Kornit Digital Ltd. Q3 FY2023 Earnings Call

Greetings and welcome to the Kornit Digital's Third 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. Jared Maymon, Global Head of Investor Relations for Kornit Digital. Mr. Maymon, you may begin, sir. Please go ahead.

Thank you, operator. Good day everyone, and welcome to Kornit Digital's third quarter 2023 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 the third quarter of 2023. Lauri will then review the third quarter numbers and provide our fourth 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 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 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 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 measures on this call. The reconciliation of these non-GAAP financial 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 now like to turn the call over to Ronen. Ronen?

Thanks Jared, and thanks everyone for joining us on today's call. Before we go into our third quarter results, I would like to take a moment to address the situation in Israel. I'm sure most of you are aware of the horrific events that have taken place in Israel over the past several weeks. I want to extend my deepest gratitude for the supportive messages we have received from many of you on this call, letting us know that Kornit is in your thoughts. Your support is greatly appreciated. I also want to stress to everyone that we are committed to the safety, security, and well-being of our teams in Israel. Additionally, three weeks ago, we sent a letter to our customers emphasizing our commitment to continuity and telling them to expect no disruption in their daily interaction with Kornit. As of today, I'm pleased to report that the situation in Israel has not materially impacted our business. We have also strategically bolstered our regional inventories to meet customer demands, not just for the upcoming peak season, but also for the first quarter of 2024. As this complex situation continues to evolve, we pledge to remain proactive and implement contingencies as needed. Now, let me talk about our third quarter results. Today, we reported revenues of $59.2 million, which is within the guidance range we provided in August. As a reminder, this includes the impacts of the fair value of issues warrants. Despite a challenging macroeconomic environment, we continue to see consumable sales growth. Impressions also increased year-over-year, marking our third consecutive quarter of year-over-year impression growth. We anticipate continued growth in both impressions and consumable sales in the fourth quarter of 2023 and 2024. However, the macroeconomic situation we saw in the first half of 2023 has continued in the second half, constraining system sales in the third quarter as was expected. Despite these headwinds, system sales improved sequentially, as we continue to convert orders from ITMA. We also continue to focus on diversifying our customer base, selling our solution to new customers in key growth regions including LATAM and Asia-Pacific, and accelerating our growth into market segments like screen replacement and retail. We are encouraged to see new key customers leverage our technology in emerging applications, which we believe can generate meaningful growth for our systems and inks. Traditionally, these key customers have used analog technology, but recognize the quality, capabilities, and sustainability of our digital solutions. Additionally, we continue to see growth in our direct-to-fabric technology as evidenced by Q3 being one of the strongest quarters for Presto system sales. We also saw additional upgrades to MAX in Q3, as customers continue to see the value of our MAX technology, which includes enhanced quality, durability, and productivity. Following the upcoming peak season in Q4, we anticipate upgrade momentum to resume in 2024. We are seeing strong interest for the Atlas MAX Poly in the sports and athleisure market. In October, we attended PRINTING United in Atlanta where we built additional momentum for this solution. Our customers are most excited about the system quality and vibrancy when printing on synthetic, natural, and blended fabrics. Moving on to the Apollo, Q3 was the first quarter where initial better systems were installed and operational. The feedback we have received from our customers is highly encouraging and we have seen strong indications on systems' uptime, yield, quality, and unit economics. As of today, we have three systems installed in North America and we expect these systems to be fully operational for the coming peak season. We continue to target general availability for the Apollo in the first quarter of 2024 and we are building a good pipeline of existing and new customers. In summary, this quarter we saw a continuation of macroeconomic headwinds; however, we were able to further diversify our customer base, expand into key textile production regions, and pursue growth opportunities in new applications. Looking ahead, we will continue to take proactive measures to resume sales growth while also focusing on enhancing operating efficiencies across our entire company. Our plan is still to approach breakeven on an adjusted EBITDA basis during the fourth quarter and grow profitably in 2024. Now let me turn the call over to Lauri for a closer look at our third quarter financials and fourth quarter guidance. Lauri?

