Kornit Digital Ltd. Q3 FY2021 Earnings Call

Greetings and welcome to Kornit Digital’s Third Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Andrew Backman, Global Head of Investor Relations for Kornit Digital.

Thank you, operator. Good morning, everyone, and welcome to Kornit Digital’s third quarter 2021 earnings conference call. With me today are: Ronen Samuel, Kornit Digital’s Chief Executive Officer; Alon Rozner, Kornit’s Chief Financial Officer; and Amir Shaked, Executive Vice President of Corporate Development. 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 related 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 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. 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 could 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, 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 direct comparable GAAP measures can be found in the company’s earnings release published today, which is also posted on the company’s Investor Relations website. At this time, I would like to turn the call over to Ronen.

Thank you, Andy, and good morning, everyone. We are here in New Jersey at our beautiful customer experience center, having just returned from an inspirational and industry-transforming Kornit Fashion Week in LA. This groundbreaking alternative fashion week, pioneered by Kornit, brings endless creativity, sustainability, diversity, and inclusiveness to the forefront of the fashion world, all by leveraging Kornit’s on-demand digital technology. It was an amazing week, with more than 1,000 inspirational designers, brands, customers, and partners coming together to establish a new reality for the fashion industry. We are at an evolutionary moment in how we all think and act about fashion. It’s about giving people the style, trends, comfort, and quality they desire, when they desire it, in a sustainable and ethical means of production using innovative digital technologies. I believe the fashion industry will look back at the Kornit Fashion Week in late 2021 and remember it as the pivotal point in its journey to transform and adjust to the needs and beliefs of the current and future generations. Turning to our results. It was a phenomenal quarter with record revenue across all regions, strong profitability and operating cash flows. We delivered a total revenue of $86.7 million, net of $7.9 million in warrants related to a global strategic account. We again exceeded the high-end of our guidance, posting 51% year-over-year growth, as we saw a great mix of sales across systems, consumables, and services. The impact of the warrants this quarter associated with our global strategic account was higher than historical quarters, due to the continued growth and global expansion. And we expect to see continued accelerated growth with this strategic account. We are also making progress with other strategic accounts, including well-known fashion and e-commerce companies. For example, we recently began an important relationship with boohoo, one of the largest e-commerce fashion retailers in the UK, with an incredible portfolio of over a dozen market-leading fashion brands. boohoo is adopting the very essence of our Kornit 4.0 vision by incorporating our technology vertically into their supply chain, while also utilizing our global fulfillment network powered by KornitX to broaden the capabilities and expand into new geographies. Earlier this month, we announced the availability of Presto MAX, the platform that reinvents textile designs and application capabilities, and will change the textile industry forever. The single-step Presto MAX solution breaks the barriers between imagination and physical applications. It is the first in the market to bring unique groundbreaking capabilities like white printing on colored fabrics, neon colors, and Kornit XDi technology for 3D decorative applications. Last week in