Kornit Digital Ltd. (NASDAQ:KRNT) Q2 2022 Earnings Conference Call August 10, 2022 8:30 AM ET
Company Participants
Andrew Backman – Investor Relations
Ronen Samuel – Chief Executive Officer
Alon Rozner – Chief Financial Officer
Laurie Hanover – Incoming Chief Financial Officer
Conference Call Participants
Jim Suva – Citigroup
Rod Hall – Goldman Sachs
Operator
Greetings, everyone, and welcome to Kornit Digital’s Second Quarter 2022 Earnings Conference Call. As a reminder, this conference is being recorded. At this time, I’d like to turn the floor over to our host, Andrew Backman, Global Head of Investor Relations for Kornit Digital. Mr. Backman, you may begin.
Andrew Backman
Thank you, operator. Good day, everyone, and welcome to Kornit Digital’s Second Quarter 2022 Earnings Conference Call. Joining me today are Ronen Samuel, Kornit’s Chief Executive Officer; Alan Rosner, Kornit’s Chief Financial Officer; Amir Shaked Mandel, EVP of Corporate Development, and I’m happy to welcome Laurie Hanover, who, as we announced this morning, we’ll be transitioning to the CFO role in November. Welcome, Laurie.
For today’s call, Ronan will recap the results for the second quarter, discuss the current operating environment and review some of the actions we’ve undertaken to help successfully navigate the current market dynamics. Alan will then dive into the second quarter numbers and provide our current third quarter outlook before turning it over to Laurie for some brief commentary. After which, we will conclude today’s call with a question-and-answer session.
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 and other U.S. securities laws will be made on this call. These forward-looking statements include, but are not limited to, statements relating to the company’s objectives, plans, strategies, statements of preliminary or projected results of operations or our financial condition and all statements that address activities, events or developments that the company intends, expects, projects, believes or anticipates will occur in the future. Forward-looking statements are subject to known and unknown risks and uncertainties and are based potentially on inaccurate assumptions that could cause results to differ materially from those expected or implied by the forward-looking statements. I encourage you to read the company’s filings with the Securities and Exchange Commission, including the company’s annual report on Form 20-F filed on March 30, 2022, which identifies specific risk factors that could cause actual results or events to differ materially. Any forward-looking statements are made as of this call hereof, and the company undertakes no obligation to publicly update or revise 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 measures to the most directly comparable GAAP measures can be found in the company’s earnings release published today, which is posted on our website in the Investor Relations section.
At this time, I would like to now turn the call over to Ronen. Ronen?
Ronen Samuel
Thank you, Andy, and good day, everyone. Thank you for joining us on today’s call. As we reported this morning, second quarter’s revenue were $58.1 million, net of approximately $4.5 million of noncash warrants impact related to a global strategic account. — in line with the preliminary revenue range we announced on July 5. As a reminder, the gap between the guidance we provided in May and our second quarter results was driven by a shortfall in DTG systems revenues, mainly in the America regions, clearly, not the great first half that we were expecting as we enter the year.
As we look across the business, we see some customers, particularly in certain e-commerce segments continue to digest excess system capacity built in the past 2 years and navigate and macro-related issues while others continue to grow nicely, although at a more normalized pace. We also see certain customers make good progress on their expansion plans and new production facilities. As a result, several deals we expected to complete at the very end of the second quarter has either already closed in the third quarter remain in our backlog or have moved to 2023. Looking at the consumables, revenues were in line with our expectations as some customers have worked through the inventory buildup experience in the last few quarters.
We continue to expect consumables to grow sequentially throughout the balance of 2022 as our customers gear up for the peak season in the third and fourth quarters. For the first half of the year, we saw good growth in both EMEA and Asia Pacific. In EMEA, the pipeline for the second half of the year is improving as the team continues to make progress with several major brands and retailers across the region. This includes CNA, Hype and one of the world’s top 5 fashion brands that is vertically integrating a number of Adama systems into one of their production facilities. They are also exploring a broader larger-scale global deployment.
