Kornit Digital Ltd. Q1 FY2023 Earnings Call

Greetings, and welcome to Kornit Digital's First Quarter 2023 Earnings Conference Call. As a reminder, this call is being recorded. I would now like to turn the conference over to our host Mr. Andrew G. Backman, Global Head of Investor Relations for Kornit Digital. Mr. Backman you may begin.

Thank you, operator. Good day to everyone and welcome to Kornit Digital's first quarter 2023 earnings conference call. With me today are Ronen Samuel, Kornit's Chief Executive Officer; Lauri Hanover, Kornit's Chief Financial Officer; and Amir Shaked-Mandel, EVP of Corporate Development. For today's call, Ronen will provide comments on the first quarter 2023. Lauri will then review the first quarter numbers and provide our second 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 US securities laws will be made on this call. These forward-looking statements include, but are not limited to, statements relating to the company's plans, strategies, 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 with the SEC on March 30, 2023, 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 our earnings press release, which is 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?

Thanks, Andy and thanks everyone for joining us for today's call. As we reported earlier today, our first quarter revenues were $47.8 million in line with the guidance provided in February, which, as a reminder, included the impact from the fair value of issued warrants. Promising indicators emerged during the first quarter in certain parts of our business, despite the persistent macro pressures in the overall operating environment. System sales, supporting our customized design customers, which historically represented about 90% of our business remained challenging during the quarter. However, we see some promising capacity utilization indicators emerge, including double-digit year-over-year impression growth from several of our larger strategic accounts. This included our global strategic account, who is bringing additional systems online to handle the current and expected volume growth this year. Remember, these systems were shipped last year but experienced installation delays due to site completions. So far, impression momentum continued in the second quarter with several of our customers being a bit more optimistic regarding overall growth at the start of 2023. Customers upgrading to our MAX technology drove a strong quarter for service revenues. During the first quarter, we received orders from several strategic customers for approximately 60 system upgrades from Atlas to Atlas MAX. Customers choosing to upgrade to our MAX technology are making a clear endorsement of its quality, color, vibrancy, durability and enhanced productivity. We continue to believe, MAX is the new industry standard and expect other large customers to upgrade their systems throughout the remainder of 2023 and in 2024. Overall, while capacity utilization in the customized design market is still not optimal, we believe we have just scratched the surface of the immense opportunities unfolding within large social, digital, entertainment and content online platforms seeking to embrace and monetize the power of on-demand digital production by making it easily accessible from within their platforms to the massive global communities of users, creators, artists, merchants and friends. As such, we are not at the same elevated levels experienced during the pandemic. We do expect growth to resume in the customized design category as overall macro conditions stabilize. Over the past several quarters, we have been making steady progress on our strategy of targeting brands and retailers and their global fulfillment partners, looking to restructure supply chains in order to address new product speed to market, margin expansion, excess inventory liability and regulatory enforcement of sustainable textile production. Our MAX technology and innovative products are the cornerstones of this strategy, with top retail quality, better cost efficiencies and new product capabilities. For example, our Atlas MAX Poly opens up massive new global fashion, leisure and entertainment apparel markets for Kornit customers enabling them to offer retail quality sportswear and fanwear. In fact, we had a strong first quarter for Atlas MAX Poly mostly with some of our largest strategic customers in North America, EMEA and in Asia Pacific. I'm also pleased to see the progress we have made in direct-to-fabric, which is now starting to contribute more meaningfully to our business. We are penetrating new markets and are building a very good funnel in key textile regions of Latin America, Europe and Asia Pacific. During the first quarter, we added several new customers including one of the prominent printing houses in Italy and in Germany, with an international producer of high-tech functional textiles for a variety of industries, including for some of the world's highest-end brands. We also successfully closed several Presto to Presto MAX upgrades. With our innovative single-step solution, Kornit is the market leader in direct-to-fabric. We continue to strengthen our leading position with Presto MAX and with new innovation including a revolutionary new ink, we will showcase at the upcoming ITMA tradeshow in Milan, that we believe will accelerate the penetration into the mainstream fashion industry. It's an exciting time at Kornit as we gear up for ITMA, where we intend to demonstrate how digital production goes mainstream and showcase sustainable on-demand manufacturing at scale. We will showcase Kornit's industry-leading technology portfolio, which offers the apparel and textile industry a complete digital transformation solution to on-demand production. At ITMA, we will officially unveil Apollo, our breakthrough platform suitable for longer run production cycles than what Kornit solution has been addressing to date. This brings digital production into the mainstream and will be a real differentiator. Based on initial feedback from our customers, we are more confident than ever that the Apollo will be a game changer in terms of productivity, automation, quality consistency and total cost of ownership. In addition to the Apollo, we will showcase our new Atlas MAX PLUS, which will take the Atlas MAX to a new level of productivity. Our new portfolio of smart curing solution based on Tesoma technology, our new RSS pallets as well as our Atlas MAX Poly, Presto MAX and KornitX solutions. We hope you will join us at ITMA to experience how Kornit's digital on-demand ecosystem will drive massive needed transformation in the textile and fashion industry. To summarize, as I mentioned on our last call 2023 is a transition year for Kornit and we remain laser-focused on executing in three key areas: approach breakeven during the second half of this year on an adjusted EBITDA and then profitable growth thereafter; successfully launching Apollo, with better trial expected to begin soon; and scaling KornitX while we are making some good progress with several demand generators. I take immense pride in our entire team's tireless effort and dedication to move the company forward. As I stated during our last earnings call, Kornit's long-term growth drivers remain firmly intact. We are confident that our strategy, product roadmap and solid balance sheet combined with improvement in overall market conditions position us well to deliver meaningful long-term profitable growth. With that, let me turn the call over to Lauri for a closer look at the first quarter numbers and the second quarter guidance. Lauri?