Los Angeles, following an event we hosted in Creazioni Digitali in Como, Italy, we showcased Presto MAX and its amazing capabilities to hundreds of prospective customers. And the reaction was incredible, which led to strong order pipelines. Looking at DTG, we continue to see very strong momentum with our Atlas platform. Recently, Sticker Mule, a global leader in fully customized B2C products, integrated a fleet of our Atlas systems into their business and are utilizing the growing customer base to support a strong DTG revenue channel. We began shipping the Atlas MAX in the third quarter, and feedback from our customers has been extremely positive. TSC, which owns and operates more than 25 Atlas systems, not only decided to add additional Atlas MAXes to their operation but also to upgrade their entire Atlas fleet to Atlas MAXes. Looking ahead into 2022, the NPI pipeline is unprecedented. On the immediate horizon, we are gearing up to start executing in Q1 2022 for our customers on extremely valuable upgrades to the Atlas fleets, including MAX, XDi, next-generation pallets, and the much-anticipated automated robotic garments handling system. These innovative upgrades have a tremendous ROI for our customers. And we expect them to have a material contribution to our business throughout the next year. Also, being released in early 2022 will be our new Atlas Poly, which will completely transform the sport apparel and athleisure segments of the market. We will also release our Quest quality control, the first-of-its-kind solution, ensuring color and quality consistency across any type of garment and machine. We continue to see great traction for KornitX across brands, marketplaces, and retailers. For example, we recently integrated Hype, a young, fast-growing UK brand, onto the KornitX platform. This will enable them to ensure their on-demand production, reduce lead time from 12 to 16 weeks to less than a day, and minimize the 12 weeks of stock. They will now be able to launch five times as many new products per week due to their new virtual approach with KornitX. In Asia, Debs Textile, one of the largest fashion apparel textile manufacturers in Japan, started to use our Presto system to enter sustainable on-demand production utilizing our KornitX platform. Hype, boohoo, and Debs are just a few examples of great opportunities we see for KornitX. Before concluding, I would like to share with you some additional news. Guy Avidan will be leaving Kornit. Guy started at Kornit as Chief Financial Officer and had a long and successful career with the company, taking us through our IPO before leading KornitX. Aaron Yanelli has been promoted to the role of President of KornitX and will be joining the executive management team. Aaron joined Kornit a few months ago as Chief Operating Officer of KornitX. Together with Guy, he has been laser-focused on successfully implementing our execution plans for scaling KornitX. Prior to joining Kornit, Aaron was Head of Operations for Merch by Amazon. Throughout his career, he has built and scaled large global on-demand businesses, utilizing cloud-based software and advanced printing technologies. Guy will be working closely with Aaron in the coming months to assist in the transition process, after which he will be moving on to his next chapter in life. In summary, we had a tremendous third quarter and first nine months of the year. We are currently focused on closing the year strong and supporting our customers to ensure they are ready for a successful peak season. We are also gearing up for what we expect to be an amazing 2022 for the company. Based on our strong momentum and with the guidance Alon is going to provide, we expect to end 2021 with over 65% revenue growth year-over-year. With that, let me turn the call over to Alon for a closer look at the numbers and guidance, before I come back and provide some concluding remarks.

