Kornit Digital Ltd. Q4 FY2022 Earnings Call

Greetings and welcome to Kornit Digital's Fourth Quarter and Full Year 2022 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Andrew Backman, Global Head of Investor Relations for Kornit Digital. Mr. Backman, you may begin.

Thank you, operator. Good day, everyone, and welcome to Kornit Digital's fourth quarter and full year 2022 earnings conference call. Joining me today are Chief Executive Officer, Ronen Samuel; Lauri Hanover, Kornit’s Chief Financial Officer; and Amir Shaked-Mandel, EVP of Corporate Development. For today’s call, Ronen will provide comments on our fourth quarter, recap the full year 2022 highlights and discuss key focus areas for 2023. Lauri will then review fourth quarter and full year numbers and provide our first quarter outlook before we open it up for Q&A. 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 financial condition and all statements that address developments that the company expects will occur in the future. Forward-looking statements are subject to known and unknown risks and uncertainties that could cause results to differ materially from those implied by 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 in March 2022, which identifies specific risk factors that could cause actual results to differ materially. Any forward-looking statements are made currently, and the company undertakes no obligation to publicly update any forward-looking statements, except as required by law. Additionally, the company will be making reference to certain non-GAAP financial measurements 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 also posted on the company's Investor Relations website. At this time, I would like to turn the call over to Ronen. Ronen?

Thank you, Andy, and good day, everyone. Thank you for joining us. Before we begin, I wanted to extend from all of us here at Kornit our thoughts and prayers to those who have been impacted by the recent devastation caused by the earthquakes. Turning to our results. As reported this morning, fourth quarter revenues were $63.3 million, net of approximately $4.3 million of non-cash flow impact related to a global strategic account and in line with the revenue guidance range provided in November, which as a reminder assumes zero impact from the fair value of the issued warrant. For the fourth quarter, consumable and services revenues were again up sequentially year-over-year and on a full year basis as compared to 2021. We saw a mixed peak season across regions and customers with some of our largest strategic accounts mainly in Americas experiencing a very good peak season. Others, especially in Europe, were generally flat to slightly up or down in terms of impressions and consumables. As expected, systems revenues were down meaningfully in the quarter given the ongoing macroeconomic backdrop. Some customers and prospects continue to take a wait-and-see approach on making meaningful investments, including adding production capacity to their existing fleet. As such, we continue to expect system sales to remain challenging in 2023 and expect to see growth for consumables and services. Like the broader global technology environment, 2022 was a tough year for all of us. We started 2022 with strong momentum and growth fueled by the introduction of groundbreaking new products that set the stage for sustainable long-term top-line growth. We closed the acquisition of Tesoma, opened our new ink plant, and cemented the position of our MAX technology as the new industry standard for quality with several strategic customers looking to upgrade to Atlas MAX, given its retail quality and superior total cost of ownership. Despite the macro backdrop, we experienced good demand and encouraging results for our direct-to-fabric solutions, especially in Latin America and in important European fashion production countries such as Italy, Portugal, and Turkey. Results in Japan are trending well, and new meaningful opportunities are beginning to develop in India, as well as in China, where the economy is slowly reopening. Our long-term partnership with our largest global strategic customer remains very strong. Relative to the market, they continue to grow nicely, contributing to the increase in our consumables and services revenues this quarter. Looking at 2023, we expect this customer to have new sites operational with added capacity driven by the systems we sold in 2022. While global uncertainties in what I call the big wave of the overall market environment are outside of our control, we are focused on what we can control. With year 2023 as an important year for Kornit, a year of transition and execution, we will focus on three key areas vital to our long-term profitable growth. First, returning to profitability. Over the past several quarters, we implemented decisive actions to reduce operating expenses, improve margins and adjust our operations to align with current market conditions. These actions combined with improvements in system utilization in some of our installed base, plus the rebuilding and scaling our system sales should help us turn the corner during the second half of this year and approach breakeven, later on moving to profitability. Second, we are laser-focused on successfully launching Apollo for which we expect to gain meaningful traction with retail brands and fulfillers to help transform the retail industry supply chain. Beta trials for Apollo are set to begin over the next several months, with the formal unveiling in June at ITMA Global Tradeshow in Milan, Italy. In addition to showcasing Apollo at ITMA, we will demonstrate how Kornit is leading digital transformation with our strong portfolio of DTG, DTF, and KornitX solutions. We will show global brands and retailers how they can fundamentally change their business models with the highest quality, flexible on-demand sustainable digital production capabilities, all while unleashing unmatched creativity and being aligned with the new rules of supply and demand. We hope many of you will join us for what will be an amazing conference. So stay tuned for more details. And third, we are focused on scaling KornitX by pursuing demand generators and further building our global fulfillment network of on-demand digital fulfillers. We have added several key customers and partners most recently with a number of global brands and marketplaces. Over the past two years, we have learned a great deal and reprioritized efforts to improve the customer experience for demand generators and further develop and scale the GFN. We continue to believe KornitX will be a meaningful contributor to Kornit in the years to come. A couple of final comments before I turn it over to Lauri. First, our long-term growth drivers remain firmly intact. The penetration of digital production remains low, and we fully expect demand for DTG systems to resume growth as capacity utilization and market conditions improve. We also see meaningful new market opportunities with Apollo, Atlas MAX Poly, DTF, and scaling KornitX. We see meaningful system upgrades and replacement opportunities across our customer base. Further, we expect a higher mix of revenues from consumables to drive additional operating leverage on our adjusted cost structure over time. While current market dynamics have impacted the timing of reaching our 2026 financial objectives, we firmly believe we can achieve our long-term financial goals in the years to come as we continue to lead the retail and supply chain transformation in the industry. It is clear to me that our vision to transform the fashion industry is happening. While we expect customized design, which represent the vast majority of our current business to resume growth and continue to be a meaningful part of our business, we see very meaningful growth opportunities in several new markets that we expect to really drive and accelerate long-term growth. For example, we see mid-sized retailers all over the world shifting their business models and transforming their supply chains with vertical on-demand digital production, or by using KornitX as they test and change product SKUs daily in order to chase trends. In addition, we see massive opportunities within surging creator economies, influencers and their communities, large digital, social and content-generating platforms, all of whom can benefit from productizing and monetizing their individual brands and platforms using Kornit's on-demand digital solutions to support their production needs. Finally, as we’ve seen over the last several years, supply chains in the broader apparel industry, including for the large traditional brands, are broken and are reliant on antiquated production cycles. We believe Kornit is best positioned to lead the retail transformation to a more efficient, profitable, and sustainable business model for years to come. As I've said before, we are a resilient company with a strong balance sheet, and we remain fully committed to long-term profitable growth. With that, let me turn the call over to Lauri for a closer look at the fourth quarter and full year 2022 numbers and guidance. Lauri?

