Kornit Digital Ltd. Q1 FY2021 Earnings Call

Greetings. Welcome to Kornit Digital Limited First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I would now turn the conference over to your host, Monica Gould, Investor Relations for Kornit Digital. You may begin.

Thank you, operator. Good morning, everyone, and welcome to Kornit Digital's first quarter 2021 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 on March 25, 2021, which identifies 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 website. I will now turn the call over to Ronen Samuel, Kornit's Chief Executive Officer, and Alon Rozner, Kornit's Chief Financial Officer.

Thank you, Monica, and thank you all for joining us this evening on our earnings call. I'm excited to share with you a strong start to the year and outstanding first-quarter results. We significantly exceeded our guidance on top line and profitability, and our outlook for the year is very strong. As the world moves into the post-pandemic era, the textile industry is in desperate need to accelerate its digital transformation and mass adoption of digital sustainable on-demand production. The business opportunity ahead of us is enormous. And we are laser-focused on introducing continuous innovation and scaling our business on all fronts. Our first-quarter results are another step on our path to becoming a 500 million revenue run-rate business ahead of plan. Total revenue increased by 152% year-over-year to 66.1 million, net of 3.1 million in warrants related to a global strategic account. We experienced another record quarter of shipments for mass production systems spearheaded by the Atlas and the Presto. Our recurring consumable business continues to scale, and we continue to outperform our profitability goals on services. During the second half of last year, we discussed engagements on major global expansion projects with multiple strategic accounts, which we are now rolling out. In March, we announced that Printful will purchase more than 50 Atlas systems during 2021 as part of its global expansion plan, and the rollout began this quarter. As an early adopter of Kornit technology, Printful has grown from a small print operation in their merging customer design segments to become a global leader in taking digital creative concepts and making them real. Their growth demonstrates the overwhelming potential of digital transformation by creating a mega marketplace that empowers digital natives to conceive and scale their brands. We are proud to help Printful reach the next stage of their journey. We are witnessing parallel expansion goals across our key strategic accounts. As an example, we expanded our partnership with a leading supplier of licensed and private-label apparel, which produces uniquely designed clothing for some of the largest gaming licenses, TV studios, and mega retailers in the world, and they are experiencing tremendous growth. This supplier added eight new Atlas systems to its fleet this quarter and expects continued growth in the coming years. As for our global strategic account, the execution remains very strong as we move into the accelerated implementation phase of their ambitious global expansion plans. We delivered a record number of Presto systems in the first quarter, doubling shipments sequentially from the fourth quarter. Our recurring DTF consumable business has almost tripled from the fourth quarter, and we're very encouraged by this momentum as we continue to build Kornit brand recognition in the heart of the fashion and home decor industries. The Kornit of this fashion week was a tremendous success. More than 40 designers showcased how diversity and individual expression can be enriched and celebrated hand in hand with a vision of a more sustainable world. While the event was focused primarily on building awareness, the business momentum this event created is remarkable, and we look forward to the global rollout of this initiative in top fashion capitals globally. Last week, we shared our exciting partnership with mega online brand and retailer ASOS and its supplier Fashion Enter UK as part of ASOS's fashion with integrity corporate goal. As part of this partnership, joint teams are implementing Kornit end-to-end workflow to enable micro-factories to react quickly to seasonal shifts in demand and establish a more efficient, low-impact, sustainable production process. We expect this partnership to expand into a mega online brand. The scaling of our new software workflow business line is progressing very well, and we are engaged in strategic activity with brand licenses and mega online marketplaces, existing fulfilled orders, and new logos of all sizes looking to leverage our unique cloud-based software workflow platform to adopt a digital native supply chain for on-demand textile production at a global scale as well as automate the production flow. In Q1, we significantly overachieved our internal targets for new and existing Kornit customers adopting our workflow solutions. Our pipeline continues to grow as customers of all sizes embrace the strategic value of our offering. Two weeks ago, we made our first strategic new product announcement of the year with the launch of our Max technology, which establishes a new standard of on-demand fashion and apparel production. The Max technology delivers unparalleled retail quality combined with our revolutionary XDi 3D printing capabilities for new high-density graphic decoration that can replace embroidery, vinyl, and heat transfer analog processes in a single waste-free digital process. We also introduced our new patent-pending robotic automation technology to significantly ease the burden of manual labor and increase productivity. The Max technology dramatically expands the reach of digital on-demand textile production into the center of mainstream fashion and apparel and significantly expands our addressable market into lucrative segments like professional team sports, high-end athleisure, and diverse categories of fashion wear. The first product from the Max line is the carbon-neutral Atlas Max, which is commercially available with deliveries starting in June, and initial revenue contribution anticipated in the second half of the year. The Atlas Max is delivered with the new XDi 3D technology built-in, and an upgrade to the Kornit Atlas systems will be available during the first quarter of 2022. This is just the beginning of revolutionary new products coming from the Max line, which will unlock additional massive and exciting market segments for Kornit. In summary, with an exceptional start to the year, our backlog continues to grow. In our last quarterly earnings call, we discussed that we expect to see significant sequential growth from the first quarter of the year. In each of the subsequent quarters, we now believe we can deliver stronger sequential growth in the subsequent quarters than we originally anticipated. Before I turn the call over to Alon, I would like to personally invite all of you to join us next week for a virtual investor event in which we will share additional highlights of our strategy, execution plans, and goals for our software workflow business line and our longer-term financial goals. Kornit is in a remarkable position, and I am more confident than ever in our value proposition, our leadership position, and our dedicated people. I look forward to seeing all of you virtually next week. Now I will turn the call over to Alon for a closer look at our numbers and our guidance.