In Asia Pacific, after a very long period of lockdowns, especially in China, the region continues to open up. Our team is traveling again, meeting with customers, prospects and making progress with several large brands, digital platforms and strategic accounts. We are also engaged with several major manufacturer in the regions that are responding to the growing demand from the global customers to transform their supply chain and shift more production volumes to nearshore shorter runs production.
In the Americas, Latin America is ramping up nicely, driven particularly by demand for the press to Max. We are seeing more new business opportunities with mid-market brands and retailers as the broader U.S. apparel industry focuses on margin and supply chain improvements. We believe this can be well achieved by shifting more production volumes from traditional offshore mass production to on-demand at a closer proximity to consumers.
On the DTG side, we have recently started working with a specialty retailer of casual apparel operating over 200 stores across the U.S. In addition, a major onshore apparel manufacturer for some of the largest licensors and retailers in the U.S. is making their first entry into digital printing with Kornit having historically produced 100% on analog equipment. And finally, we continue to work in a very close partnership with our largest global strategic account on their meaningful domestic and international expansion plans.
We have a clear understanding of the key focus areas, potential meaningful new opportunities and our relationship is stronger than ever. While the overall operating environment remains uncertain in parts of our business, the opportunities ahead of us remain firmly intact. However, to successfully navigate the current market dynamics, we are focused on 3 key areas within our business. First, we continue to work with brands, retailers and fulfillers of all sizes on helping them better understand the operational and financial benefits of shifting production volume to Kornit’s on-demand sustainable mass production digital solutions. — second, ensuring a successful rollout of our NPIs, including Presto max, Atlas Masspoly, Atlas Max upgrades and a new user interface for our Conitex offerings, in addition to the widely anticipated launch of the Kornit Apollo in mid of 2023. Feedback on the Apollo has been excellent, validating that our technology is superior and fits perfectly with their long-term growth plans. Simply stated, customers, including some of our largest strategics on apollo now; and third, returning to profitability.
While we have made some tough but necessary decisions recently, including a forcereduction in force last month — we continue to strategically review all aspects of our business, and we’ll continue to adjust our cost structure as needed without sacrificing our key growth initiatives, investments in long-term programs and our ability to support our customers. Okay. Two more comments before I turn it over to Alon. As announced this morning, our Board authorized the repurchase up to $75 million of the company’s ordinary shares. We believe this is a flexible way to return value to our shareholders while not adversely impacting our ability to execute on our strategic growth plans.
We also announced that alone will be stepping down as Kornit CFO in November for personal reasons. Alon has been an integral and trusted member of our executive management team and an extremely valued colleague to everyone here at Kornit. I am very proud of what Alon has built in joining the company, especially helping us navigate through the global tademic. We are all extremely grateful for all his accomplishments and wish him only the best in his future endeavors. Thank you, Alon.
Also announced was the appointment of Laurie Hanover as our new CFO. Lori has served as a member of Chrome’s Board of Directors since 2015 and served as our Audit Committee Chair and as a member of our Compensation Committee. Laurie knows the management team very well as a deep understanding of our company and brings over 25 years of CFO experience for multiple industries. Since I joined Kornit as CEO 4 years ago, Lauri’s advice and counsel have been invaluable to me. As such, I have no doubt that she is best positioned to energetically step into this role from day 1 to build upon and execute on Kone’s exciting long-term growth objectives. Welcome Lori.
With that, let me turn the call over to Alon for a closer look at the numbers and the outlook, along.
Alon Rozner
Thanks, Ronen, and good day to everyone. As Ronen mentioned, second quarter revenues were $58.1 million, net of $4.5 million noncash warranty impact related to a global strategic account, lower-than-expected DTG systems revenues drove the shortfall between the guidance we provided in May and our second quarter results, while consumables were in line with our second quarter plan. Top 10 customers were in line with our expectations and accounted for approximately 52% of total revenues this quarter.
