Kornit Digital (NASDAQ:KRNT) Q2 2020 Earnings Call

0:00 Greetings and welcome to Cornet Digital second quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kelsey Turcotte. of the Blue Shirt Group. Please go ahead. Thank you, operator. Good afternoon, everyone, and welcome to Cornet Digital's second quarter 2020 earnings conference call. 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, Thank you for joining us.

1:23 and are based potentially on inaccurate assumptions that could cause results to differ materially from those expected or implied by the forward-looking statements. The company's actual results could differ materially from those anticipated for many reasons, and I encourage you to review the company's filings with the Securities and Exchange Commission, including the company's quarterly report on Form 6-K, filed May 19, 2020. which identifies specific risk factors that may cause actual results or events to differ materially. Any forward-looking statements are made of this call, herefore, and the company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. Additionally, the company will be making reference to certain non-GAAP financial measures on this call. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's earnings release published today, which is posted on the company's investor relations site.

2:32 Before I turn the call over to Ronen Samuel, Cornete's Chief Executive Officer, and Guy Avedon, Cornete's Chief Financial Officer, I would like to invite you to a virtual fireside chat next Tuesday, August 18th, Thank you, Kelsey. Good evening and thank you for joining us on this afternoon earning call. I hope you and your families are all safe and healthy.

3:18 Before Guy and I share with you in more details the results of the quarter, I'd like to highlight the exciting announcement we made earlier today with the acquisition of Custom Gateway, a leading global provider of cloud software workflow solution enabling on-demand fulfillment. This strategic acquisition accelerates our organic development and strengthens our value proposition for brands, retailers and fulfillers in this fascinating area of digital transformation. Our industry is an inflection point. The online channel is booming across B2C and B2B environments. and Traditional Retail Channel are transforming how they operate in order to remain relevant to consumers, while at the same time solving their massive inventory inefficiencies.

4:17 Destructive moments like this, driven by changing consumer habits, create a perfect storm for the accelerated adoption of agile, digital and sustainable on-demand textile production. The combination of custom gateway software workflow portfolio with Cornit existing and future technologies will bring to the market a unique end-to-end solution for on-demand production. Together, we will revolutionize how global brands and fulfillers transforming the supply chain into sustainable on-demand production to meet consumer needs. We have partnered with Custom Gateway for several years now and have seen the synergy between the two organizations firsthand in shared strategic accounts like Printful, DTG2Go, and Fanatics. Custom Gateway has over 300 customers globally, including leading brands and retailers like UK's largest fashion retailer, Next. This is an extremely important next step for us in transforming the textile industry and we are pleased to welcome the Custom Gateway team to Kornit.

5:36 Turning to our second quarter results, I'm very proud of how well the team executed. We deliver total revenue of 37.4 million, net of 842,000 in warrants related to Global Strategic Account, which represents sequential growth of approximately 44% in Q2 compared to Q1 2020. These strong results reflect the positive momentum we started seeing in late April as production sites reopened and our customers started responding to the surging demand coming mostly from online channels. We believe that Kornit is in the midst of a sharp V-shaped recovery.

6:25 Our visibility into the second half of the year is as strong as ever, and we remain very confident in the business outlook not only for the second half of 2020 but into 2021 as well. For the second half of 2020, we now expect to deliver year-over-year revenue growth in the low teens and a positive operating profit for the full year. This is an increase to the high single-digit year-over-year revenue growth we focused on our first quarter call and reflects the significant and building momentum we have in the business. Despite the continued impact of COVID on regular daily routines in certain territories, our global operations are fully operating in line with the safety guidelines of the relevant local authorities.