Thank you, Ronen and good day to everyone. As Ronen mentioned, third quarter revenues were $59.2 million within the guidance range that we provided in August. We saw revenue growth in consumables during the quarter both year-over-year and sequentially. Services sales declined slightly year-over-year due to significant upgrade activity from a key customer in the comparable quarter of 2022. As anticipated, system sales were once again lower on a year-over-year basis, but were much improved sequentially as we continued to convert orders from ITMA. Excluding purchases in EMEA from our global strategic account, system sales were up year-over-year. In the Americas, year-over-year growth was driven by strong system sales in Latin America following ITMA. In EMEA, consumables revenue grew nicely as utilization rose and upgrades to MAX continued. Turning to APAC, sales were flat compared with the same period last year. As Ronen described earlier, we continue to develop a meaningful pipeline of long-term opportunities in this region. Moving to margins, non-GAAP gross margin was 37.4% compared with 35.5% in the same period last year. The year-over-year improvement is due primarily to comparatively higher margin consumables representing a greater portion of total revenues. We continue to expect gross margin improvement for the balance of this year, as consumables typically comprise the highest percentage of sales in the fourth quarter. Looking at expenses, total third quarter non-GAAP operating expenses were $31.1 million, a decrease of 15% from $36.7 million in the same period last year and down 9% from $34.1 million last quarter. This year-over-year improvement in expenses reflects the benefit of our active cost savings efforts, which include our previously completed workforce reductions. The sequential improvement primarily reflects lower expenses attributable to our participation at the ITMA Trade Show, which, as a reminder, was a Q2 event. All of this resulted in an adjusted EBITDA loss for the third quarter of 2023 of $5.6 million, a significant improvement compared with the adjusted EBITDA loss of $10.5 million in the same period last year and the adjusted EBITDA loss of $10.7 million just last quarter. Adjusted EBITDA margin for the third quarter of 2023 was negative 9.5%, again within the guidance range we provided in August, and reflects a substantial improvement both year-over-year and sequentially. Our cash balance, including bank deposits and marketable securities at quarter-end was approximately $569 million. Cash used in operations during the third quarter was $7.7 million, driven primarily by the operating loss and changes in working capital. Accounts receivable increased due in part to a higher balance of extended payment terms related mainly to converted deals from ITMA. Other prospective customers are being directed to financing partners, including two new partners recently onboarded for extended payment plans. Inventories declined sequentially. We continue to remain focused on improving working capital to drive cash conversion. Since the beginning of the year, we have repurchased approximately 1.6 million shares under our share repurchase program for an aggregate amount of $36.8 million, representing an average price paid per share of $22.97. The unused balance of our previously announced share repurchase program is approximately $38 million. We plan to be more aggressive in our repurchasing efforts given our current enterprise value. Turning to fourth quarter guidance as we discussed last quarter, we continue to plan to approach breakeven on an adjusted EBITDA basis in the fourth quarter. We currently expect revenues for the fourth quarter of 2023 to be between $55 million and $60 million and adjusted EBITDA margin to be in the negative 6% to 0% 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 Ronen noted earlier, while the pipeline we have built for our solutions coming out of ITMA and PRINTING United is encouraging, we continue to see macro headwinds weighing on our sales cycle. As we move into 2024, we anticipate that our customers will likely face similar pressures to those experienced during 2023. These headwinds include constrained CapEx budgets, high interest rates, and difficulty in securing financing. Similarly, we see rising risks to discretionary consumer spending stemming from tightening credit, rising rates, higher energy prices and other such factors. The spending behavior of the end consumer, therefore, could impact the investments our customers are willing to make. To date, in 2023, we have worked closely with our key customers to mitigate some of their challenges while also focusing on improving our own operating model. We have reduced costs and reallocated resources towards long-term opportunities with the goal of generating improved returns on invested capital. In 2024, we will continue to proactively work with our customers, invest in our product roadmap as planned, and improve our operating model. We are therefore planning to deliver profitable growth for the full year 2024 on an adjusted EBITDA basis. To clarify, our 2024 plan considers the typical seasonality inherent in our business model, which implies that revenue and adjusted EBITDA margin will be stronger in the second half of 2024 as compared to the first half of 2024. That concludes our prepared remarks. And with that, I will now turn it back over to Ronen to open up the call for Q&A. Ronen?