Thank you, Ronen, and good day to everyone. Fourth quarter revenues were $63.3 million, net of $4.3 million non-cash warrant impact related to a global strategic account. For the full year 2022, revenues were $271.5 million, net of $22.5 million attributed to the non-cash warrant impact, compared with $322 million, net of $25.4 million attributed to the non-cash warrant impact in 2021. As Ronen described earlier, consumables and services revenues were each up year-over-year and on a full year basis as compared with 2021. While systems revenues were down meaningfully in the quarter, as we expected, and for the full year 2022. In the Americas, we had a solid quarter of consumables and services revenue growth, with some customers experiencing a strong peak season, while others continue to work through excess capacity. Although overall system sales remain challenging, we continue to gain traction for our DTF solutions in Latin America, with yet another encouraging quarter of growth. In EMEA, consumables and services revenues were generally flat compared with the same period last year. While system sales continued to be impacted by capacity utilization and higher financing costs. We are seeing encouraging results in important European countries like Italy, Portugal, Iberia, and Turkey, with additional opportunities opening up in the UAE and Northwest Africa. The APAC region delivered stable performance despite the tough macro backdrop driven by China's zero COVID policy. Both consumables and services revenues were flat to slightly up, and system sales were lower year-over-year. We do see encouraging penetration of the MAX technology in APAC, with installations in Japan and Australia, and as Ronen said, meaningful opportunities developing in India and China. Moving to margins. Non-GAAP gross margin, net of a 4.1 margin-point warrants impact, was 36.4% compared with 49.6% in the same period last year. The lower year-over-year gross margin was driven primarily by reduced sales volumes compared with the same period last year, as well as approximately $6 million of inventory write-offs associated with older generation systems and spare parts as customers continue to move to our newer generation systems. We continue to examine our bill of materials; selectively raise prices; and seek opportunities to generate efficiencies within our services offerings. We therefore expect gross margin to improve over time, particularly as system sales volumes rebuild and recover to a run rate that generates operating leverage on our reduced cost structure. Turning to expenses. Total fourth quarter non-GAAP operating expenses were $32.9 million, down approximately 14% from $38.4 million in the same period last year. The change was due to cost structure improvements across the board, including prioritizing R&D and sales and marketing initiatives and reallocating resources from non-customer facing activities to development and to customer engagement functions, thus enabling acceleration of our long-term growth engines. We also completed workforce reductions over the past two quarters, which will reduce overall headcount by approximately 10%. We ended the fourth quarter with 934 employees. Non-GAAP operating loss was $9.9 million, net of $4.3 million non-cash warrants impact, which was in line with our guidance for the quarter. For the full year 2022, non-GAAP operating loss was $41.8 million, net of $22.5 million attributed to the non-cash impact of warrants, compared with non-GAAP operating profit of $30.3 million, net of $25.4 million attributed to the non-cash impact of warrants for the full year 2021. Fourth quarter adjusted EBITDA loss was $6.1 million compared with adjusted EBITDA of $6.8 million in the prior year period. For the full year 2022, adjusted EBITDA loss was $30.8 million compared with adjusted EBITDA of $36 million for the full year 2021. Please refer to our updated adjusted EBITDA disclosure in the earnings press release, as well as the details provided in the GAAP to non-GAAP reconciliation table for details. Next, I would like to address two special tax items impacting the reported fourth quarter and full year 2022 results. First, approximately $11.5 million or $0.23 per basic share was paid to the Israeli tax authority. Specifically, the company took advantage of a window of opportunity to pay taxes for trapped profits from prior years at a steeply discounted rate, which provided us with material tax savings compared with the