7:19 Travel restrictions have been eased in many places, allowing our sales and service personnel to support customers on-site when needed. And all our manufacturing and R&D sites in Israel are fully staffed. Originally, we had exceptionally strong performance in North America across both new and existing customers. We are also seeing continued growth in Central and Latin America and believe this region will become increasingly strategic in the coming years as brands and retailers look to nearshoring and onshoreing as a necessary evolution in their existing supply chains. While there continues to be a lingering impact from COVID in Europe and Asia, the mega-trends propelling our industry are similar to those serving as a tailwind in the US, and we expect increased demand from these regions as we move through the year.

8:22 To that end, we are accelerating investment in both regions as we build a larger direct touch presence in the UK, Germany and Japan in conjunction with local partnership. This infrastructure will allow us to accelerate growth and support of our global strategic account as they expand to new territories. From a system perspective, it was another excellence quarter for the Atlas. which is proving to be a huge success across both new and existing customers. Our customers are making significant investments in the Atlas to create new capacity for on-demand fulfillment, in many cases deploying multiple systems. At the same time, demand for our Vulkan Plus is strong, with new customers engaging in active conversation with us and following orders placed in the quarter. These follow-on orders are particularly impressive given the Vulcan Plus was just introduced to the market in the first quarter of 2020.

9:31 And finally, the PolyPo. As we shared earlier this year, we expect to release significant technological enhancements to the PolyPo during the first half of next year, and we are very encouraged by the building pipeline of customers excited about its unique capabilities. On the direct-to-fabric side, the Presto continues to perform beyond our expectations with new and existing customers, and we believe we have the best technology in the market to capture a huge opportunity for sustainable on-demand manufacturing in the fashion and home decor market. On the operational and service side, our teams globally are focused on customer excellence, delivering on the numerous large-scale implementation we have in place with customers like TSC, Printful, Spoonflower, DTG2Go, Spreadshirt, and many others, which will not only generate revenue for the second half, but will also drive growth in ink and supplies in 2021 and beyond.

10:41 Some of those projects we identified with regional and strategic account in our first quarter call have proven to be significantly larger than we had anticipated, as our customers are experiencing a steep growth in orders for on-demand proximity short-run production. Our partnership with our global strategic account continues to be very strong, and we are successfully working with them on their ambitious growth plan while expanding globally. We are also seeing good progress with leading global brands on their way to transforming the supply chain into on-demand production for both B2C and B2B business models.

11:29 These are exciting times for Kornit and for the entire textile industry. Thank you very much. at 10.30 a.m. Eastern Time to discuss the vision beyond the acquisition of Custom Greatway in more detail, as well as more details on our execution plan. Now, I will turn the call over to Guy for a closer look to the numbers.

12:14 Guy. Thanks, Ronen, and good evening, everyone. Before beginning the financial overview, I would like to remind you that the following discussion will include GAAP financial measures as well as non-GAAP performer results. Our second quarter non-GAAP performer results reflect adjustments for the following items. Stock-based compensation expenses, which total $2.5 million. Total amortization expenses relating to the acquisitions of intangible assets in the amount of $141,000. and non-cash deferred tax benefit in the amount of $71,000. Adjustments related to COVID-19 pandemic this quarter are non-cash inventory adjustment of $222,000 and warehousing expenses of $100,000. As the company has significant operating lease liability in foreign currencies, we incur foreign exchange gains or losses from the re-evaluation of these liabilities.

13:18 Thank you very much. Thank you. Second quarter revenue net of 842,000 non-cash warrants impact was 37.4 million, a decrease of 17.4% compared to the prior year period and an increase of 42.8% sequentially.

14:08 From a year-over-year perspective, we saw very healthy demand for our systems on the part of customers serving online market in the US, Offset in part by headwind in the fashion and apparel market due to COVID-19 pandemic. Services revenues for the second quarter was 5.6 million, net of 120,000 warrants impact. Accounting for 14.9% of total revenues, a decrease of 14.8% compared to the prior year period and an increase of 45.8% sequentially. The amount attributed to the non-cash impact of warrants in the second quarter was 842,000, or 2.2% of revenues, compared to 974,000, or 2.1% of revenues in the second quarter of 2019, and 564,000, or 2.1% of revenues sequentially.

