Earnings Call Transcript - KRNT Q2 2023

Operator, Operator

Greetings, and welcome to Kornit Digital's Second 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.

Andrew Backman, Global Head of Investor Relations

Thank you, operator. Good day to everyone and welcome to Kornit Digital's second 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 second quarter 2023. Lauri will then review the second quarter numbers and provide our third 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 which was filed with the Securities Exchange Commission on March 30, 2023, which identifies specific risk factors that could cause actual results to differ materially. Any forward-looking statements are made concurrently 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?

Ronen Samuel, CEO

Thanks, Andy. And thanks to everyone for joining us on today's call. Earlier today, we reported second quarter revenues of $56.2 million in line with the guidance we provided in May, which, as a reminder, included the impact from the fair value of outstanding warrants. During the quarter, impressions grew at a double-digit pace year-over-year for the second consecutive quarter, driving a steady improvement in capacity utilization. Consumable revenue grew at a strong double-digit rate across our customer segments, including key strategic accounts and throughout all our operating regions. So far in the third quarter, impression growth is again on pace to increase at a double-digit rate year-over-year which gives us confidence in solid consumable growth for the second half of the year. Our services business also continues to demonstrate exceptional revenue growth during the second quarter. And so far during the third quarter, as our customers actively upgrade and transition to our MAX technology. We are very pleased with the customer feedback we have received on our MAX technology, anticipating additional upgrade orders during the second half of this year, and throughout 2024. Additionally, our services have improved considerably, both in terms of revenue generation and increased operating efficiencies. System sales volumes remained soft during the quarter, mainly due to continued challenges in capital equipment spending, as our customized design customers continue to navigate through excess capacity. While we anticipate the prevailing softness in system sales volumes to continue in the short term, we have implemented strategic measures to attract new customers, including brands, retailers, and digital platforms. Additionally, we are targeting new growth regions within key textile production hubs to diversify our customer base and establish a healthy pipeline for 2024 and beyond. In addition to diversifying our customer base and entering new markets, we have taken various actions to increase efficiencies throughout our operation. Based on our progress to date, we currently expect to report breakeven on an adjusted EBITDA basis for the fourth quarter of this year, even at the quarterly revenue run rate in the mid-$60 million range due to a favorable sales mix of higher margin consumables, and quarterly OpEx in the low to mid-$30 million range. We are also aiming to deliver profitable growth for the full year 2024. As a result of our focused R&D, marketing and other efforts, we had hugely successful ITMA trade shows in Milan. We had very high customer engagements with new customers from key textile regions such as India, China, Turkey, Morocco, and from LATAM countries such as Argentina, Brazil and Mexico. We also secured a high number of quality leads and sales orders for both direct-to-fabric and direct-to-garment systems. For example, at ITMA, we signed a deal with one of the top textile manufacturers in India, which we are planning to deliver in the third quarter. This new relationship opens up a new market for us in India, a market we believe has the potential to meaningfully grow over the next several years. Approximately 60% of the deals signed were from net new customers, opening the door for additional systems, consumables, and services sales, providing us with a healthy pipeline for 2024 and beyond. The level of energy and innovation Kornit brought to ITMA was incredible, with hundreds of customers and prospects providing fabulous feedback on our portfolio. We also unveiled our new Apollo high-throughput platform and secured several new orders. We expect to recognize revenues for the Apollo in the first quarter of 2024 and are currently focused on building a substantial order backlog for the full year. During the second quarter, we installed our first beta system in the US, which is now up and running. And we are in the process of installing the second beta in this region. As we have stated previously, the Apollo platform has the potential to provide us with annual consumable and services revenue of approximately $1 million per system once installed and running at high utilization rates. In summary, we've built a solid foundation for future growth and Kornit’s long-term growth drivers remain firmly intact, a view reinforced by our recent experience at ITMA. We have made substantial progress throughout the first half of this year, as evidenced by our successful introduction of new technologies and solutions. Our MAX platform has been well received by the market, becoming the new standard in the market. Our quality of prints, XDi capabilities, and our ability to sustainably print white on dark fabrics have opened up new markets and driven increased customer interest and engagements. As a result, we continue to diversify our business and bolster our pipeline. We have also materially adjusted our cost structure and operation, reallocating resources to further enable growth engines, such as launching the Apollo platform and capitalizing on growth opportunities in new markets for our direct-to-fabric business. We remain confident that our strategy, product roadmap and solid balance sheet position us well to generate meaningful long-term growth. On a final note, this morning, we issued our third Impact Report, which highlights our activities and the progress we made on Kornit’s long-term impact strategy demonstrating our commitment to a more sustainable fashion and textile industry. With that, let me turn the call over to Lauri for a closer look at our second quarter financials and third quarter guidance. Lauri?