higher rates we would have paid in the future, including tax associated with our previously announced share buyback program. Second, we took a valuation allowance against our deferred tax asset given cumulative losses incurred over the past three years, of which approximately $10 million impacted the P&L or $0.20 per basic share. From a P&L perspective, the Israeli tax authority payment was a one-time cash expense, while the deferred tax revaluation was non-cash. Please refer to the GAAP to non-GAAP reconciliations in our press release for further details. Our cash balance, including bank deposits and marketable securities at quarter end was approximately $646 million. Cash used in operations during the fourth quarter was approximately $39.6 million, driven primarily by the operating loss, the Israeli tax authority payment I just discussed, and changes in working capital. As expected, inventories remained high, and our less than typical payables balance reflects lower material purchases and payments in advance of cutting over to the new ERP system, which we successfully transitioned to in January 2023. As described in our recent 6-K filed in December, we are pleased to report that the Israeli court has approved our request to authorize a share repurchase program of up to $75 million. We continue to believe opportunistically purchasing shares is in the best interest of the company and our shareholders, and that the share repurchase program will not impact our ability to execute on our growth initiatives, given our strong balance sheet. Before discussing first quarter guidance, I'd like to highlight key changes to the guidance that we will provide to the investment community going forward. As has been our historical practice, the guidance provided assumed no impact of the fair value of issued warrants related to our global strategic account. However, we received valuable feedback from the investment community to make our financial reporting easier to understand. To be better aligned with our reported financials, we have therefore decided to provide guidance net of the warrants impact on revenues and profitability going forward, starting with the first quarter of 2023. We are also providing a guidance range for adjusted EBITDA margin expectations going forward, instead of a range for non-GAAP operating margin. In this regard, depreciation expense has materially increased after the completion of our new ink manufacturing plant. As such, we believe adjusted EBITDA margin is a more useful financial metric instead of non-GAAP operating margin to measure the performance of our business. We have included reconciliation table of our GAAP net income to adjusted EBITDA in our earnings press release for the last three years. So, turning to first quarter guidance. We currently expect revenues for the first quarter 2023 to be between $47 million and $52 million and adjusted EBITDA margins to be in the negative 27% to negative 35% range. Again, the guidance for revenue and adjusted EBITDA margin includes the impact of the non-cash expense associated with the fair value of the company's warrants to our largest global strategic accounts. I'd like to remind everyone that the first quarter guidance reflects the typical seasonality we see in our business, with the first quarter typically being the lowest quarter for higher margin consumable sales, and also factors in a difficult year-over-year comparison for system sales volumes. As a result, generating operating leverage on the revenue range provided in our first quarter guidance is difficult as our operations were built to be profitable at a higher revenue run rate. I will note, given the decisive actions we have taken over the past several quarters to adjust our operations, we see breakeven on an adjusted EBITDA and operating margin basis at a quarterly revenue run rate of approximately $70 million with gross margins in the mid 40% range, depending upon mix and operating expenses in the mid 30s. As Ronen mentioned, we expect to turn the corner during the second half of this year and approach breakeven and later on move to profitability, again on both adjusted EBITDA and operating margin basis. Looking out, we continue to believe substantial long-term growth drivers remain fully intact and that we can achieve our long-term financial objectives as overall markets improve, capacity utilization increases, and as we penetrate several new markets. With that, let me turn it back to Ronen.