Thanks, Ronen, and good morning, 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 results. A full reconciliation of our results on a GAAP to non-GAAP basis is available in the earnings press release issued earlier today and on the investor section of our website. Now let's dive into the financials. We are very pleased with our strong first-quarter results, which once again exceeded our guidance on the top line and profitability. First-quarter revenue increased 152.3% year-over-year to $66.1 million, net of $3.1 million non-cash warrants impact, and was well ahead of our guidance of $61 million to $65 million, excluding the impact of warrants. Our first-quarter results were driven by record achievement of our mass production DTG and DTF systems and execution of major global expansion projects with multiple strategic accounts. Services revenue for the first quarter was $8.2 million, net of non-cash warrants impact of approximately $0.3 million, accounting for 12.4% of total revenue, an increase of 113.8% year-over-year. The first quarter was strong in the Americas with revenue more than doubling from the first quarter of last year and accounting for 68.3% of total revenue. Revenue from EMEA accounted for 23.7% of revenue and more than tripled from the first quarter of 2020. While Asia-Pacific continues to experience COVID-related travel limitations, we are pleased with the rebound in sales, which accounted for 8% of revenue and more than doubled from the first quarter of last year. In the first quarter, we had two customers that contributed more than 10% of total revenue. Our top 10 customers accounted for 61.6% of total revenue. Moving to profitability, non-GAAP gross margin in the quarter, net of warrants impact, rose to 47.1%, an improvement of over 14 percentage points year-over-year. On a GAAP basis, gross margin in the quarter was 46%, an improvement of 15 percentage points year-over-year. Our first-quarter gross margin expansion is attributed to a significantly higher mix of mass production systems and continued acceleration of services profitability. Moving to our OpEx items. I will discuss these items on a non-GAAP basis. We continue to invest in the business to accelerate growth. Each of the following line items reflects headcount additions and investments supporting the growth opportunities ahead of us. Research and Development expenses were $8.9 million or 13.5% of revenue compared to $6.1 million or 23.4% of revenue in the first quarter of 2020. The increase in R&D is a result of the accelerated investment in new products, innovative applications and use of materials. Sales and marketing expenses in the quarter were $9.9 million, or 14.9% of revenue, compared to $7.7 million or 29.4% of revenue in the first quarter of 2020. We continue to invest in expanding our go-to-market capabilities, marketing and brand awareness programs, and customer-facing activities. General and administrative expenses in the first quarter were $5.8 million or 8.8% of revenue, compared to $5.3 million or 20.3% of revenue in the first quarter of 2020. The mild increase in G&A cost is mainly related to additional headcount, professional services, and facilities expenses, and is a reflection of tight budget control and continued operational leverage as we scale our infrastructure. We ended the quarter with 700 employees, a year-over-year increase of 135 employees from the first quarter of last year, and an increase of 28 employees compared to the previous quarter. For the remainder of 2021, we will continue to invest in growing the organization to support our business, mainly in R&D and sales and marketing. Non-GAAP net profit for the first quarter was $7.7 million or $0.16 per share on a fully diluted basis, compared to a loss of $8.9 million or $0.22 per basic share in the first quarter of 2020. First-quarter GAAP net profit was $5.1 million or $0.11 per share on a fully diluted basis, compared to a loss of $10.1 million or $0.25 per basic share for the first quarter of 2020. Adjusted EBITDA for the first quarter of 2021 was $10.8 million compared to negative adjusted EBITDA of $9.2 million in the first quarter of 2020. Net cash provided by operating activities was $5.1 million this quarter compared to net cash used in operating activities of $13.1 million in the first quarter of 2020. We ended the quarter with strong backlogs including $23.7 million of deferred revenue and customer advances. We continue to expect the deferred revenue balance to convert to revenue in 2021. Our cash balance, including bank deposits and marketable securities at quarter end, was $438.7 million compared to $435.9 million as of December 31, 2020. Turning to our view on the second quarter of 2021, as Ronen discussed, we continue to execute on large global expansion projects with strategic customers and ended the first quarter with a strong backlog and great momentum in the business. We plan to continue investing in scaling our go-to-market and technology roadmap to capitalize on the massive opportunities ahead of us. For the second quarter of 2021, we expect revenue to be in the range of $76 million to $80 million and non-GAAP operating income to be in the range of 11.5% to 13.5% of revenue. It has been our practice in the past that these numbers assume no impact from the fair value of issued warrants in the quarter. In summary, we are very proud of our Q1 results as we continue to execute on our strategy and are very confident in our ability to meet our 500 million run-rate goal ahead of plan. We invite you to attend our virtual investor event next week where I will share more insight into our long-term growth plans, and I look forward to seeing you all there. I will now turn the call back to Ronen.