Thank you, Lauri, and for that operator, we are ready to open the call for Q&A.

Thank you, everyone. We will now begin the question-and-answer session. The first question comes from Greg Palm at Craig-Hallum Capital Group. Please proceed.

Yes, thanks. Hey everyone, just first off, wanted to offer my continued support and sympathies for all you and all the Kornit’s employees and everyone in Israel. So with that said, can you just talk a little bit about contingency plans in light of everything going on? I think you alluded to building some inventories regionally, but what other steps have you taken or will you take in the coming months?

Thanks Greg, for the question and supportive comments. Before I start talking about the contingency plan, just to remind everyone, yesterday it was exactly one month since the horrific event that happened in Israel where more than 1,500 people were slaughtered, many of them children and elderly, and over 250 people were hostages, still hostages. And thousands of missiles were shooting all over Israel. We are still dealing with this situation with two primary focus areas. One is the well-being of our employees and supporting the community of the Israeli employees and the families. We have 10 employees whose families were directly impacted by this horrific event and supporting them and also other employees that are now serving in the army. And of course, in parallel, we are putting major focus on full business continuity. From the first day, our ink plant was in full operation. Happy to say that it’s still in full operation and we don’t see any impact to the production. In parallel, we immediately shipped all the needed ink supplies and spare parts to the regions to be close to the customers and to be ready for the peak season. At this moment, we are actually shipping all the consumables and spare parts already for Q1, and our ink plant is in full production. Our contract manufacturers are global companies and they are fully in production and we don’t see any issues. In parallel, we have a strong and clear contingency plan in place in case we need to move production out of Israel if necessary. So we are working very, very closely with our customers. We sent them emails explaining the situation already three weeks back. From that moment we’re updating them on a weekly basis. They know that they have the inks, spare parts, and even systems if they need in the regions. We are committed that they will not feel any impact to their businesses.

Okay. Well, I appreciate all that color. I guess my second question has to do with kind of your visibility into 2024 at this point. You made some comments that there are clearly a lot of things outside of your control. But I also think there are some company-specific drivers as well, whether that’s new products like Apollo, you’ve got maybe an accelerated upgrade cycle to MAX, pipeline conversions from ITMA. So it sounds like you’re still committed to growing in 2024. But can you give us a little bit more color on what those expectations might be?

Yes. So before going down to the bottom line, how do we see Q4, let me give you the background. Of course, we’re all familiar with the macroeconomic headwinds that we are all suffering from. Interest rates are high, it’s very difficult to get financing and sales cycles are getting longer, resulting in customers delaying decisions, many of them delaying decisions after the peak season. From a more macro perspective of the textile industry and what we see in our industry, we see the continued momentum into the move of production from offshore to nearshore and onshore is very visible. Everyone’s seeing it; our customers are seeing it, whether it’s the fulfillers, brands, or retailers moving production directly onshore, and it’s a driver of growth for our business. On-demand production is now something everyone is talking about, and sustainability is a major issue that brands need to report on in terms of how they produce products. Overall, they still have high inventory and in order to reduce it, they have to move to on-demand production. When we look at our customer base, it’s already the third quarter in a row that we see inks grow. We see ink growth across the board. We also observe increased impressions, and importantly, improved utilization of systems across the fleet. This is a very good indication of the health of our customers' businesses. In terms of our portfolio, we have by far the strongest portfolio ever. Our MAX technologies continue to be the mainstream and this is the new standard of the industry. We had many upgrades in Q3, and we expect that the upgrades will continue after the peak season into Q1 2024 from Atlas to Atlas MAX. Our Presto MAX recorded a very strong quarter coming out of ITMA, reflecting our continued operational activities during Q3. So overall, we are very excited about the Apollo and we are starting to convert the opportunities we have into sales.