The growth in headcount is mainly attributed to operation functions, engineering and customer support to strengthen our infrastructure. Non-GAAP net income for the third quarter was $3.9 million or $0.09 per diluted share, net of $0.12 warrants impact, an increase of $0.9 million versus the prior year. Non-GAAP diluted earning per share without warrant impact increased by $0.02 over the previous year period. GAAP net income was $2 million or $0.05 per share on a diluted basis compared to net income of $3.1 million or $0.09 per share for the year-ago quarter. Non-GAAP financial income this quarter was $0.8 million as a result of accrued interest of cash investments. GAAP financial income this quarter was $0.6 million. Cash balances, including bank deposit and marketable securities at quarter end were $250.4 million compared to $110.9 million as of September 30, 2018.

Next I'll discuss our adjusted EBITDA. For the third quarter 2019, adjusted EBITDA was $9.5 million compared to $7.5 million for the third quarter of 2018, an increase in adjusted EBITDA of $2 million. Net cash used in operating activities was $20,000 this quarter compared to $4.4 million in the second quarter, and net cash provided from operating activities of $11 million in the third quarter of 2018. In the third quarter, DSO was higher than the previous quarter. And we expect it to return to normal levels in the fourth quarter.

Turning to our guidance for the fourth quarter of 2019. We expect revenues to be in the range of $46.5 million to $50.5 million, and non-GAAP operating income to be in the range of 14% of revenues to 17% of revenues. As has been our practice in the past, these numbers assume no impact of fair value of issued warrants in the fourth quarter of 2019. As a reminder, the calculation of warrants fair value is based on the combined effect of: estimation of future revenues from Amazon; future Kornit share price in unknown dates; future stock volatility as well as other variables that currently are not predictable, and some of which have no correlation to our business. Since as of today, we are not able to predict these variables, we assume the warrant impact at 0 value for guidance purposes only. I'll now turn the call to Ronen.

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [5]

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Thank you, Guy. Now we are ready to open the call for questions from the audience.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Tavy Rosner with Barclays.

Your next question comes from the line of Brian Drab with William Blair.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [2]

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Congratulations on another good quarter. Just on gross margin, I'd like to just make sure that I understand the dynamics here and see if you could add any more color. So you said mix was a headwind in the quarter. I'm wondering why we would be down still 300 basis points year-over-year. If you also have the positive effect of going direct and taking Hirsch out of the mix, that should be about a 300 basis point tailwind. So if you adjust for that, gross margin is down even more, 500, 600 basis points year-over-year. And I'm wondering if you could just talk about how significant this mix shift is? And specifically, are you seeing degradation in gross margin in systems? Or are you seeing degradation in gross margin in consumables at all?

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Guy Avidan, Kornit Digital Ltd. - CFO [3]

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So as we said in the previous call that we expect that the second half of the year to be above 50%, and we were above 50% without the warrants impact. We mentioned before and we still faced it in the last quarter, we launched 3 new product and gross margin is not perfect from this product yet due to ramping up. We mentioned the fourth quarter, in terms of product mix, as usual, due to seasonality. The fourth quarter is characterized with more ink, and as a result, we expect gross margin to behave better.

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [4]

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Just to add 1 more comments. Looking forward, we see gross margin improving as we discussed on previous calls, so we continue to sell more high-end products. So the mix is favorable in terms of gross margin, and we can see the growth coming also from impressions on the supply side, expecting in future quarter to see an improvement on the gross margin above the point that we are today.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [5]

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Okay, got it. And then just to clarify, the new products and their impact on the gross margin, I was under the impression that the Polypro would be pretty immediately accretive, or a tailwind to gross margin. And isn't it the Atlas and the Presto that are weighing on gross margins somewhat as those ramp?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [6]

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The main issues on the growth side is more on the ramping up of those systems. So it's more on the service and support side. And this is why you see the impact on the service side, which impact overall gross margin. So it's less on the -- it's not on the income there and on the hardware, a bit on the hardware because we are still ramping up the production on all those 3 machine, but it's more on the service and support side.

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Guy Avidan, Kornit Digital Ltd. - CFO [7]

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Eventually, as we've said before, Brian, each product, we carry higher gross margin than the product before the Atlas will carry a higher gross margin than the Avalanche and so is the Presto versus the Allegro. As mentioned, it takes some time to ramp up.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [8]

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Okay. And just my last question, just to be clear, the Polypro then, in terms of gross margin on the system itself, is not in line with or it's below the average gross margin for your systems? Is that fair as it ramps?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [9]

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No.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [10]

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No? So that is -- the Polypro's already above?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [11]

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Yes, correct.