Thank you, Alon. With that, we are ready to open the call for questions.

At this time, we will be conducting a question and answer session. Our first question is from Jim Suva with Citigroup Investment Research. Please proceed with your question.

Thank you, and congratulations on really strong results and a good outlook. As the world starts to hopefully get back to some type of post-COVID normalcy in the countries that are ahead on the timeline for recovery from the pandemic, can you talk about the behavior of your customers in those regions? Are they phasing in production? Are they using older machines and increasing ink consumption? Are they looking at new solutions and your workflow processes? I'm just wondering about the trends there since Israel has higher vaccination rates than the U.S.

Yes. Thank you, Jim. Great question. I actually will refer more to North America, where the majority of our customers and revenues are coming from and where there has also been significant advancement in vaccinations. Over the last year, our customers have seen a peak season. They have experienced huge demand, such as from retailers, brands, and licensed accounts. In terms of workflow, we are collaborating closely with our customers and brands to connect them. The trend in the market is moving toward on-demand production, onshore or nearshore production, leveraging Kornit technology. We see great traction both within our installed base and also with retailers and licenses as they look to change their supply chains to on-demand manufacturing utilizing our workflow.

Great. Thank you so much, and I appreciate it. Congratulations.

Thank you.

Our next question is from Rod Hall with Goldman Sachs. Please proceed with your question.

Yes, hi, guys. Thanks for the question. I wanted to check a couple of things. First of all, can you give us a backlog number? It sounds like the backlog is really high, and I am curious how high it is. Secondly, on Printful, that's a lot of systems they're taking. What's your outlook for demand there? That sounds potentially very substantial.