Lauri Hanover, CFO

Thank you, Ronen and good day to everyone. As Ronen mentioned, second quarter revenues were $56.2 million in line with the guidance range we provided in May. We experienced strong double-digit year-over-year revenue growth from both consumables and services. Yet, as expected, meaningfully lower year-over-year system sales drove the low single-digit decline in total revenues as compared with the same period last year. In the Americas, year-over-year growth was attributable to a double-digit increase in consumables across strategic accounts and again, a strong quarter of services growth, contribution due mainly to MAX upgrades. In EMEA, while consumables growth was robust due to a larger installed base and increased usage, the year-over-year decline was driven by lower system sales as customers continued to encounter financing challenges. We continue to explore ways to support qualified buyers to secure financing and now have a number of third-party financing partners lined up. We continue to seek additional partners who understand our business and how the company's solutions help our customers. The APAC region also experienced healthy consumables and services growth as compared with the same period last year. As Ronen said, we continue to develop a meaningful pipeline of long-term growth opportunities in this region, especially in key textile producing countries such as India and China. Moving to margins, non-GAAP gross margin was 36.1% compared with 38.6% in the same period last year; lower system sales volumes drove the year-over-year decline in gross margin even as higher margin consumables grew nicely, and as the profitability of services meaningfully improved. We continue to expect gross margin improvement throughout the balance of this year, given the historical cadence of consumables as a percentage of sales being progressively higher in the third and fourth quarters. Turning to expenses. Total second quarter non-GAAP operating expenses were $34.1 million, down approximately 16% from $40.7 million in the same period last year. The year-over-year decline primarily reflects the impact of our previously completed workforce reductions and lower marketing spend. As a result, adjusted EBITDA loss for the second quarter of 2023 was $10.7 million, an improvement compared with an adjusted EBITDA loss of $15.7 million in the same period last year. Adjusted EBITDA margin for the second quarter of 2023 was negative 19%, again, in line with the guidance range we provided in May. Our cash balance, including bank deposits and marketable securities, at quarter-end was approximately $592 million. Cash used in operations during the second quarter was $15.5 million, driven primarily by the operating loss and changes in working capital. Accounts receivable increased due to the timing of collections as well as a higher balance associated with extended payment terms to select customers while 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 938,000 shares under our share repurchase program for an aggregate amount of $21.8 million, resulting in an average price paid per share of $23.20. The initial six months court-approved period for the company's share repurchase program of up to $75 million expired on June 15. We have applied for and received new approval from the Israeli court covering the unused balance of our previously authorized share repurchase program for an additional six-month period. Given our strong balance sheet, we continue to believe that we can opportunistically repurchase shares without impacting our ability to execute the company's growth initiatives. Turning to third quarter guidance, we currently expect revenues for the third quarter of 2023 to be between $58 million and $62 million, and adjusted EBITDA margins to be in the negative 6% to negative 13% range. As a reminder, the guidance for revenue and adjusted EBITDA margin includes the impact of the noncash expense associated with the fair value of the company's warrants to our largest global strategic account. As Ronen mentioned, we currently expect to approach breakeven on an adjusted EBITDA basis for the fourth quarter. And before I hand it back to Ronen, I want to announce that Andy Backman, our Global Head of Investor Relations will be leaving Kornit at the end of this month to pursue a new opportunity. Since joining Kornit, Andy has played a pivotal role in leading and transforming our Investor Relations program, establishing it as a world-class program and operation. He will be greatly missed, and we thank him for all his many accomplishments and contributions to the company and wish him only the best in his new endeavor. We are also excited to announce that Jared Maymon, who was here with us today in Israel will be assuming the role of Head of Investor Relations. Jared comes to us from Berenberg Capital Markets, where he covered Kornit as a Sell-Side Analyst for the past two years. Jared, welcome aboard and we all look forward to working with you. With that, I would like to turn it back over to Ronen to open the call up for Q&A. Ronen?

Ronen Samuel, CEO

Thank you, Lauri. Operator, we are ready for the Q&A session.