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Operator [12]

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Your next question comes from line of Tavy Rosner with Barclays.

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Peter A. Zdebski, Barclays Bank PLC, Research Division - Research Analyst [13]

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This is Peter on for Tavy. I apologize for the technical difficulty earlier. My question was around strategic accounts. And specifically, the seasonality now that you have more accounts in the mix, especially large ones, how should we think about the prior seasonality in the fourth quarter, in terms of mix of systems and consumables?

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Guy Avidan, Kornit Digital Ltd. - CFO [14]

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So we have seasonality, and we see it very clearly this year that our strategic account ordering system, mainly in the second and third quarters. So we hardly will see as any of our top strategic ordering in the fourth quarter, so it's more medium-sized and small-sized account at ordering systems in the fourth quarter. However, the fourth quarter is always the peak season for our entire installed base and definitely for our key strategic accounts, and so we will see a mix -- favorable mix into the supplies, an overall impression from our installed base in Q4.

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Peter A. Zdebski, Barclays Bank PLC, Research Division - Research Analyst [15]

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And if I could have a follow-up. Is that -- should we expect that to filter through on the services side?

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Guy Avidan, Kornit Digital Ltd. - CFO [16]

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On the services side, we expect normal behavior during the peak season. Nothing special.

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Operator [17]

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Your next question comes from the line of Greg Palm with Craig-Hallum Capital Group.

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Danny James Eggerichs, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [18]

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This is Danny Eggerichs on for Greg today. Just starting with Amazon revenue. I guess, just the breakdown, I was wondering if any of that revenue this quarter was from system contributions? And if there was, was that a result of existing facility expansions or possible new facility openings? Just a little color there would be helpful.

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [19]

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So as you know, unfortunately, we cannot relate with specific customer business and mix between hardware and supplies. Our business with all the strategic accounts, specific with the global strategic account is very, very strong. You can see it with the warrants as well, the impact on the warrant. It's -- the relationship is as best ever, and we see great momentum moving forward.

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Danny James Eggerichs, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [20]

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All right. And then, I guess, looking back at the 3 big product introductions earlier this year. I guess, just breaking it in 2 categories. How much of that revenue has been driven by existing customers? And I guess, and how much is that, of that has come from new customers? And how are you kind of seeing the adoption and ramp-up of those new systems differ between those two?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [21]

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It's a great question. I don't know the exact number. What I would say, it's about 50-50 between existing to net new. And the difference is with the Polypro and the Presto, I would say, it's more tending into net new customers that we are penetrating, net new brands that we are penetrating, some of them big accounts, some of the midsized accounts, but we see the shift into net new accounts. On the Atlas, I would say, it's more tempting into our current installed base that now adding additional capacity but we see also net new that's starting with the Atlas as well.

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Danny James Eggerichs, Craig-Hallum Capital Group LLC, Research Division - Research Analyst [22]

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All right. And then just last one for me. In the APAC region, are you seeing any impact from the macro volatility going on in the Hong Kong region? I'm not sure if you can quantify of how large that area is in the APAC region, if you are seeing any impacts?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [23]

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So our main business in Asia Pacific currently is focused on Japan, South Pac, Korea and China, of course, less in Hong Kong, while we have the headquarter in Hong Kong, our business is outside of Hong Kong. So we don't see an impact directly on our business. We do have impact on the team, of course, in Hong Kong, and we are taking care very closely on what's going on there and contact with our team there and supporting them. We see a very, very nice growth coming out of Japan, and we see a real adoption, both for our new products, like the Polypro and the Atlas, but also the existing product.

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Operator [24]

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Your next question comes from the line of Jim Suva with Citigroup.

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Jim Suva, Citigroup Inc, Research Division - Director [25]

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Could we just revisit the topic a little bit about the margin pressures and the product ramping? And maybe it's just because I'm not the smartest person on this call, but if you could help me understand that the pressure is kind of like the duration that we expect the pressures and the margin are ramping? Is it kind of like 3 quarters? Or as we think about they're kind of always constant where you're always inventing and having new things come on, so why wouldn't it be kind of more steady state about ramp headwinds and then layering off of efficiencies?

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Guy Avidan, Kornit Digital Ltd. - CFO [26]

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So it's not a margin pressure due to competition. We mentioned that before that we will see a gradual increase in gross margin. We said it's going to be above 50% in the second half. And we also mentioned in the fourth quarter due to seasonality, we expect even better gross margin. Not every year, we launch 3 very material product, and the gross margin relative decline here is actually due to cost of good, not revenue.