Thank you, Ronen and good day to everyone. As Ronen mentioned, first quarter revenues were $47.8 million, in line with the guidance range we provided in February. As expected, the year-over-year decline in revenues was attributable to meaningfully lower system revenues, primarily in the customized design market. While we did see double-digit growth in impressions from some customers, consumables revenues were essentially in line with the prior year period due in part to the timing of some orders from a large global strategic customer. As Ronen described earlier, services revenues posted very strong year-over-year growth due primarily to customers upgrading systems to our MAX technology, higher contract revenue growth, as well as higher sales of printers and spare parts. In the Americas, we had a very solid quarter of services growth, while overall system sales in the region remained challenging due to the macro environment, which continues to drive longer sales cycles. Looking at the pipeline in the region, we expect a healthy cadence of customer upgrades throughout the year, which will drive services revenues as well as positive trends in consumables as we see some signs of stabilization emerging. In EMEA, consumables growth was exceptional as compared with the same period last year primarily driven by higher year-over-year volumes and ASPs. As expected, system revenues remain constrained, with customers increasingly seeking financing alternatives for capital expenditures. Our DTF portfolio continues to gain traction in EMEA as we added several high-quality customers during the quarter. The APAC region delivered robust services growth as compared with the same period last year in addition to strong sales of Atlas MAX Poly systems in South Korea. We continue to focus on developing meaningful opportunities with strategic accounts and partnerships in the region, particularly in India, Japan, Australia and China. For the balance of this year and for 2024 we believe the upcoming ITMA tradeshow in Milan will be a catalyst to not only close a number of transactions but to also help build a healthy sales funnel of new opportunities across the regions. Moving to margins. Non-GAAP gross margin was 30.2% as compared with 41.5% in the same period last year. The year-over-year decline in gross margin was driven primarily by lower systems volumes and mix. We continue to expect gross margin improvement throughout the balance of this year given the historical cadence of consumables as a percent of sales being progressively higher heading into the peak season and longer-term as sales volumes recover to a run rate that generates operating leverage on our reduced cost structure. Turning to expenses. Total first quarter non-GAAP operating expenses were $32.4 million, down approximately 8% from $35.2 million in the same period last year. The year-over-year decline reflects the impact of our previously completed workforce reductions and additional cost structure improvements we implemented across the board. This includes prioritizing R&D and sales and marketing initiatives and reallocating resources from non-customer-facing activities to developments and customer engagement functions that enable the acceleration of our long-term growth engines. As a result of the above, adjusted EBITDA loss for the first quarter of 2023 was $14.7 million as compared with adjusted EBITDA of $1.5 million in the same period last year. Adjusted EBITDA margin for the first quarter of 2023 was negative 31%, in line with the midpoint of the guidance range we provided in February. Our cash balance, including bank deposits and marketable securities at quarter end was approximately $624 million. Cash used in operations during the first quarter was approximately $14 million, driven primarily by the operating loss and changes in working capital. In this regard, accounts receivable rose due to the timing of collections and a higher level of extended payment terms for system sales to select customers while inventories were modestly higher to reflect the receipt of raw materials from suppliers and additional new systems including Apollo. Further, during the quarter, we repurchased approximately 338,000 shares under our share repurchase program for an aggregate amount of $6.8 million, representing an average price paid per share of $19.97. As a reminder, we have an authorized share repurchase program for up to $75 million. Given our strong balance sheet, we believe that we can opportunistically repurchase shares without impacting our ability to execute on the company's growth initiatives. Turning to second quarter guidance. We currently expect revenues for the second quarter of 2023 to be between $54 million and $59 million and adjusted EBITDA margins to be in the negative 19% to negative 27% range. As a reminder, 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 account. As I mentioned on our last earnings call, we expect to generate breakeven operating results on an adjusted EBITDA basis as quarterly revenues reach a run rate of approximately $70 million with gross margins in the mid-40% range, obviously depending on mix and OpEx in the mid-$30 million range. We continue to expect to turn the corner during the second half of this year and approach breakeven and later on move to profitability, again on an adjusted EBITDA margin basis. And with that, let me turn it back to Ronen.