15:08 As Ronen mentioned, it was a particularly strong quarter in the Americas with 66.5% of total revenues coming from that region, 24% from Europe, the Middle East and Africa, and 9.5% from the Asia-Pacific region. In the second quarter, we had one customer contributed more than 10% of total revenues, while the global strategic customer contributed 8.8% of total revenues. Our top 10 customers accounted for 59.3% of our total revenues compared to 44.5% in the prior year period. Moving to profitability. Non-GAAP gross margin in the quarter net of warrants impact was 44.1% compared to 47.7% in the prior year period and 33% sequentially.

16:03 Non-GAAP gross margin in the first half of 2020 reflects COVID-19 related impact on revenues. Given our expectation that revenue growth will re-accelerate in the second half of this year relative to the first half, we expect non-GAAP gross margin to revert to pre-COVID levels of 50% in the second half of the year, excluding the impact of warrants. On a GAAP basis, gross margin in the quarter was 42.2% compared to 44.3% in the prior year period and 30.6% sequentially. Moving to our OPEX item, I'll discuss these items on a non-GAAP basis which exclude non-operating charges previously mentioned and highlighted in our GAAP to non-GAAP reconciliation included in our today's press release.

16:56 As Ronen discussed in his prepared remark, We expect that we are in the early stages of a V-shaped recovery driven by our customer need to transition from analog printing to digital. The systematic change in the textile industry, which we have anticipated for some time now, has been further accelerated by COVID and represents a significant market opportunity for Kornit. Accordingly, Each of the following light items reflect the headcount investment to build the infrastructure necessary to support the growth opportunities ahead of us. We ended the quarter with 574 employees, a year-over-year increase of 90 employees and a sequential increase of only 9. Looking forward, Custom Gateway and other workflow activities will bring approximately and many more.

18:15 Sales and marketing expenses in the quarter were 7.4 million or 19.9% of sales compared to 8.7 million or 19.2% in the prior year period. The decline in sales and marketing expenses this quarter is mainly attributed to the absence of trade shows and reduced travel expenses. General and administrative expenses in the second quarter were 4.9 million or 13.2% of sales Thank you very much. Non-GAAP net loss for the second quarter was 1.3 million or 3 cents per share net of 2 cents warrant impact.

19:21 GAAP net loss was 4.6 million or 11 cents per share on a basic basis compared with net income of 1.9 million or 5 cents income per share for the prior year period. Our non-GAAP financial income this quarter was 1.1 million as a result of accrued interest Our GAF financial income this quarter was $0.6 million. Turning to adjusted EBITDA. For the second quarter 2020, adjusted EBITDA was negative $0.9 million compared to positive adjusted EBITDA of $6.5 million for the prior year period. Net cash use in operating activities was $9.2 million this quarter, mainly due to a 6.8 million increase in account receivable and an 8.4 million increase in account payable offset by 4.3 million decrease in inventory compared to net cash used in operating activities of 4.4 million in the prior year period and 13.1 million net cash used in the first quarter of 2020.

20:32 Cash balances, including bank deposits and marketable securities, at quarter-end were 237.4 million, compared to 247.5 million as of March 31, 2020. The decrease in cash balances was primarily driven by the year-over-year decrease in revenues and associated net loss, as well as cash used in operating activities of 9.2 million, as previously discussed. Turning to our view on the third quarter and the second half of 2020. We expect revenues to be in the range of 53.5 million to 57.5 million and non-GAAP operating income to be in the range of 8% of revenues to 11% of revenues.

21:21 As has been our practice in the past, these numbers assume no impact of fair value of issued warrants in the third quarter of 2020. Before I turn the call back to Ronen, I would like to highlight the following. First, for the second half of 2020, we currently expect low-teens year-over-year revenue growth as compared to the second half of 2019 without warrant impact. Second, as I briefly mentioned, we expect gross margin revert to pre-COVID levels of 50% in the second half of 2020. Third, Total acquisition consideration of Custom Gateway in the third quarter of 2020 is $16.9 million.