Thanks, Ronen, and good morning, everyone. As Ronen said, we are very pleased with our outstanding third-quarter results, record total revenues, strong operating margins, very good cash flow from operations, and a very solid balance sheet. Revenue increased 51% year-over-year to $86.7 million, net of $7.9 million non-cash warranty impact. Revenue was also well ahead of our guidance of $88 million to $92 million, which, as a reminder, excluded the impact of the warrants. We again saw very strong demand for systems, consumables, and services, as our customers begin to get ready for their peak season. As Ronen mentioned, we made great progress with new customers while continuing our strong momentum with large strategic customers, which we expect to continue for the balance of 2021 and throughout 2022. Our services revenue was $10.1 million for the third quarter, net of the non-cash warrant impact of approximately $400,000. Services revenue was 11.7% of total revenue and increased 25% year-over-year. Our top ten customers accounted for approximately 65% of total revenue. As we have said before, we would expect our top ten customers to remain in the 65% total revenue range. But the composition of those top ten customers should change given the progress we are making with new strategic and other customers. Geographically, it was a record quarter for all regions with very strong growth in North America and Asia Pacific. Moving to profitability. Non-GAAP gross margin for the quarter, net of the impact of the warrants, was 47.8%. On a GAAP basis, gross margin in the quarter was 46.8%. We expect gross margins to improve longer-term, given the ongoing shift to a higher mix of mass production systems contributing from our recurring consumable business along with the acceleration of KornitX. Looking at supply chain. Despite major disruption in the global supply chain, we have experienced minimal impact on our business results in this challenging environment. Given our good visibility into the business and our experienced operations team, we’ve been able to proactively manage our supply chain enabling us to meet our customers’ requirements. Turning to OpEx. For the third quarter, OpEx was $32.9 million, up almost 13% from the second quarter and 55% year-over-year due to continued investments mainly in R&D and sales and marketing. Research and development expenses were $10.8 million for the third quarter or 12.4% of revenue as compared to $7.9 million or 13.8% of revenue in the third quarter of 2020. R&D was up due to continued investments in innovations and new products, including the addition of Voxel8 for which the integration is growing extremely well. Sales and marketing expenses were $14.4 million, or 16.6% of revenue as compared to $7.8 million or 13.5% of revenue in the third quarter of 2020. The increase was due to the expansion of our go-to-market capabilities, marketing, and customer-facing activities. General and administrative expenses in the third quarter were $7.7 million, or 8.9% of revenue as compared to $5.5 million, or 9.6% of revenue in the third quarter last year. Non-GAAP operating margin net of the warrants impact was 9.9% versus 11.3% in the year-ago quarter. This decrease was driven by the expected increase in OpEx. We ended the quarter with 849 employees, a year-over-year increase of 192 employees, and an increase of 86 employees from last quarter. The increase was mainly in R&D and sales and marketing. Non-GAAP net profit for the third quarter was $11.5 million, or $0.24 per share on a fully diluted basis, compared to $7.7 million, or $0.18 per share in the third quarter of 2020. Third-quarter GAAP net profit was $3.9 million or $0.08 per share on a fully diluted basis, compared to $3.9 million or $0.09 per share for the third quarter last year. Adjusted EBITDA for the third quarter was $18 million as compared to $9.4 million in the year-ago quarter with very strong cash flow from operations. Net cash provided by operating activities came in at nearly $33 million, up over 60% from the third quarter of 2020. We ended the quarter with a very strong backlog, including $11.7 million of deferred revenue and customer advances. Our cash balance, including bank deposits and marketable securities at quarter-end, was $457.5 million. Turning to guidance. Based on our current visibility in the business, including our very strong backlog and pipeline, we expect revenue for the fourth quarter to be in the range of $89 million to $93 million and non-GAAP operating income to be in the range of 13% to 15% of revenue. As a reminder, consistent with our practice in the past, this guidance assumes no impact of fair value of issued warrants in the quarter with our global strategic account. As Ronen said, we do expect to see continued growth with this strategic account. In summary, we are very proud of our strong quarter and year-to-date performance. On a personal note, as I approach my one-year anniversary as Kornit’s CFO, I am very happy and excited to be part of this amazing team as we continue to execute together and lead the transformation of this industry. With that, let me turn it back to Ronen for some closing remarks.