Operator, Operator

Our first question comes from Erik Woodring with Morgan Stanley.

Erik Woodring, Analyst

Thank you for taking my question. It's great to see the increase in impressions and the improvement in utilization for both the second quarter and the early data from the third quarter. Based on your discussions with investors and any data you have, can you provide insight into the current average utilization? How much longer can your customers continue to maximize their current assets before needing to expand their capacity? I would appreciate more details on that, and I have a follow-up as well. Thank you.

Ronen Samuel, CEO

Thank you, Erik. Good morning to you as well. This is an excellent question. It really depends on the type of segments we are looking into. So when we're talking about utilization and underutilized, we mainly refer to our customers in the customized design, where we saw a huge peak during 2020, the second half of 2020-21. They invested a lot in many new systems, and then saw the downside at 2022. What we see in Q2, and we saw it already in Q1, we saw them increasing volume, some of them, actually going into double-digit growth. Across our installed base, we see double-digit growth, not only in the strategic account, but across all our installed base. We also see it in the supplies revenues. Overall, we see good improvements in utilization. However, we will need to wait for the peak season to see that they are getting to high utilization in order for them to reach a point that they need to invest in additional capacity. We assume that those key customers in the customized design will get into the cycle only next year, after the peak season, after there's better visibility. Currently, the trends of supplies continue to be very positive across those types of customers. On the other hand, we see customers in different market segments. If it's in the DPF, direct-to-fabric, or if it's in the replacement of the screen market, then we see massive growth in specific customers across US, EMEA, and Asia Pacific. We see them adopting the MAX technology. If it's Atlas MAX in the future, we will see it also on Apollo, and we see them growing very rapidly. As I mentioned, it depends on different end markets. But overall, we see a very positive trend.

Erik Woodring, Analyst

Now that's super helpful. Thank you, Ronen for that color and kind of that bifurcation between DTF and DTG. The second question I just want to pick your brain on was in your prepared remarks, and in the press release or presentation you mentioned a strong pipeline for 2024 and beyond post ITMA. Can you maybe just double-click on that comment and talk about some of the devices that saw some of the strongest interest at ITMA, any new trends that emerged that you think are important for all of us to think about? And then any kind of advice or guidance that you could provide us in terms of how to think about the timing of revenue recognition for any of those new products that are now in your pipeline. And that's it for me. Thanks so much.

Ronen Samuel, CEO

Yes, so thank you, Erik. For us, to fulfill the impression we've made, it was an incredibly successful event for Kornit. We saw, first of all, from the market trends we were talking about, it is really happening. Customers and visitors that came to our booth were talking about how they move into on-demand manufacturing, on-shore production, sustainability becoming a big issue for the brands and retailers. They are all looking for pigment solutions. By far, we have the best pigment solution. We met with hundreds of visitors, including brands, retailers, customer prospects, and different partners. The excitement about the solutions that we showcased at ITMA was remarkable. People were amazed by the MAX technology, which is now the new standard, the new benchmark in the industry; everybody's talking about it. It's penetrating deeply into the screen market, specifically in the replacement market, which is a totally new area for us. The Atlas MAX Plus, with the additional capability of enhanced productivity, the Poly set, and XDi have opened up new market entries for us. ITMA was a very successful event for our Atlas MAX Poly. Atlas MAX Poly is gaining momentum within retailers, sports retailers, and sports brands. We see it both in the professional sport and in the athleisure market. We closed quite a few orders of the MAX Poly and have a very strong pipeline moving into H2 and 2024. The Apollo was an unbelievable success, running around the clock; people were amazed that for the first time they can see a system that runs at 400 garments with full productivity with one operator. This is a breakthrough for this industry based on MAX technology. We received multiple orders for the Apollo. As I mentioned, we are already running the beta and installing the second one. The feedback has been great. This will position us deeply into the screen market, and we expect substantial growth on the Apollo next year. We expect to recognize revenues for the units we are going to install this year will happen only in Q1. Presto, with the new ink focusing on the ability to print on dark fabrics with white ink, opened for us the fashion market and the home décor market for the first time. We are also engaging with various textile market hubs around the world, including India, Turkey, Brazil, and Mexico. We have a strong pipeline there filled with excitement. The show confirmed that placing emphasis on customized design allowed Kornit to switch gears and focus on the replacement market, both in direct-to-fabric and direct-to-garment areas, both of which present significant opportunities for us. We collected more than 1,000 leads during the show and identified hundreds of real opportunities to pursue. We have seen that 50% of those leads already converted into purchase orders or are in the pipeline for conversion very soon. Overall, when we look at the show, it is clear that Kornit demonstrated market leadership, and all eyes are now on Kornit. In terms of conversion, some of the deals were finalized in Q2, while others will be recognized in Q3 and Q4. However, the majority will come in 2024. We are actively engaged in converting those leads one by one. As I mentioned, many of those leads are very promising. We still face macroeconomic challenges, with interest rates affecting some customers who prefer to wait for the big season before moving forward. But they are excited about our solutions and are serious about making investments. We believe we can convert many of these opportunities into sales during 2024. We anticipate that 2024 will be the year we show growth and profitable growth as well.