Thank you, Lauri. And we are ready now to open the call for the Q&A session.

Bernard, could you open up the Q&A, please? Can you hear us, Bernard? Bernard, can you hear us?

Ladies and gentlemen, we apologize for the technical difficulties. We will begin our Q&A session. We do have a question coming from the line of Jim Suva with Citigroup. Please proceed.

Thank you so much. Just a quick housekeeping item before I proceed with a more interesting question. The change in guidance to include the warrants. Am I correct that's more just of a housekeeping and getting sell-side analysts and consensus numbers all on the same definitional term? And there's actually been no relationship change or contractual change between you and your larger strategic customer?

Hi. You're absolutely correct. We’ve been engaged in very frequent dialogue with our current investors, as well as the research analyst, and we received very valuable feedback that we need to make our financial reporting easier to understand and less confusing, as well as aligned with our reported financials. And that's the reason that we've taken this.

Great. That was my understanding also. Thank you. And I think everybody will appreciate that. Then my more meaningful question. We all know interest rates have materially increased during the past year or so. With that, with Kornit selling their large printers for the purchase decisions, are they now starting to come back to a more normalized level and discussions? Or are your customers kind of still pausing and struggling for financial arrangements? And if they're struggling for financial arrangements, does Kornit kind of change the way that it helps its customers with getting across the finish line for that? Or how should we think about the impact from the closing phase of selling products and Kornit able to get it across the finish line for a sales contract? Thank you.

Yes, thank you for the question. So, we still see impact of the macroeconomics on decision-making by our customers. Many of them are still sitting on the fence and waiting to see the direction of the market. The positive sign in Q4 was that we saw growth on the supplies and impressions versus last year. To remind you, Q4 2021 was a very strong peak season, showing growth this year or the supply is very, very healthy. We see the utilization of the overall systems getting better. We still see some overcapacity, but our customers are closing it, and there is better utilization. However, some decisions on buying new equipment are being delayed. Now, we are still selling. We have segments where we are actually accelerating. Direct-to-fabric, for example, is a growing segment; we had a very strong Q4 and we have a very strong Q1 for the DTF. We are starting to penetrate with the direct-to-garment to new markets, like the retail markets. We are starting to see very nice success. Q4 was a nice peak season for some of the retailers. We can see interesting stories with retailers. They’re buying handful of systems, Atlas MAX's, and utilizing them to the max. This is different from the previous business where it was mainly custom design business of one-off. They’re leveraging this equipment for meter run length. Some of them are printing up to 3,000 linear copies or impressions, which is a great testimonial of going after the retail market and the brand. As for financial solutions, Lauri and her team are working very closely with partners to find financial solutions to support our key customers moving forward. We are selective as of today. We are supporting our customers, but we believe in them longer-term, and we're already supporting them on payment terms, and as I mentioned, we will come with financial solutions around it. Maybe Lauri can add a bit more on that point.