Thank you, Lauri. Operator now, it's time to open the call for Q&A.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from Tavy Rosner from Barclays. Please go ahead.

Hi. Good afternoon, and thanks for taking my questions. I wanted to talk about system sales for a minute. You mentioned the challenging environment across most geographies. And I'm wondering what the kind of pushback you're getting especially from potential new customers. Are they pointing to financing issues or operational issues on their end, or do you feel that perhaps there is more education that needs to be made into the value proposition that you guys offer?

Yeah. So I'll take it. Thank you, Tavy for the question. First of all, we see the macroeconomic pressure which in general, it's tough for our customers and new customers to raise capital due to the interest rates. So this is one element that we need to deal with. Sometimes we're dealing with longer payment terms in order to assist them and sometimes connecting them to the right leasing program with third-party that's supporting some capital investment. In general, we also see in the segment of the customized design some customers are still having overcapacity in terms of systems although as we mentioned in my script, we see an improvement. We see an improvement in utilization of the systems, mainly in key strategic customers and we believe that they are going to go into a cycle of growth and investment in new systems. So this is in general, what we are looking ahead we believe H2 will be stronger much stronger than H1. We always said that H2 will be stronger. We believe that it will be stronger also in systems. So in general, H2 from an ink perspective will always be much stronger peak season by the end of Q3 and into Q4. On the service side, we expect major growth in H2 as well due to some of the upgrades that we're expecting from our customers. We already had a very strong quarter this quarter. Q1 and Q2 are also going to be strong on the service side from the upgrade. As for the systems, ITMA will be a major catalyst in driving the growth on the systems. We are dealing with many customers some of them new customers that will come to ITMA as we're expecting hundreds of meetings there with prospective customers that ITMA will be the point that we will take decision. We are very much focused on that and we expect to get many orders during ITMA which will influence H2 this year.

Thanks for that. And just a last one for me. You mentioned the scale-up of KornitX going on. Can you give any granularity of where that stands?

Yeah. KornitX is still in a low scale. Although, we see a few million dollars coming directly from KornitX, the good indicator that we have is that we see some good progress with few demand generators that are going some of them actually driving directly new sales of systems into the GFN. So we see in the network of the GFN, the Global Fulfillment Network some of them buying new systems of course more ink due to the connection into demand generator. And in Q1, we had a very nice progress. We are working on business development with some major digital platforms on social media platform, gaming platform, entertainment platform, and we expect some of them to be onboard in H2. Of course, you're familiar already with Wix and Kantra onboard but there are other major platforms that we would like to bring on board in H2. And all of this will drive growth to system and impressions. So it's important to look at Kornit, it's not only in the direct contribution of dollars that are going through the transaction, but also on the indirect fulfillment that is going into our GFN customer base that is buying more ink and more systems due to additional demand that they're receiving.

Great. Thank you for that. Thank you, Ronen.

Thanks, Tavy. Next question please?

Thank you. Your next question comes from Brian Drab from William Blair. Please go ahead.

Hi guys. Good morning. This is Blake on for Brian.

Hi, Blake.

You have already mentioned the upgrades you experienced in the first quarter and your expectations for them as we move through 2023. However, I was wondering if you could provide more details on the upgrades and the pace you anticipate as the year progresses.

What I can tell you is we mentioned that in Q1 we got orders from a few key customers, strategic customers for about 60 upgrades from Atlas to Atlas MAXs. This is after continued momentum in the second half of last year. We're expecting this momentum to continue in Q2 and in H2 and into 2024. We have a few of our major customers that are now considering moving into the MAX technology and it will influence both 2023 and 2024. What is important to mention is that the MAX technology now is becoming the standard of the industry, and customers understand that they have to move there. So we are expecting to see not only in upgrades from Atlas to Atlas MAX, but we are looking now deeply into our installed base that's using Avalanches and Storms and helping them to trade in and to go into the Atlas MAX technology or the MAX technology that is now the new standard and the best-in-class quality and durability and productivity in the industry.