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [27]

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But we already see an improvement, for example, on the cost of goods on the Atlas, and we will start to see the positive impacts, and the Atlas is -- we are selling it in big quantities. So we will start to see an improvement in gross margin in the coming quarters.

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Operator [28]

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Your next question comes from the line of Patrick Ho with Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [29]

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Ronen, it's encouraging to hear the new customer traction for a lot of new products, which I think highlights the ability to grow the top line over the next several years. Can you give a little bit of color on the type of buys? And what I mean by that is, are these new customers buying maybe 1 or 2 systems initially to try, I don't want to say evaluate the system, and you'll see these multiple system buys down the road as they increase capacity? Or are they really starting off at a kind of multiple system buys once they see the product?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [30]

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So there's no 1 clear answer for that. It's different from customer to customers and from segment to segments. If you're referring specifically to the brands, what we can see on the brand side, we see big-sized brands, really the biggest sized brands and also the mid-sized brands going into on-demand manufacturing, needing Kornit solution, working very, very closely with us. Usually, those brands are starting with a few system, 1 or 2 system, evaluating, starting a pilot, and then they're going to full capacity and growing. So we are in a stage with different brands in different evaluation. Some of them moved already to full production and are scaling up, some of them in early stage of evaluation. As for customers, there's all kinds. We have the example in Japan that I mentioned. It's a new customer that is focusing on polyester and started with 2 Kornit Polypro. We see customers that are starting with multiple Atlases. But usually, they're starting with 1 or 2 units, taking it for about 6 months up to 1 year, scaling the business and then increasing capacity.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [31]

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Great. That's helpful. And maybe as my follow-up question, given your strong growth in the Asia Pacific region, is it coming from any 1 specific product where you're really seeing strong traction? Or is it very broad-based across all your product lines?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [32]

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It's across, I would say, all product line. More on the midrange, more on the Avalanche HD. The Avalanche HD has a great traction in Asia Pacific. The Polypro, specifically in Japan, is doing fantastically. We start to see more adoption of the Atlases across Asia Pacific, so it's all of our product portfolio.

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Operator [33]

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Your next question comes from the line of Jim Ricchiuti with Needham Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [34]

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Just a question on the service business, and thanks for a little bit of color on that. The decline that you're seeing, I mean, clearly, you had a strong comparison a year ago. But the HD upgrade? I mean, how should we think about the service business and the profitability that you're trying to achieve in that area? It sounds like there are 2 factors: number one, on the revenue line; but also number two, on the fact that you continue to have to increase sales and support. So as you guys have talked about targeting, bringing that business to breakeven, when do you see that occurring?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [35]

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As we said in the past, we still expect breakeven in services mid-2020.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [36]

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Okay. Question on the brands. And I know you can't disclose customer identities in most instances, but is there a way for you to give us a better feeling for how many of the brands you've penetrated thus far, whether it's in this past quarter or year-to-date? Any color along those lines would be helpful, because it does sound like you're getting traction both with Atlas and Polypro with the brands.

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [37]

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So I can say that we really have a great traction with brands, and this is only the starting point. I cannot relate to specific numbers and names other than Adidas that we already mentioned. This is the second time that we are doing demonstration, live demonstration, together with Adidas and the second time we did it now in united print a month ago. But with, as I mentioned before, we have mid-sized brands that buying out our equipment, we have big-sized brands that some of them buying themselves and some of them working with their fulfillers directly with us buying our systems, so there's a lot of tractions. I can tell you that we are working in parallel on multiple projects, exciting projects on a global base.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [38]

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And if I may, last question for me. In Europe, it looks like in the EMEA region, you showed growth, but it was -- it looks like fairly modest. And I'm wondering if you're seeing any sign of any kind of macro related weakness that might be resulting in some hesitancy on the part of customers there?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [39]

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So actually, we see a very nice growth in Europe. It was something that, misleading last year, the same quarter, we have a big deal with a global account in Europe, that this is the reason why you don't see year-over-year. It was a very strong quarter for us last year. Overall, the business in Europe is doing very well. We recruited a very strong, talented team there. We have the momentum out of ITMA. The funnel looks strong, entering Q4 with a strong pipeline, so we feel very comfortable, confident about our European business. And we don't feel slow down like in other industries.

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Operator [40]

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Your next question comes from the line of Chris Moore with CJS Securities.