Brian Drab, Analyst

Hi, thank you. I'm on two simultaneous calls, so I'm going to try and just ask my questions and then get back in the queue. Can you talk about the upgrade timing, particularly at some of the bigger customers going into 2024 for upgrades to MAX technology? And also the Presto demand, which I know has generated a lot of interest at the ITMA show. How many of those did you sell or sign letters of intent for, and what’s the timing like for the delivery of some of those orders and revenue generation? Sorry, I'm just going to jump back into the queue though. Thank you.

Ronen Samuel, CEO

Thank you, Brian. Regarding upgrades, H1 was very strong in implementing upgrades from Atlas to Atlas MAX for both our key customers and smaller clients. We expect Q3 to be another strong quarter for upgrades across different regions. However, we do not expect Q4 to be strong for upgrades, as customers are very busy during that period. We will focus on completing as many upgrades as possible in Q3. We already have insights regarding customers who plan to continue upgrades in Q1 and Q2 next year, including some strategic customers. As for our global strategic customer, we have passed all testing regarding quality and productivity; we are merely waiting for the green light to begin upgrades on their existing systems. With respect to Presto, as I mentioned, we've shown the quality of the new inks that we presented and the ability to print on dark fabrics with white ink, the XDi. This opened the door for us to enter the replacement market. Until now, we primarily sold the Presto to customers looking for short runs and niche printing. Now, for the first time, we're working with significant textile manufacturers in major hubs around the world who are looking to transform their business toward a more sustainable on-demand model. The ability to print on almost any fabric without pretreatment, post-treatment, or excessive water waste is tremendously appealing. We expect to see strong demand for Presto in Q3 and Q4. However, many of the deals and prospects we identified at ITMA will not be implemented until the beginning of 2024. Considering this, we see a massive growth opportunity in direct-to-fabric as a principal driver for our business moving forward.

Tavy Rosner, Analyst

Hi, thanks for taking my question. I wanted to ask about Amaze, broadly speaking, how is your relationship going? Last quarter, you mentioned that some systems they ordered haven't been shipped yet, so I was wondering if those didn't ship and were installed? And if there's any update with Amazon potentially upgrading their portfolio to systems like Apollo.

Ronen Samuel, CEO

Yes. Thank you for the question, Tavy. Our global strategic customer, Amazon, has a very close relationship with us. As I mentioned before, we are always working with them on long-term plans. Their business has been doing very well; they had a great H1 and we continue to see growing momentum. The momentum, in this case, implies strong double-digit growth in impressions, among other metrics. As you may recall, last year, they were set to open new sites where we sold many systems; those sites were delayed. Currently, those sites are ready, and we are in the process of installing systems, ensuring they will be operational by the peak season in Q4. This is expected to drive substantial growth in impressions from our global strategic customer into Q4 and definitely in 2024. As for additional capital investment, that remains part of their internal discussions. There are multiple opportunities for capital investments with varying timelines. One of those could involve upgrading the fleet of Atlas to Atlas MAX. They have completed all the testing and are now discussing the potential upgrade to Atlas MAX Plus. They have expressed excitement about the Apollo as well. They are looking into the future growth arising from this platform. We anticipate they will be testing the Apollo very soon, positioning us well for 2025.

Unidentified Analyst, Analyst

Hi, good morning. This is actually Chris going on for Jim, thank you for taking the questions. Late in June, you announced the Amaze deal, and I was just wondering if you could elaborate on that deal; whether it entails incremental units or is largely leveraging the existing fulfiller network, and what you see in terms of additional enterprise scale prospects for Kornit? Thank you very much.