Got it. Thank you. And then have you guys seen when you talk with customers, have you seen customer buying activity muted not only by the macro environment but also frozen ahead of the ITMA show waiting to see up the new product introductions?

Yes, we are indeed in discussions with numerous customers around the globe as well as potential clients. We're anticipating a significant attendance from Latin America and Asia Pacific, along with strong representation from Europe and North America. Many customers are expressing that they are waiting for ITMA to make their final decisions. We are eager to meet with senior management and believe there will be favorable business opportunities at ITMA. Some customers are particularly interested in seeing the Apollo, which we will introduce for the first time. This is a groundbreaking technology, and many strategic and new customers are eager to engage with Apollo as we enter completely new markets, specifically the screen market that offers services for brands and retailers. In addition to launching the MAX technology, we are delivering high productivity levels—approximately 400 t-shirts per hour—through full automation with a single operator managing the entire solution connected to in-line dryers developed from the Tesoma technologies we acquired last year. We're confident in the exceptional print quality and productivity we can achieve. ITMA is set to be a pivotal event. Reflecting on the last ITMA in Barcelona in 2018, it had a significant influence on Kornit over the following four years. This time, we believe our MAX technology and the Apollo introduction, along with the DTF and the new ink from the Atlas MAX Plus, will elevate productivity. The complete line of Tesoma technology, including smart dry systems, and the progress we're making with the Atlas MAX Poly will make ITMA a crucial opportunity for Kornit’s future.

Got it. Thank you. I’ll pass it along.

All right. Thanks. Sergio, next question please?

Thank you. Your next question comes from Erik Woodring from Morgan Stanley. Please go ahead.

Good morning guys. Thank you for taking my question. Maybe Ronen if I start with you, historically how should we think about both the correlation and the lag between impression growth and then system sales or ink and consumable sales? Meaning if we're seeing good impression growth today from select customers, how does that usually flow through on the Kornit side to actually monetize that? And maybe I'd ask the same question about the ordering of printheads and spare parts. Is that a leading indicator that we should think about, or is that just a bit more of a unique one-off? And then I have a follow-up. Thanks.

That's a great question. I'll keep it brief. The best leading indicator for our business is the health of our customers, which we measure through impressions. We look at the trend in impressions and how many are being produced. Last year, we noticed a decline in many customers. However, in the second half of the year, we began to see a positive shift, and in the first quarter, we experienced growth in impressions from some customers, including significant double-digit growth from a key global strategic customer. This is a strong sign that things are changing. As impressions increase and utilization per system rises, it indicates that customers will need more capacity. This typically leads to increased purchases not only of ink but also of systems, including upgrades to MAX technology. Overall, this is a very encouraging sign for the future.

Okay. That's super helpful. And then, maybe I'll direct the second question to Lauri and that is just I think today call it over 70% of your market cap is effectively in cash. I realize that, you guys have the buyback authorization for $75 million. I'd imagine, when you look at your stock today you'd call yourselves intrinsic value buyers of your stock. And so why not just maybe get a little bit more aggressive on capital returns or buybacks just given the strength of the balance sheet and the cash balance you have where the stock is today? Would just love your thoughts on that. And that's it for me. Thanks so much.

Okay. So as you know, we purchased about $7 million of our common stock in the first quarter. Given the point that you just made we do expect to be more active in the second quarter given these current trading levels. And again, we agree with you that we believe the company's current low enterprise value severely discounts our prospects to generate long-term growth and profitability.

Next question, Sergio?

Thank you. Your next question comes from Chris Moore from CJS Securities. Please go ahead.

Hey, guys. Thanks for taking a couple of questions. Yeah. I was hoping that you could talk a little bit about the current competitive environment that you're seeing with respect specifically to Apollo.

Thank you, Chris. The primary competition we face for the Apollo is from the analog and screen markets, where 99.9% of impressions are currently generated. For the first time, Kornit is set to enter the screen market. It's important to note that over 90% of our current business relies on enabling customized design. Most of our customers operate with very short runs, often producing single items for e-commerce. With the Apollo, we are entering a much larger market. Previously, we couldn't penetrate this market for various reasons, chief among them was that while our print quality in digital was top-notch, it wasn't sufficient to replace screen printing for retail and brands. Now, with our MAX technology, our quality matches or even surpasses screen printing, especially in photographic images, durability, and other metrics. Another key advancement is in productivity. The Atlas MAX we introduced can offer productivity that's 3.5 times greater than the Atlas MAX, closely resembling the speed of large screen machines. However, the productivity of our digital machines is significantly enhanced, as screen systems often experience downtime for replacing screens, cleaning, and changing inks—digital systems have no idle time between jobs. Our goal is to maintain a competitive total cost of ownership, especially for jobs under a run length of 500, where we see substantial market potential. We're targeting billions of impressions in this segment, positioning Kornit to disrupt the market and solidify our presence in untapped incremental markets.