Thanks, Alon. Okay, a couple of comments before opening up for Q&A. Shortly following our last earnings call, we issued our ESG report and received extremely positive feedback from major fashion brands and global investors. At Kornit, ESG is not just a check-the-box issue, it’s a mission. We are going to lead the way in transforming the second most polluting industry in the world. If you haven’t done so, I invite you to read our report and reach out to us with any questions you may have. I would also like to take this opportunity to welcome Stef Strack and Jay Lee, who have recently been appointed as strategic advisors to the board, and whose insights and immense experience at Nike and eBay will be invaluable to the company. We plan to nominate both Stef and Jay for election to the board at our 2022 Annual Meeting. Welcome, Stef and Jay. And finally, I would like to thank all the amazing Kornit employees around the globe, who continue to work extremely hard with the utmost level of passion and dedication. I could not be prouder to be the CEO of this amazing company, led by the best employees in the industry. Operator, we are now ready for the Q&A session.

Thank you. Our first question is from Tavy Rosner with Barclays. Please proceed.

Hi, this is Chris Reimer on for Tavy. Thank you for taking my questions. On the direct-to-fabric sector, can you talk a little bit about the level of interest you’re seeing across the DTF market?

Yeah, thank you, Chris, for your question, and good morning. So, the DTF market, we believe that we are on the verge of really creating a huge transformation of this industry. This industry is the most polluted industry or the second most polluted industry in the world, creating huge amounts of waste, both of water and material, which needs innovation. Bringing to the market the Presto MAX really enables on-demand production with full sustainability without wasting water and producing exactly what’s needed. On top of that, we are enabling endless creativity with this solution. You don’t need to plan one year ahead of time what the design will be or what the consumer will want to wear. You can react fast to market trends and changes. And this is the perfect solution for the market. We released the Presto MAX and demonstrated it last week both in LA and the week before in Italy. We got amazing feedback. The Presto MAX actually brings, on top of what the Presto provided before, the capability to print on dark fabrics with white ink. Also, the XDi printing 3D elements on top of the fabric, and neon colors really enabling a huge amount of creativity. This industry needs a major change. Last week in LA, we actually got feedback from thousands of designers, brands, and retailers who were with us, and they said this is exactly what we needed. What we demonstrated with designers last week is exactly what the market needs in terms of creativity, sustainability, on-demand, and democratizing fashion into anyone that wants to create designs.

Okay, thank you. And just on KornitX, you mentioned in your opening comments a little bit about the system, but could you talk about the pace of adoption, and how brands and facilities have been responding to KornitX?

Yeah, again, here we have great feedback from many brands, retailers, and marketplaces. We gave a few examples in my earnings calls before of the adoption of this technology. What brands and marketplaces are looking for is connecting the virtual world to the physical world. KornitX enables this connectivity. The world is moving digital, e-commerce is growing, enabling endless creativity. But what we are doing is unleashing this creativity and connecting it to the physical world. We believe KornitX will be a major driver of growth and change for this industry. We see a very strong adoption. We are building the team now, and Aaron Yanelli is taking the lead and building a very strong team around him. I’m fully confident that this will take Kornit beyond the $1 billion we have been discussing.

Okay, thank you for that. I’ll go back to the queue.

Thank you, Chris. Next question, please, Joe.

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

Yeah. Hi, guys. Thanks for the question. I guess I wanted to start off with the product trajectory. Obviously, the growth continues to be really high here. We were able to attend that Fashion Week last week. It’s pretty exciting to see how engaged the industry is with these products. And I just wonder, as you look into 2022, what products are you most excited about from a revenue growth point of view? I mean, what do you think the main drivers will be next year in terms of product? It just seems like you’re coming out with so many different things. It’s kind of hard for us to keep track in a way of what might be the primary drivers of growth, and then I have a follow-up.

Yeah, it’s a great question, Rod. And, thanks for participating last week in LA. We’re having a people touch-point, with personal interactions in terms of the industry, but also in terms of the product introduction and innovation. The Atlas MAX, what we see today and what we believe for next year will be the main products that we will continue selling. These products are really unleashing endless creativity in the DTG. We see a great adoption. So, Atlas MAX will continue to have many new systems sold, but we already received POs and requests from our customers to implement upgrades on their Atlases for the Atlas MAX. It’s bringing a totally new level of quality, productivity, and creativity into this market segment. On top of that, I already touched on the Presto MAX. We see a very strong pipeline now after we demonstrated the capabilities during the fashion show. We are also gearing up to release the Atlas Poly by the end of Q1, which is targeted for the sports and athleisure market. This is a huge market that, with this technology, we are going to penetrate. We believe that we will transform this industry into digital. We also have lines of upgrades to the installed base. I’m referring to the MAX upgrade, but it pertains to the DTG and DTF for the Presto. The automation for the installed base is super, super important. We are getting tremendous feedback from our customers, many of whom would like to upgrade at the beginning of 2022. I can't disclose everything right now, but there will be some surprises next year. So, yes, there are a lot of products. But we are really excited about 2022 and the opportunities. There is a lot of work ahead for the team to begin implementing these.