Yes, just to remind you, as I stated last time, one of my key initiatives for this year is to evaluate various programs and to ultimately formalize an alternative financing solution with third parties with whom we have relationships and who understand our business and how Kornit solutions help our customers. I really believe this kind of a program could provide the company with a significant competitive advantage in the marketplace.

Thank you, and congratulations to your team for getting through and navigating a challenging 2022. We're all looking forward to 2023. Thank you.

Thank you very much.

Thank you.

Thanks. Appreciate it. Bernard, next question, please.

Thank you. Our next question comes from Tavy Rosner with Barclays.

Hi, good afternoon. Thanks for taking my questions. I wanted to ask a little bit about the outlook. I was wondering if you can comment on the demand you are seeing through different end markets. I'm thinking the global strategic customers, the e-commerce channel, the brands, are you seeing kind of the same wait-and-see reaction from everyone or is it this particular segment? And I guess as a follow-up to that, is there any indication you can give with regards to potential top line growth in 2023? Or is it too soon to talk about growth this year?

Thank you, Tavy. So 2023, as you can see, we are starting, and Q1 is always, from a seasonality perspective, on the low side. So we expect Q2 to be stronger than Q1, and H2 to be stronger than H1. As I mentioned, we are aiming to move back to breakeven in H2 and then to profitability. The main driver for that, first of all, will come from systems sales. In the mid of the year in June, we have a big event, ITMA, where we are going to introduce and reveal the Apollo and start selling it. But we are going to also introduce many other new technologies both on the direct-to-garment and the direct-to-fabric and on KornitX. The ITMA show is a long show; it is more than a week. And it's a sales show. We know many customers that we're speaking with today are waiting for the show to make their final decision on purchasing of new equipment. We expect ITMA to contribute already to Q2 but definitely for H2 and beyond that. On the system side, we see a mixed reaction; some customers are really sitting on the fence and some of them from the custom design segment, but we see some that are seeing the opportunity. We need to understand that the textile market, the fashion market is going through a major transformation right now. Supply chains are fully broken. Inventory is the biggest issue for brands and retailers. Retailers require today to have many SKUs on a daily basis to attract the Gen Z. For that, they have to move into on-demand production in a sustainable way onshore, and the only solution that they can leverage to do that is using Kornit's digital solution, both on the system side and Kornit side. Therefore, we believe long term, when we look at 2023 and beyond that, we are in an inflection point where the market will accelerate and move to on-demand production. As for the supplies, Q1 is the slowest supplies quarter. We will see an increase in Q2 and definitely a strong increase in H2 and in Q4. Services, we expect nice growth across the year. We see some major key customers adopting the MAX technology and upgrading their fleets of Atlas models to Atlas MAX, and we expect across the year the same pattern we saw in Q4. So, interesting part on the segment side, and I mentioned it also before, 90% of our business as of today is coming from custom designs. Customers like Amazon and Printful will continue to grow and we expect this segment to continue to grow. However, in overall impression, this is a relatively small segment. A much bigger segment, which is more than tenfold larger, is the screen market and the screen replacement market, mainly working with the retailers and the brands. Now with the MAX technology serving as the new standard and surpassing screen quality, with all the market trends I've spoken about over the last four years, this is really happening now. Brands are moving to on-demand production onshore, and now is the time for Kornit to significantly penetrate the replacement market. We expect to start seeing this in 2023, mainly in H2, and definitely into 2024 and beyond that.

Thank you, Ronen.

Tavy, thanks. Next question, Bernard, please.

Our next question comes from Brian Drab with William Blair.

Hi. Thanks for taking my questions. The first one, I just want to clarify something. I think on the last call you said that you expected your large strategic customer to begin purchasing equipment again in the second quarter of '23. And I don't know. Ronen, if I misinterpreted, but it sounded like you made a comment along the lines of they’ve added the capacity in 2022 that they would need for 2023. I don't know if I misinterpreted that.