Got it. That's helpful. Thank you. Just to follow up, you seem very excited about Michele in June. I'm trying to understand what a reasonable expectation for Apollo is coming out of that. Is it a certain number of orders or certain betas that are committed? I would appreciate your thoughts on this.

Yeah. So beta already signed and actually we already shipped a machine for one of our customers on the beta, and we already shipped the machine for ITMA. ITMA is for us is a sales event. We are very, very much focused not only selling the Apollo of course selling the Atlas MAXs, the Presto MAX, the Poly and many more solutions that we have on the floor. We have a clear target on how many orders we would like to get per region for the Apollo already in 2023, but we are very much focusing also with the Apollo in 2024. And we aim to start building a backlog of orders for 2024 out of this event. So it's a very meaningful event. Our team is very much focused, and I hope to be able to update you immediately after ITMA and the results.

Thanks, Chris. Sergio, next question?

Of course, our last question comes from Greg Palm at Craig-Hallum. Please go ahead.

Yes. This is Danny Eggerichs on for Greg today.

Hi, Danny.

I was hoping to touch quick on your thoughts on the path to profitability. I think the verbiage is to approach breakeven EBITDA in the second half. I guess just given where we are at in the macro right now, I mean is actually achieving breakeven profitability? Does that get pushed out at all? What are your thoughts on that?

I'll start and maybe Lauri can add on top of that. So as we promised to the market we are aiming to report breakeven during the second half of the year and we feel confident in achieving it. Now on what does it base? We mentioned very clearly to be breakeven we need a run rate of $70 million of revenue. We need to be somewhere in the mid of 40s for gross margin and in terms of OpEx in the mid of 30 on the OpEx side. And it all depends now on revenue because the major impact that we have in gross margin is on the volume on the systems on the revenue. So when we break the revenue into three parts which is systems, inks and services, we feel very confident that we have very good line of sight to the service business. We have very good confidence in line of sight to the ink business and how much it will impact into the H2. And we are working and counting on ITMA to help us to ramp up the system volume in H2. When we're looking now at the funnel that we're building into ITMA and what we're expecting to come out of ITMA, I can tell you we feel confident to deliver what we promise approaching breakeven during the second half of this year.

Got it. That makes sense. It sounds like your global strategic customer is starting to install some of the delayed systems. Since our last conversation, do you have any updates on whether they still expect to restart system contributions in 2024?

Yes. So in terms of the relationship, we have a great relationship with our global strategic customers. We are meeting with them on a daily basis on a weekly basis and to be with the senior management on a quarterly basis. They are sharing with us our three-year plans and we are working very, very closely. They had a very good peak season. They continued to grow in Q1 strong double-digit and we start to see them in the beginning of Q2 with nice orders of ink, which indicate again another strong quarter. And this is on top of now delivering or installing the systems that they purchased last year and there were delays in those sites that we wanted to open. Now the sites are almost ready. We are installing the systems now and they will be ready to run before the peak season. So we expect to see accelerated growth of impression and ink usage during H2 and mainly into Q4. And we are looking forward to continue growing with our global strategic customers. There are different parts of course. One area of course is of course upgrading the fleet into the MAX technology. We went through a deep qualification. We qualified and understand the value of the MAX we are waiting now to get the POs and probably it will happen only in 2024. There are other parts of opening new sites. Of course, they are very deeply involved in the Apollo and looking forward to start testing the Apollo early 2024 and later on to of course to open sites based as well on the Apollo. We are looking at expanding our business with them on the fashion side. So there's many areas. And of course there are also age fleets of Avalanches, but we are looking forward to trade them, upgrade them with new technology with Atlas MAX or the Apollo in the future.

All right. Got it. I will leave it there. Thanks.

Next, Andrew.

Thank you. Mr. Backman, there are no further questions at this time. You may proceed.

Great. Thank you, Sergio, and thank you all for joining us today. As always, if you have any follow-up questions, please do not hesitate to contact me directly. Sergio, will you please close the call?

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Thank you.