Moving to margins. Non-GAAP gross margin, net of the impact of the warrants was 38.6% compared to 48.2% in the same period last year. The lower year-to-year gross margin was driven by materially lower systems revenues, mainly in the Americas region. Looking forward, we anticipate gross margins in the second half of the year to improve versus second quarter as revenues from consumables and services increased throughout 2022 and as we gain operational efficiencies on the fixed cost structure of the business.
Turning to expenses. Total second quarter non-GAAP operating expenses were $40.7 million for the second quarter as compared to $29.2 million in the same period last year. The main drivers for the increase were higher research and development expenses, which increased 39% year-over-year to $12.8 million or 22% of revenues and sales and marketing expenses, which increased 55% year-over-year to $19.3 million and represented 33% of revenues. G&A expenses increased 15% year-over-year to $8.6 million and represented approximately 15% of revenues.
As I mentioned last quarter, our second quarter spend was mainly associated with readying multiple NPIs such as the Atlas Max poly and the Presto Max as well as significant go-to-market and branding events, including Fashion Week Tel Aviv, Fashion Week London and the Fespa industry event in Berlin, Germany. We currently expect operating expenses level in the third and fourth quarter to be lower than the second quarter, in part due to lower marketing expenses and as we start to realize some of the benefits of the cost structure adjustments we have made in the business thus far.
Non-GAAP operating loss was $18.3 million, net of $4.5 million noncash warrants impact — as I mentioned, the substantially reduced level of second quarter revenues, coupled with materially higher sequential operating expenses drove the operating margin to negative 31%, inclusive of the noncash warrant impact of approximately 10%. We ended the second quarter with 1,009 employees, a year-over-year increase of 246 and an increase of 96 employees from the previous quarter, due mainly to additions from the acquisition of the Soma.
As Ronen mentioned earlier, we recently made the difficult but necessary decision to complete a focused reduction in force last month. Non-GAAP net loss for the second quarter was $15.6 million or a loss of $0.31 per basic share as compared to non-GAAP net income of $10.5 million or $0.22 per diluted share in the same period last year. Adjusted EBITDA loss for the second quarter was $16.1 million as compared to adjusted EBITDA of $11.4 million in the second quarter of 2021. Our cash balance, including bank deposits and marketable securities at quarter end was $705 million.
During the quarter, receivables decreased as expected due to a healthy collection associated with closing sales late in the first quarter. Inventories increased due to systems that are waiting for shipments to one of our customers who is experiencing delays in the completion of their new production facility. In addition, during the second quarter, we closed the acquisition of the Soma. As Ronen mentioned, our Board authorized a share repurchase program of up to $75 million, which, as an Israeli-based company is subject to receipt of Israeli court approval. The Board and management agree that using a portion of the cash on our extremely strong balance sheet to repurchase shares is in the best interest of the company and our shareholders. Further, we believe that the share repurchase program won’t impact our ability to execute on our growth plans.
Turning to guidance. We continue to adapt to the current market dynamics by strategically looking at all aspects of our business and adjusting as needed without sacrificing key growth initiatives, investments in long-term programs and our ability to support customers’ needs. We have a good line of sight for the third quarter. We currently expect revenues to be between $66 million to $70 million based on the closing of some of the transactions that were delayed from the second quarter, our current systems backlog and the expected growth contribution from consumables and services revenues.
We further expect fourth quarter revenues to be at the similar levels to the third quarter with a higher mix of consumables. We — we anticipate operating margins in the third quarter to be in the minus 15 to minus 11% range with EBITDA margins in the minus 12% to minus 8% range. We further expect fourth quarter operating and EBITDA margins to improve sequentially as compared to the third quarter. I will remind everyone that all guidance provided today assumes 0 impact from the fair value of issued warrants in the quarter with our global strategic account.