Okay, thanks, Ronen. And then on the numbers, I just wondered, I mean, this line has been pretty volatile. But the services gross margin was a little bit lower than last quarter at 0%. And I know they’ve ranged from negative to positive. Just wondering what’s going on in the services gross margin line this particular quarter? Do you have any color on that?

Yes, hi Rod. This is Alon. So, the service business for us has become a profitable business and will continue to be so. We are investing a lot in customer support. We see the great potential, and we build the organization. We build the infrastructure, and sometimes there isn't a perfect fit of expenses in businesses. We need to be ready with our organization now for the peak season and the ramp-up of a few big projects. So, we are investing. This is one aspect. The other one is related to KornitX, in which we also invest heavily now in building the organization. Ronen just discussed some of the changes we are making. We are crafting a solid management team for KornitX. We see potential here. This is the time for us to build it, and then we will start seeing rapid results. Customer success and support are vital for Kornit, not only for the success of our customers but in terms of their growth engine for the future. We envision that 2022 will witness a massive growth in both revenue and profitability on the customer success line of business.

Do you guys think that’ll remain depressed a little bit then as you continue to invest? Or is that kind of a one-off thing this quarter?

It’s more of a one-off this quarter. Again, the results are good, but a bit lower than the previous quarter because of the investment. As I mentioned, next year you will see a massive expansion both in revenue and gross margin on this line of business.

Okay, all right. Great. Thank you, guys. Appreciate it.

Thanks.

Thanks, Rod. Joe, next question, please.

Our next question is from Jim Suva with Citigroup. Please proceed.

Thank you so much and congratulations to you and your team for the great results. I found it very interesting and encouraging that you are one of the fewer or even only companies that I’ve heard in the past few months that didn’t blame an excuse on the tech supply chain about inability to procure parts and components, both on the results and the outlook. So, can you talk to us a little bit about those efforts? And maybe as we look ahead, I guess, the question will be, is how were you able to pull in some of that? And are there going to be some challenges of securing your parts and products in 2022?

Okay. Hi, Jim. So, yeah, I mean, the environment is very challenging. We see it everywhere. And, as you said, it’s really an effort. We are investing a lot of effort managing this challenge. We are doing it in several different ways. First, I think we have the benefit or even luxury to have great visibility into the business. So, we are able to place orders and secure production flow for many quarters ahead. We are doing so. We have long-term engagements with vendors, which allow us to secure the raw materials. We are increasing the capacity with our contract manufacturers. We added another contract manufacturer this year, our third one. We have started a process of qualifying another contract manufacturer, most likely in America. So, this will allow us additional flexibility and bandwidth in terms of production. It’s genuinely a daily effort by the operations team. We see the pressure, and we do suffer some hits by prices and longer lead-times. On the other hand, we did increase our ASPs this year to offset this impact. As a result, currently, the impact is quite minimal to our business.

Yeah, I would like to jump in first of all to really acknowledge the hard work from our operational team. It’s actually phenomenal what they’re doing. They’re working day and night. I can tell you that on a daily basis, we have surprises of things being delayed or not coming, and parts are missing. Our team is fully committed and passionate to deliver to the SLA to our customers. So, first of all, really big thanks to the team. As Alon mentioned, we see a lot of questions coming from our suppliers, both in terms of cost increases and logistics. It’s a nightmare on the logistics side. So, we are not skipping what other companies are facing. The benefit that we have, as Alon mentioned, is that we have a very strong pipeline of visibility to our business. We already placed orders for the entire year with our suppliers and we have a very strong professional operational team that is working tirelessly to deliver to our business needs. We have confidence that we will continue to deliver on that.

And then, my quick follow-up is at the beginning of the conference call in the prepared remarks, Ronen, I think you made a comment about the upgrades. I couldn’t tell if you said you were getting out or giving out? I just wanted to understand that a little bit about it. Is that just giving out as in free or getting out, as in getting the upgrades out and your customers are paying for that upgrade?