No, no, you're absolutely right. I mentioned on the previous call that we expect our strategic customers, our global strategic customers to add more capacity in 2023. Let me clarify. 2022 was a very strong year for our strategic global customer from our perspective. We saw an increased volume in terms of the number of systems, opening new sites, and definitely in terms of impressions. There's a nice peak season and gaining momentum going into 2023. We expect in 2023 that they will open new sites. However, they are going to leverage systems that we sold them in 2022 to deliver them into those sites in 2023. So they will open new sites, adding more capacity, and we expect to see increased volume in 2023. We are not expecting at this stage to sell additional systems to this strategic customer in 2023. We see massive opportunities for growth with this customer, not only by selling new systems in 2024 but also upgrading the existing Atlas portfolio into the Atlas MAX trade-in of the old technology and potentially with Apollo in the future, and getting into new businesses with this account as well. So, there's a lot of potential here, and we have a very strong relationship and are working on field plans. We expect to see major growth coming in the years to come.

Okay, thanks. Thanks for clarifying that. And then I'll just have one more for now. Do you still see the potential for this business to generate greater than 50% gross margin, or has something changed structurally? What needs to happen, maybe besides volume leverage, to get to the 50% plus?

So, longer term, we still firmly believe in that model. We have a very strong business model with the supplies. We need to uplift the volume on the system. We definitely believe that we can achieve a gross margin above 50%. We believe, longer term, that we will be in operating profit of more than 20%. As Lauri mentioned, to be breakeven in terms of our current cost structure, we can achieve breakeven around $70 million in revenue and around mid-40s in gross margin with the current topics that we have to be at breakeven. So we are aiming to achieve breakeven in the second half of the year and hopefully move to profitability later this year and beyond. So, longer term, yes, we firmly believe that Kornit can be a multibillion-dollar company with a strong gross margin of above 50% and an operating margin of above 20%.

Okay. And then one last quick one. To be clear, when you say breakeven, you're talking about on an EBITDA basis?

Both. Both EBITDA and operating margin.

EBITDA. Okay, thank you very much.

Thanks, Brian. Next question, please, Bernard.

Thank you. Our next question comes from Erik Woodring with Morgan Stanley.

Hey, good morning, guys. Excited to be on the call. Thank you for taking my questions. Maybe Ronen first one for you, I should say. I very much hear you on the opportunities that you highlighted for the future in terms of better penetrating kind of midsize retailers, the creator economy, social platforms, transforming supply chain, that all makes sense to me. I guess my question is, are you having customer conversations with these kinds of customers today, and are they expressing kind of interest in your types of digital systems, or software enablement, or are you more so saying these are markets that make sense and we will approach them? I just kind of want to understand if those conversations are already happening, and you're hearing about demand, or if you're just saying these are ripe for opportunity, and we're going to go after them in the future. And then I have a follow-up. Thanks.

Thank you for the question. So it's not only discussions happening; actually, a major part of the new systems that we're selling today are going to those retailers, brands, and digital platforms. We see an increased volume of supplies of ink coming from those brands and retailers. This is a massive opportunity. Most of our team engages with those discussions and sales today. We are selling many systems to those types of customers that we were dreaming about two years ago, and it's happening now. It's happening now for two reasons. One is the macro of the textile industry; the supply chain issues, inventory levels, the ability to be creative, and invent oneself every day without carrying inventory, all while making it sustainable. So this is one reason that is happening now. The second reason is digital finally—Kornit finally provides the quality, productivity, and total cost of ownership that can address this market and transform it once and for all to more sustainable on-demand production.

Great. That is very helpful. Thank you, Ronen. And then maybe Lauri, one for you. Seasonality does at least look a bit different than normal. Right now, it looked a little different in Q4, and it looks a little bit different in Q1, just in terms of forecasting kind of your second-largest seasonal decline after the March 2020 quarter, which we know was impacted by COVID. And so I guess my question is, is there any visibility into when you believe revenue growth can return to more seasonal trends or even above seasonal trends? And if so, why would that be the case? Thank you.