And finally, as Ronan said, in about 2 months’ time, I will be leaving Kornit for personal reasons. This was an extremely difficult decision for me as I truly love working at KONI and with its entire world-class team. I have no doubt the company is perfectly positioned to capture the tremendous opportunities ahead and wish everyone here only the best. I know the company is in great hands with Lori. Having worked so closely together since my time here, and I look forward to working with her to transition the CFO role.
And with that, let me turn it over to Laurie.
Laurie Hanover
Thank you, Alon. I joined Ronen in thanking you for all of your accomplishments and tireless efforts as our CFO over the past 2 years. I look forward to working closely with you through the transition and wish you the very best. For me personally, I’m very excited to join this amazing company at this point in its evolution and to working closely with the entire management team to execute on our long-term strategy and drive value creation. Having served on the Board for the last 7 years and understanding the company, I strongly believe that the best is yet to come. I look forward to personally meeting many of you in the investment community over the coming months.
Andy?
Andrew Backman
Great. Thank you, Laurie. Before we open it up for Q&A, I want to note that Ronan is joining us remotely today due to the passing of his mother. All of us want to express our deepest sympathies and condolences to Ronan and his family.
Jamie, will you please open it up for Q&A.
Question-and-Answer Session
Operator
Ladies and gentlemen, at this time, we’ll begin the question-and-answer session. [Operator Instructions] Our first question today comes from Jim Suva from Citigroup.
Jim Suva
I have a question and a follow-up. You mentioned since your July 5 negative press release that many of the hardware units or printers have been sold or in the process. I just want to see, are they all going to be sold in Q3? Are they lingering into Q4 or some cancellations? Just kind of an update on the Q4 shortfall due to the inventory digestion? And then I have a follow-up.
Ronen Samuel
So Jim, thank you for the question. If I understand or you mean the shortfall that we had in Q2 due to the site readiness of our strategic global customer. Am I correct? This was the question?
Jim Suva
Yes. Yes.
Ronen Samuel
Yes. Okay. So I would start by saying we have a great visibility and great working relationship with our global strategic customers. We actually met with them a month ago here in Israel. And a week ago, there was management meetings with top senior management from our strategic customers in the U.S. and we got visibility to the continuous development on the site readiness across the world. Specifically on the Q2 site readiness, this site is being ready these days. We have seen the process of shipment of the systems to decide. We are going to install those systems during Q3 and Q4. And therefore, you will — we will always see the revenue recognition on those systems delay for Q2 during H2. On top of that, there are other sites that have been deployed and on the process of construction. Those sites, we got an update that pays a very good progress. We will start most likely to ship systems to those sites during Q4 and the beginning of 2023.
Jim Suva
And then my follow-up question was on the consumables. I believe in your prepared comments, references made that Q3 and Q4 should grow. Are we talking, I assume, sequentially quarter-over-quarter as normally people buy more stuff in the second half of the year. But also I wanted to know, is the magnitude tempered down a fair amount from prior years or similar perhaps so we think about that comment as far as the magnitude about the growth?
Ronen Samuel
So first of all, the comment was regarding sequential. You will see Q3 higher than Q2 and of course, Q4 higher than the 3%. Q4 is always the peak season, end of Q3 as well. So this is the comment — now we have much better visibility. We don’t see the volatility that we had in Q1. We start to see more normalization into — and now that we are almost in the middle of Q3, we have great visibility on the consumable growth. We see some customers going back into the growth phase. But in H1, they were declining year-over-year. We expect to see H2 supplies higher. We will see a growth versus H2 of 2021. So H2 2022, you will see a growth on supplies, but in a lower pace versus what we have seen in 2021 compared to 2022. So there will be growth, but the growth is still lower than what we saw in previous years.
Operator
Our next question comes from Rod Hall from Goldman Sachs.