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Christopher Paul Moore, CJS Securities, Inc. - Senior Research Analyst [41]

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Yes, maybe more of a big picture question. I mean, 2019, obviously, has been an exceptional year of rolling out new products and platforms. When you look at the $500 million run rate goal for 2023, does it assume additional -- significant additional new product rollouts? Or does the kind of existing base really get you there?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [42]

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So first of all, we are tracking, as you mentioned, 2019 very well on a direction for the $500 million run rate in 2023. And at this point of time, we feel very confident that we will continue this traction in the coming years. The growth is coming from different areas: One is from the current new portfolio that we just released. We're just starting the growth on the Atlas. We're just starting the growth on the Polypro and the Presto, we just released it, and we have great, great traction on the Presto. So each of those products will bring growth. Of course, we will continue to innovate and bring new products and new solution to different markets in the coming years. So we are building the growth also on new systems that will come in the coming years as well. Major growth is coming from new segments that we are entering. The brands are a big, big growth engine for us. Working directly with the brand now, we can really suit, we have a solution that meet the needs for the brands. We can see all the brands are moving to on-demand manufacturing, they are talking about it, all of them are talking about a sustainable production and the way to do on-demand in a sustainable way is really using digital manufacturing and Kornit is the only solution that they have today in the marketplace, so this is a major growth for us. Also penetrating the polyester, which is 20% of the global apparel market is about -- is polyester, so this is a new market for us. And we continue to see a huge growth from the online segments. We can see new players are coming into the online and existing player growing really, really fast, both on the global strategic account, but also mid-range key accounts that are growing very, very fast on the online production. And the last segment is promotional items, we can see as well their growth penetrating to net new screen printers, but focusing on the promotional item. This is another growth engine. On top of all of that, we, of course, working very hard on workflow and other solutions as we are bringing around our systems. And we will start to see growth in this direction in next year. And the last point is really the growth of coming from expansion of our teams, feet on street, we were a very, very smooth team, selling the Presto or selling the DTG. Now we are starting to have much better coverage. We're still missing coverage in many potential, big potential territories, and we will continue to expand our team and services and the growth will come also from geographic expansion.

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Operator [43]

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(Operator Instructions) Your next question is a follow-up from Brian Drab with William Blair.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [44]

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I'm going to take a quick break for e-mailing back and forth with the data aggregators, trying to clarify what your real earnings result was, about 20 e-mails back and forth already regarding the warrants. Mike, last question is just, if you look at next year, because I know that that's the third quarter call, but I mean it's November, and we're all trying to model 2020. So far, since you announced, Ronen, the target of the $500 million, and that requires 25% to 30% revenue growth, you're delivering on that, and if you were to do that in 2020, which I assume is roughly the plan, what kind of growth rate would you expect for operating expense, just relative to revenue growth? Is this a year 2020 when revenue growth will far exceed operating expense growth as those level off? Or is that investment in the team going to continue significantly into 2020?

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [45]

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So Brian, first, as you know, we're talking about next quarter only. But since you mentioned the warrant before, so just to let you know that November 2019, actually, very recently, Financial Accounting Standard Board, the FASB, issued final guidance that require entities to measure and classify SBC, share based compensation, that are granted to customers in conjunction with revenue arrangement and are not exchange for distinct good and services in accordance with ASC 718. What it means actually that it's going to be much easier for us and for you guys to predict the warrants impact in the future. This new standard is actually going to be effective next year, but management can have an early adoption. It is permitted based on the ASC 718. And obviously, we will give more data in the future regarding the warrants, we will be able to discuss OpEx of 2020, leverage and other things in the next call.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [46]

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Okay. You can't -- you won't even go directionally above or below revenue growth at this point? Sorry to push on that, but would be helpful.

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Guy Avidan, Kornit Digital Ltd. - CFO [47]

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As Ronen mentioned, when you look back and when we guided for 5, $500 million, you could imagine some CAGR. And this quarter, the CAGR was about 26%, which means we're on track or above track, actually. And that's the plan.

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [48]

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As for the OpEx, as we mentioned in the past, we will continue to grow to the $500 million run rate in 2023, while improving our gross margin and improving our operating profit, okay, during this period. So you should see continued improvement on the operating profit as well.

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Operator [49]

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Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Ronen Samuel for closing remarks.

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Ronen Samuel, Kornit Digital Ltd. - CEO & Director [50]

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So thank you, everyone, for joining on today's call. Again, I would like to thank all of our employees for their hard work and dedication. And our customers for their continued support. And finally, for our investors, for the trust they have in Kornit. I look forward to updating everyone on our fourth quarter call, and I wish you have a beautiful and good evening. Thank you very much.

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Operator [51]

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This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.