22:08 And finally, for the entire year, we expect to deliver positive operating profit, reflecting our commitment to both growth and profitability. I'll now transfer the call to Ronen. Thank you, Guy. With that, we are ready to open the call for questions. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions.

23:01 Your first question comes from the line of Tavi Rosner with Barclays. Please proceed with your question. Hi, this is Peter. Congratulations on the great quarter. You saw one of the highest top 10 customer concentrations in some time, close to 60%. I see that only about 2% to 3% of that growth was your global customer. How much of the rest could we attribute to growth in traction with the branded accounts? And then I have a follow-up. Good question. What you can see here is that some of those growths coming from big projects that we discussed early in Q1 that materialized during Q2.

23:46 We see some of the existing customers that are really growing rapidly during Q2 and also in the second half of the year. We see interesting also some new customers that are entering to digital and really with big investment into the Atlas and even into the Vulcan Plus. Could you give us some color on how you've seen the consumables trend in the second quarter and so far in the third quarter? and how consumption has trended or recovered.

24:33 So, Tavi, as you know, we're not really breaking down between Inc. and other consumable systems in the quarter. As Ronen mentioned in his preferred remarks, we had very strong demand for systems this quarter. Thank you. Your next question comes from the line of Jim Suva with Citigroup Investment Research. Please proceed with your question. Thank you very much. Can you help me understand a little bit about, you talked about increased distribution as well as geographic reach, and yet you also announced an acquisition which appears to be a little more software oriented.

25:21 Are you kind of So those are two different topics. In terms of the acquisition of Custom Gateway, this is a strategic acquisition of technological capabilities that Kornit was looking for a few years already. This is by far the best technology that we found out there. The aim of this technology is to enable brands and fulfillers to do on-demand manufacturing in textile, primarily for apparel and home decor market.

26:07 This is super strategic. We are engaging with many brands that are looking now when they are moving online to move to on-demand manufacturing. and this software capability together with Kornit technology will enable them finally to do a real on-demand manufacturing and to eliminate a lot of waste and to be able to deliver the product to customer within a short time. So this is in one aspect. Of course we will continue to invest on the workflow side. There is a lot of internal investment within R&D and inorganics that we are looking on top of the acquisition of Custom Gateway.

26:58 Regarding the expansion or investment in UK, Germany, and Japan, those are major territories that we see a benefit to move more into direct touch with our customers. With some of those countries like UK and Germany, we already have our service organization. We're investing more now in sales, business development. Some of our biggest strategic accounts are moving and investing both in Japan, in UK, and in Germany, and they expect to get the same level of both pre-sales and post-sales. directly from Kornit, and this is one of the drivers for this investment.

27:47 We see a big potential both in Asia Pacific, in Japan, and definitely in Europe, in Germany, in UK, and this is why we decided to invest more in those territories. Great. And then my second question is, with COVID and the challenges with small and mid-sized businesses, Are you having to find it useful to be a little more generous or flexible like with payment terms or the way you used to do business before or after? I know a lot of small and mid-sized businesses have cash flow difference now versus prior. Thank you. The short answer is yes.

28:33 We're looking at our customers as our partners and we Talking with them about their future business and based on their business plan and their forecast we increased credit terms with some of our customers. Thank you so much for the details and clarification. Thank you. Your next question comes from the line of Brian Drab with William Blair. Please proceed with your question. Hey Ronen, hey Guy, thanks for taking the questions. Hi, the top 10 customers, I'm just wondering if you can say anything more on the difference between the group of top 10 customers in second quarter 2020 versus second quarter 2019. Has there been much change in that top 10 and were there any major brands in the top 10 in second quarter 2020?