In terms of seasonality, currently in 2023, we are not expecting a change in seasonality. Q1 will be the lowest, and Q4 will be the strongest one in terms of supplies; Q3 will be the strongest in terms of systems, and Q2 will be higher than Q1. So we don’t expect change. Longer term, getting into the retail market, more and more into the brands, will start to see a bit of different seasonality across the year. Most of our business today, as I mentioned before, is from the custom designs for those customers selling mainly in the peak holiday season. One-off, working with the retailers and the brands, needs to stay across the year and listen to the shops and retail trends. So we expect the seasonality in terms of supplies to moderate in the coming years.

Super. Thanks so much.

Thanks, Erik. Next question, Bernard, please.

Our next question comes from Jim Ricchiuti with Needham & Co.

Hi. Thank you. The question I have relates to the systems business in '23. You provided a framework in terms of how you get back to breakeven later in the year. But what my question relates to is, if we think about the systems business this year, do you expect more meaningful inroads with new customers? Or a possible recovery later in the year from existing or some combination? And to what extent does Apollo play into this? Maybe in broad strokes, the launch is midyear. But what are your expectations as it relates to Apollo?

Yes, it makes sense; it will differ between regions and segments. For example, on the DTF side, which is a relatively new segment for us, most of the deals that we're doing in DTF are net new customers, if it's in Brazil, Argentina, Poland, Japan, etc. Turkey has been good business for us in that segment. When we talk about retail and the screen replacement, there are mainly net new customers as well. Finally, we are getting to those retailers, many of them are buying systems and many working with KornitX. So this is a new type of customer. On the custom design side, this is mixed. We expect in 2023 for some of our biggest customers to stop getting into the cycle of buying additional systems. We see it in the utilization of the current fleet that they have. They need to trade in some of the old legacy systems for new systems, and we definitely see it in the upgrade from Atlas to Atlas MAX. This is regarding the type of customer and the type of segments. And again between regions, in Asia Pacific, most of the customers that we're selling to are relatively new. In Latin America, the same goes for North America. Europe is a mix. As for the Apollo, it is the largest launch that we've done in the last four years. It's bringing tons of innovation. This is what the market was looking for: the highest quality technology with one operator full of automation, quality controls, and many more elements incorporated, such as smart queuing. We are going to reveal it in ITMA, and we’ll start installations at beta sites before each month. In the next few months, we're starting the installation of the beta. As I mentioned, in the previous call, we aim for 2023 to install less than 10 units, primarily for beta sites and demo centers in the U.S. and Europe. We expect them to be the second order from beta sites this year. A real acceleration of growth will come in 2024 driven by revenue. I can tell you that we already have a list of customers that are waiting for the Apollo. We expect ITMA to be a very strong demand generator for the Apollo, and we believe that after ITMA, we will be able to close 2024 in terms of capacity for the Apollo.

Got it. And a question for you. Some of this is going to be disclosed in the Form 20-F. But I'm wondering if you can provide us, if you could share with us any color around the breakdown of systems in consumables and service? Is any of that detail available? Or do we need to wait for that?

Yes, it can certainly help you out here. Let's say, you're looking for about a year.

Well, it would be great if we had it for the quarter as well. But I'll be back to you.

Hey, Jim, you'll see it in the 20-F. As you know, we haven't tracked any products and services throughout the quarter. We don't break it out yet, but you will see that segregation between systems and services. Okay. So, Jamie, you can break it down between the system, which includes a machine and an ink, and the services. So you can see a major growth from the services side, which include the upgrades for the MAX. You don't see the breakdown on a quarterly basis right now on the 20-F, but you will see the breakdown between the ink and the system. What I can say is that we see a larger portion of ink versus system compared to previous years. So we see growth on the ink side compared to system side, whereas in 2021, the latter was a very strong year.

Got it. We'll look for that. Thank you.

Now next question, please.

Our next question comes from Chris Moore with CJS Securities.

Hey, good day, guys. May we talk a little bit about KornitX? I know it has changed or evolved quite a bit over the past two years. I guess there's two questions. What do you know now that you didn't know then? And two, just from a marketing standpoint, you talked about mid-sized retailers, etc. as being kind of a prime market? How will the marketing approach differ from what you're doing right now on the system side?