Yes. In terms of the backlog, we are not specifying the level of backlog we have. We do specify the deferred revenue we have, but I can mention that the backlog is growing and is at its peak ever in terms of backlog of orders. We have strong visibility for the entire year, and we are already building a backlog for 2022. As for Printful, as we mentioned, we have been working with them from the start when they had two employees, growing together from Latvia to North America and other parts of the world. They are growing tremendously and are very successful in adding capacity. They have purchased 50 Atlas systems, and we are in the implementation phase, starting it in Q1, but the implementation will continue throughout 2021, and we believe this is just the beginning of continued growth for Printful.

Okay, and then I wanted to double-check on the Polypro technology, the Max printer. Are those supplies comparable in terms of value and margin to other supplies? Could you explain if there’s anything special about that?

Yes. We are going to roll out the Max technology on different platforms. We announced the first order, which is the Atlas Max, and next week on our investor conference call, we will share more information on the future products we plan to unveil. The consumable aspect of it is totally different. The value proposition we are bringing to the market is immense, and we believe we can gain better margins on the system side, the ink, and the workflow.

Great, thanks a lot.

Thank you.

Our next question is from Brian Drab with William Blair. Please proceed with your question.

Hi, good morning. Thanks for taking my questions. You mentioned sequential growth throughout 2021 in terms of revenue. Can you clarify what you originally expected and what that means for guidance for the back half of the year?

Yes, Brian. We are guiding only one quarter ahead and are not giving annual guidance. What we are saying is that there will be very strong growth, stronger than we expected. The guidance for Q2 reflects much higher anticipated results than previously expected. We expect H2 to be higher than H1.

Thanks, and can you comment on gross margins hovering around 50%, with a possibility of moving higher in the longer term?

Yes, our long-term goal remains close to 50% gross margins. Q1 typically has the lowest gross margin due to supply mix, but we are happy with the gross margins this quarter versus last year and even in 2019.

The two main factors that impact gross margin are continuous improvement and operational leverage as quantities go up. We plan to continue increasing gross margins.

Thanks very much, and congrats on the new product introductions and results.

Thank you very much, Brian.

Thank you.

Our next question is from Patrick Ho with Stifel. Please proceed with your question.

Thank you very much, and congrats on a nice quarter start of the year. Ronen, you delivered well on systems during the quarter, even given some supply chain issues. How are you managing through those potential constraints as 2021 progresses?

While the mix between supplies and hardware was tending towards systems in Q1, we saw significant growth from the supplies, achieving a record quarter for supplies. Looking forward, we don't have any availability issues this year and do not see significant impacts on cost. We placed orders with our suppliers well in advance, and we do not anticipate any supply chain issues.

Great, that's helpful. In terms of gross margins from the systems perspective, can you discuss cost reduction efforts and how that affects long-term gross margins?

We are actively engaged in both cost-cutting and leveraging economies of scale. While we are focused on growth, our operational teams are continually improving the cost structure of every element of our solutions.

We see very good results on gross margins in systems, and we are driving continuous improvements.

Great, thank you very much.

Our next question is from Jim Ricchiuti with Needham & Company. Please proceed with your question.

Hi, thank you. Just want to go back to your comments, Ronen, about the acceleration you are seeing in the business. Are there particular areas that are performing beyond your expectations?

Yes, we observe acceleration across the board. The trends we've spoken about for years are becoming a reality. Consumers desire self-expression, and e-commerce is growing. Businesses are pivoting to on-demand manufacturing to reduce waste and inventory. We see this reflected in our DTG and DTF operations and in our service business, which is now very profitable. Overall, we are on track to meet these mega trends and believe this growth will continue for years.

As we look at margins, we plan to keep investing, but we will also work to ensure we can maintain leverage as the business grows.

Okay, thanks a lot. Congrats on the quarter.

Thank you for joining us this morning. We are very pleased with our first-quarter results, which exceeded our expectations for both top-line growth and profitability. We believe that the remainder of 2021 will be just as exciting for Kornit. We look forward to sharing our strategy, execution plans, and groundbreaking innovations at our upcoming investor event and hope to see many of you virtually next week. Thank you very much.

And this concludes today's conference, and you may disconnect your lines.