29:39 Well, we cannot really be specific, but let's say most of the big names last year are participating in the top ten this year. Regarding the brands part, we cannot answer this question. Okay. And then, you know, looking at the revenue margin guidance, Implies you're going to start stepping OPEX back up in the third quarter, I think, just my first rough pass calculations. Is that primarily related to the hiring you mentioned? And would that be divided primarily between selling and marketing and G&A? And should both of those line items see increases on a dollar basis in the third quarter sequentially?

30:26 Yeah, we said that we have a plan to grow and obviously we're increasing OPEX. Most of our OPEX and most of the increase is attributed to additional headcounts. And it's going to be in S&M and G&A? Predominantly R&D. We discussed that in the previous quarter we're still investing in growing R&D and as well as mainly S&M, much more than G&A. All right, I'll save the rest of my questions. Thanks a lot. Thank you. Your next question comes from the line of Patrick Ho with Stifel. Please proceed with your question.

31:12 Thank you very much, and congrats on the nice quarter and the acquisition of Custom Gateway. Maybe Ronen, first off, with the acquisition itself, it obviously seems like you're expanding the software capabilities and the workflow solution and there's a lot of value added for the big brands and retailers given what you described. Is that the focus primarily with this acquisition or does it also help smaller shops in terms of their inventory management and even on their supply chain? Excellent questions. There are two main pillars here or main targets for the acquisition.

31:57 One, as I mentioned, is to enable the on-demand production for the brands. This is the one pillar. The other target is really enable our customers, the fulfiller, small, medium-sized fulfiller, to scale up their production. So automate the production flow from order entry to Thank you very much. What actions have you taken to ensure that your customers' solutions are still working and your ability to grow that business over time?

33:08 First, right now, at least in Europe and in North America, our teams are traveling and flying all around and visiting customers. What we have done supporting our customers is remote support. We open remote support around the clock, follow the sun, remote support. We actually manage to support our customers. More than 90% of the cases are being solved in the remote support, and the rest we are doing it by sending our engineers on sites. There's a lot of trainings that we are doing. We encourage customers to have on-site kits so they don't need to wait for spare parts to arrive.

34:01 So many, many other activities that the team is doing to enable the customer to be more self-sufficient. Great. Thank you very much. Your next question comes from the line of Jim Ricciuti with Needham and Company. Please proceed with your question. Thank you. I just wanted to go back to the investment you're making in the UK, Germany, and Japan and see if we can understand a little more about the main drivers for that. Is this investment really based on discussions you've had with your customers or More recently that require this investment or is this just the case of you're feeling a little better about the business environment, you knew these are investments you had to make and now is the right time to make them?

35:05 It's a combination. From one direction, of course, we see our top accounts, strategic accounts, are entering and growing within UK, Japan, and Germany, and we are working with them day to day. On the other hand, we see existing customers growing very fast in those territories. We see big, big potential to grow into new accounts. We just released the Vulcan Plus, the Atlas, the Presto, We're investing in new technology, taking it to more high-end technology, more productive, with more solution, and it requires better engagement from Kornit, and we believe that this will bring better value to our customers, and we will be able to accelerate the growth, on top of that we believe there will be benefit on the gross margin side.

36:13 With respect to new customers, and if I heard you correctly, it sounded like obviously you've had healthy demand from existing customers, but I thought I heard you say that you've also sold Atlas and Vulcan Plus into a new customer, or maybe it was customers during the quarter that contributed significantly to revenues. Can you tell us the type of customers Is this a brand? Is this someone in the supply chain? I'll give you one example. The customer is actually the screen printer.

36:59 So really from the analog world. He had a breeze, a small digital breeze. and he started to see that the business is moving into short runs, into on-demand and they decided to invest in Multipal Vulcan Plus. So it's a big jump and it's a relatively new customer only with Breeze so it will go very fast. It's a big analog screen printer. Thank you. And last question. You also talked about PolyPro and significant enhancements that you're planning for the first half of 21.