So we are getting out, meaning releasing the upgrades already in Q1. We already have many orders for upgrades from the Atlas to Atlas Max. Of course, there is a huge value for those upgrades, both in terms of quality and productivity. And we are charging our customers; it will be meaningful, very meaningful revenue, additional revenue to our P&L for the entire year. We will not finish all the upgrades in Q1. It will take us probably the full year and even beyond because it’s not only the upgrades of the Max; there are many other upgrades as well, including automation. We’re not giving it away. We are selling it. It will bring huge value to our customers and it will be very meaningful to our revenues during 2022.

Thank you so much for the clarifications and the details.

Great. Thanks, Jim. I appreciate it. Joe, next question, please.

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

Thanks for taking my questions. First, I just want to start by saying, Ronen, you were just talking about how hard the team is working. And then you see these headlines that come out when you report your results, and that must be frustrating to still have this reporting issue. But I just want to make sure that I understand this correctly. If you adjust for the warrants that were issued, revenue for the quarter would have been $94.6 million. The consensus was at $89 million, and that’s apples to apples, the $94.6 million to $89.2 million. And I just want to clarify that the apples-to-apples comparison for EPS, adjusting for the warrants, would be you reported $0.40 relative to the consensus of $0.24, right? Am I looking at that correctly?

Yeah, you’re looking at it 100% correctly. This is the record quarter both in terms of revenue and EPS.

Right. And also the gross margin would have been 52.1%, I guess, if you make that adjustment as well, which is really at the high end of what you’ve done in the past. So I just wanted to make sure that I was interpreting that correctly because I know that consensus doesn’t take into account anything related to warrants when the analysts post those estimates?

Yes, I know it’s confusing, and thank you for the clarification.

Okay, thank you. I just wanted to ask about KornitX, and the very interesting change in leadership there that’s taking place this year. How does that, if at all, affect the business model for KornitX? And maybe that’s not the change that’s affecting the business. Has the business model for KornitX changed in terms of how you’re thinking about monetizing the valuable service?

So, Aaron joined us a few months back. So Aaron is only fully, fully involved in all the development of the business model. I don’t see this change is driving a change in the business model. However, we have tons of opportunities of different business models within KornitX. At this point in time, we are experimenting with different types of business models with different customers to see what will be the future mainstream business model. I can tell you that the opportunity here is really incredible. And we see huge adoption and great feedback from customers who would like to join, both in terms of fulfilling brands and retail and marketplaces. Recently, Jay Lee joined us from eBay to the board. Jay Lee has tremendous experience in marketplaces and the digital world and brings many ideas. He decided to join Kornit not only because of our technology and people but because he is really excited about KornitX and believes in it. He has raised his hand to be the main mentor and worked very closely with Aaron and the team to drive this business to great success. So, I’m very confident we have a strong team to take this forward, and look forward to sharing more information on the business model early next year.

Okay. And can I just ask, I think it was May when you had the Analyst Day, you talked about a $100 million revenue expectation for this business by 2026 for KornitX? Has your understanding of the opportunity for that business, does that make you feel like the $100 million might be a little conservative for 5 years from now?

So I can only tell you that the opportunity for this business, and forget to put aside the timeline right now, is much, much bigger than the $100 million. We’re talking about billions of dollars of opportunities here. We’re talking about really enabling more than just the connectivity of the virtual world to the physical world. There are a lot of activities around how we leverage the data around this system. How do we add value in the creativity and the design side? You will see some very exciting directions that we are taking and leveraging KornitX moving forward.

Okay, thanks for taking my questions.

Thanks for taking my questions. As always, if you have any questions, please feel free to reach out to me here in New Jersey. Thank you, everyone. Have a great day.

This concludes today’s conference. You may disconnect your lines at this time. Thank you very much for your participation and have a great day.