Ronen Samuel, CEO

Yes, thank you for the question. It's an interesting deal and certainly another proof point for the direction the industry is taking. We see massive opportunities with digital platforms like Canva and Wix. Our association with Amaze is significant since they chose Kornit as their platform, selecting Atlas MAX as the sole system for garment decoration. This is a very important message. Although their business is just beginning, we have connected them with several of our global fulfillment network partners. I can share that one has already ordered several systems as a result of this connection in North America, providing more evidence of how digital platforms can drive demand and benefit our existing customers. We anticipate Amaze will experience significant growth potential not only in the US, but also in Europe and Asia Pacific. We support them, just as we support other digital platforms, brands, and retailers.

Derek Palm, Analyst

Yes, thanks, everyone. Thanks for taking the question. I guess just starting off, it seems like the implied second half outlook in terms of revenue is a little bit lower relative to where we were three months ago, so I'm just curious what changed; how much of some activity that you thought would have landed this year has been pushed into 2024? And then as you sort of look at other ways to convert customers, I'm curious if you can give us a little more color on financing alternatives, it sounds like you've opened up that option? And I'm just curious if you think that can be a big driver of conversions going forward.

Ronen Samuel, CEO

Yes, so thank you for the question. If you remember that we were discussing visibility for H2 and previously stated we have around 70% visibility coming from supplies and services. As of today, the ink and consumables are trending better than we expected and growing faster, which is certainly promising as it reflects our customers' health and indicates they will be needing more systems in the future. Services revenue is also growing faster and gross margin looks strong as well. The area where we are falling short of our expectations in total revenue comes from system sales. We now have clear visibility into our pipeline, and importantly, we have established a line of sight for H2 and beyond, including our pipeline goals for 2024. Some leads that we expected to convert following ITMA are taking longer due to macro-economic factors. Customers are currently evaluating financing options or are reticent to commit until after the peak season. This has slightly tempered our outlook for system sales in H2 compared to what we would have liked. However, the good news is that both supplies and services expected gross revenue and gross margin are looking good. We took preventative measures on OpEx and are anticipating to achieve breakeven on an adjusted EBITDA basis, reporting that in Q4. We believe this is achievable. Regarding 2024, as I mentioned before, we aim for a profitable yield growth compared to 2023.

Derek Palm, Analyst

And just to begin, yes, thanks for that was very helpful, detailed answer. And just to be clear on Q4, specifically, I think you mentioned approaching breakeven at a revenue run rate that's now towards the mid-60s versus 70 previously. So are you effectively guiding revenue in that sort of mid-60s range for Q4; just want to confirm that?

Ronen Samuel, CEO

So we are guiding only for Q3. We are not guiding for Q4. We are stating that we can achieve breakeven approaching the mid-60s with OpEx in the low to mid-$30s. This is our current assessment of where we see the business. We are not making explicit guidance for Q4 yet.

Chris Moore, Analyst

Hey guys, thanks for taking the questions too. So, it sounds like the ITMA conversion rate, LOI to purchase orders was quite high. Is there any way you can size the purchase orders to date?

Ronen Samuel, CEO

We are not providing those specific numbers. What I can share is that Kornit, post-ITMA, with the technologies we brought to the DTG and DTF, has emerged as a different company—much more diverse and stronger than before. Historically, Kornit generated 90% of its revenue from DTG, mainly from a few key clients and North America. Today, we are a different company with direct-to-fabric evolving into a significant growth market. In DTG, we are penetrating into the replacement market, which is much larger. We are engaging with many new key customers, with opportunities spanning major textile markets globally. For instance, the deal I mentioned in India involves one of the largest textile manufacturers, indicating potential for many systems sales specifically for those customers. In China, we also installed our DTS system for an exciting new application, which may lead to significant unit sales for us. Overall, we see growth in retailers, and we have active engagements with brands requiring on-demand production, reflecting their commitment to sustainability. We have seen a considerable uptick in interest for our solutions, and we believe the future starts now for Kornit. We committed to reaching breakeven in 2023 as part of our transition, and we anticipate 2024 will be the year we return to profitable growth. We are optimistic.

Andrew Backman, Global Head of Investor Relations

Great, thank you so much, Lotyam. And thank you all for joining us today. As always, if you have any follow-up questions, please feel free to reach out directly. So, Tony, will you please close the call? Thank you so much.

Operator, Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. Have a great day.