37:48 Is there any more color you could provide on that? Because it sounded like you were fairly satisfied with where you were with that technology. What could this be? Is this potentially introducing this into a larger type of piece of equipment? We addressed it a bit on the previous call. We have the technology that can print on polyester. We are actually the only digital technology that can print on polyester, on dye polyester, and overcome the dye migration. We released this product a year ago.

38:38 and with huge success. And we have customers that bought multiple systems. But during this process, we found out that we still have some limitations. In some cases, when you're using polyester that is called brush polyester, the print quality is not good enough. And brush polyester is becoming more of a trend right now. So we are developing solutions to enable a customer to print on dye brush polyester to cover a wider range of materials. This is part of the solution. There are other areas of the solution that we are bringing to the market in the first half of 2021.

39:24 Of course, we are planning to expand the portfolio around this important market segment. Okay, thank you for clarifying that for me. Thanks. Thank you. As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. As a reminder, if you'd like to ask a question, please press star 1 on your telephone keypad. One moment, please, while we poll for more questions. Your next question comes from the line of Chris Moore with CJS Securities. Please proceed with your question. Hey, good afternoon, guys. Yeah, just maybe a little bit longer term perspective.

40:11 I know, you know, given COVID, things are obviously still quite dynamic. Last call, you talked, you know, still kind of talked about the longer term $500 million run rate goal. Likely it sounded like it would get pushed a bit. Just curious, at this point in time, do you have enough visibility to kind of reframe the timing? Secondly, given where we are in this inflection, wondering if the mix that you were thinking about, that 60 to 40 systems to ink and consumables, when we do get to that 500, is that still likely the mix or could what's going on in the market change that a little bit?

40:59 Thanks for the question. So first of all, we are in the middle of a very, very sharp V-shape. And we are very confident about the momentum we have in the business. We are very confident about the forecast that we gave for H2, about the growth. And actually more than that, we are very bullish about 2021. We are bullish about 2021. because I can say that we have a very good line of sight on big projects that are going on already in H2 and coming in into beginning of 2021. So in terms of the business momentum, I would say we've never been in such a great situation and it's fueling, propelling mainly because of the e-commerce and probably you all read that the e-commerce growth or penetration in the last three months is equal to the penetration for the last 10 years. And within the e-commerce, the biggest portion or the biggest segment is the apparel. It's not only the biggest, it's the fastest growing segment.

42:10 And a lot of it is now moving into digital, into on-demand manufacturing. So this is the growth. Now, regarding the long term, I would say that right now we feel very, very confident to deliver what we've promised more than a year and a half ago to our investors. We are aiming to deliver the $500 million runway business during 2023, in Q4 2023, to deliver $125 million. Got it. I appreciate that. Regarding your second question, we believe that the split between Thank you very much.

43:15 The next question is a follow-up from Brian Drab with William Blair. Please proceed with your question. Just one question that I know a lot of people will be wondering about as they look at the guidance. Has Custom Gateway been generating material revenue and is that incorporated into the third quarter guidance? Can you say anything about what level of revenue they generate?

44:03 As I mentioned, the acquisition of Custom Gateway is a technological acquisition. The revenue is not material to Kornit. But yes, it was taken into account in our guidance. Ronen, can I just say, I don't want to push back too hard on that, but as you look at your total revenue, you guys are at the third quarter run rate over a 200 million revenue company, so not material to some people means less than 5% or something. Could this be a Ladies and gentlemen, we have reached the end of the question and answer session and I would like to turn a call back to Mr. Ronen Samuel for closing remarks. Thank you for joining today's call and we appreciate your continued interest in Kornit.

45:14 We look forward to speaking to many of you throughout the quarter and to host you during the virtual fireside chat next Tuesday to discuss the acquisition of Custom Gateway and our strategic vision. We are very excited about the future of Kornit and the acquisition and we wish you all Good luck and be healthy and good night. Thank you very much. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.