Yes, so we have learned a lot in the last two years from the acquisition of Custom Gateway, and we adjusted our business model. We developed new solutions and have much more clarity and better traction than before. We have very high confidence about KornitX as a material contributor in both terms of revenue and in terms of driving impressions and volume to our systems and to the Global Fulfillment Network. What happened in the market is that many digital platforms are keen to monetize and productize for their platforms. The age of community is happening; the creator economy is happening, and many of them are leveraging those platforms. Those platforms are looking for a black box that they can send all the jobs to and fulfill locally, closer to the consumer in a sustainable way, without dealing with production. This is KornitX. In a nutshell, if you think about the Uber model, KornitX is the platform. It is the app that connects the volume of impressions that come from brands, marketplaces, and digital platforms into a network of fulfillers that use Kornit machines to drive volume to those machines, which will ultimately lead to more machines and more ink.

And just kind of a best guess, in terms of when KornitX does get to a meaningful revenue level, would that likely be in fiscal '25 versus fiscal '24 from where you sit today?

Yes, so the— it depends how you look at it. From a revenue perspective, it has already generated a few million dollars, okay? We expect to see growth in 2023 compared to 2022. But even more importantly, what we are measuring is how many impressions are being routed to KornitX, to our customers that are using it. Because of that, they’re buying more systems and more ink. This is very, very material. And we are starting to see the volume pick up. we are very, very focused on those retailers and brands. Some of them do not want to go vertical and buy systems, but they're looking for solutions to produce for them all over the world leveraging Kornit.

Got it. Helpful. I will leave it there. Thanks, Ronen.

Thank you.

Mr. Backman, our last question comes from the line of Greg Palm from Craig-Hallum. Please go ahead.

Yes. Hey, everyone. Thanks for taking the questions here. I just wanted to follow up on the commentary on your global strategic accounts. I just want to make sure I understood that correctly. So they will not be purchasing any new systems in 2023, is what I heard, but they're still opening up new sites. Are they using systems from other existing sites to fill the new sites? Is that essentially what's going on?

So, first of all, the first sentence is correct. We are not expecting them to buy additional systems in 2023; this is the current assumption that we are taking into our model. We still work with them on many other opportunities, as I mentioned before. As for the new sites, as you remember last year, we discussed delayed sites. Systems sold last year for those sites will be utilized this year. So from their perspective, there will be a major increase in potential volume.

Okay. So some of the printers that you sold them in 2022 were for these new sites that they're opening this year?

Yes.

And I'm just following up on the Apollo. Last quarter, I think you said in selling and installing dozens of systems. I think you said less than 10. I don't know if I misinterpreted you last quarter. But can you just confirm that? And then just in terms of revenue recognition, are you expecting to recognize any of those systems this year for the beta sites, or will revenue recognition be in 2024?

Let me confirm. In 2023, our aim is to make Apollo the most successful product, and by that, we are very much focused on delivering less than 10 units, mainly for beta sites and for the demo centers. We expect revenue recognition of those systems to occur only beginning in 2024. We are taking the conservative approach in our expectations.

Okay, perfect. And I guess just one last question, if I can just maybe one more clarification. Your commentary implies approaching breakeven in the second half. I think that sort of implies revenue in the $70 million range, if that makes sense. I just wanted to be clear that is including the impact of the non-cash expense associated with accounting as well.

Yes, if we’re talking only about net, the $70 million is net. And yes, we expect to reach breakeven in H2 based on that expectation. I mentioned earlier a revenue design of around $70 million and around a mid-40 gross margin. Of course, it's different from Q3 to Q4 as Q4 usually is a strong quarter from our supplies perspective. So hopefully, we will move into profitability.

Perfect. Okay. Thank you so much for the color.

Yes, thanks, Greg. Thank you.

Mr. Backman, we have no more questions at this time. I would like to turn the floor back over to Mr. Backman for closing comments.

Great. Thank you. And thank you to everyone for joining us today. As always, if you have any additional follow-up questions, please feel free to reach out to me directly. Have a great day. Thank you so much. Bernard, please close the call.

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