Rod Hall
I guess I wanted to kind of come back to the big picture here. We know that capital spending in a lot of areas has been weaker. I mean, I think it’s obvious the macro is causing a lot of uncertainty out there. But then, Ron, in your comments on the large customer, it sounds like you’ve got pretty good visibility there. And I’m just curious, as you look out into next year, and I’m not really asking for guidance, but I’m curious about your visibility. Do you feel like the order pipeline looking into next year looks pretty good? Do you think you’ve got visibility on what might happen next year? Is it just sort of a wait-and-see situation with the customers and how they’ll behave as we enter the beginning of next year.
Ronen Samuel
Yes. So I would start with saying that it’s too early now to give any direction for 2023. I will give you some direction, but it’s too early to really forecast to give guidance. What we see right now, we have much better visibility in Q3, and we gave a clear guidance and we feel very confident about the guidance we gave to Q3. We’re also starting to get better visibility to Q4. It’s too early to talk about visibility for 2023. Other than our global strategic accounts that we are working on a 3-year plan, and we have a very clear visibility for 2023 and their deployment plans on other areas or other customers, which is still too early to forecast 2023. Now we should remember that 2023 is based on many of the new products and the base that we have done in the second half of 2022. And we start to see a really strong momentum on that. If it’s the Atlas Max, if it’s Atlas Max Poly, which we didn’t have before, the Presto Max is gaining really nice momentum and nice traction. We were talking about the upgrade of the Atlas to Atamas. We have done a change in this kit, and we start now to deploying the kid. We start to see very nice momentum.
Actually, one of our biggest customers decided to deploy the entire fleet of paces to update to Aramark — and we expect that 2023 will be say strong in terms of upgrades to the Atlas maxes. And to remember, in the mid of the year, we are going to release the Apollo the anticipated Apollo, which is a totally different ball game going to a totally different market as a replacement, and we already have a very, very nice demand for this machine for the systems. Many of our key customers were here in Israel, and we introduced a system we’ve got amazing feedback on the system. I can tell you there were people even this week saying we want it now. We would like to be part of the beta. So we expect 2023 to be strong. We expect 2023 to be stronger than 2022, but it’s too early now to give any indication on the growth rate of 2023 versus 2022.
Rod Hall
Okay. And then, I also wanted to follow up on the OpEx and operating margins. Maybe a question for you, Alan, just sort of what the trajectory expected there is? When would you expect an improvement in operating margins? And I guess, how are you thinking about operating cost control in different revenue scenarios. Do you feel like you kind of have taken all the actions that you could take in any scenario? Or do you think of things – the broader macro gets worse? Would you look to cut more? I’m just kind of curious what you’re thinking there? And if you can give us any guidance on – or thoughts on operating margin trajectory. And by the way, Alan, great working with you as well.
Alon Rozner
Thank you. Thanks, Talos. So operating margin is impacted by revenues, obviously, and the higher the revenues are in general, the better margins, gross margins are as the impact of the fixed cost getting lower. As we go towards the end of the year, third and fourth quarter, we expect higher mix of consumables at higher margins. So we do expect to see higher margins towards the end of the year. So this is one driver to improve the overall operating margin. In terms of the OpEx, so we said before, I mean, second quarter was high or the highest in the year in terms of OpEx, mostly because of the special events that we had in the quarter, and we expect lower OpEx in third quarter. We don’t see a big impact of the cost adjustments we’ve done last month in third quarter, somewhere in programs and some was in reduction in force. So we do see some benefits or savings in third quarter. We expect to see higher savings in fourth quarter, having a full quarter of savings as a result of the reduction in force.
And we continue to look at our business. We said that we are committed to profitability, and we are taking measures to ensure that we will be profitable as soon as possible. Again, theoretically, we can do it very fast, but the cost will be very high in terms of sacrificing the future, and we don’t believe this is the right thing. So we do it in a responsible way, reduce wherever we can with a clear target to get to profitability as much as possible.
Ronen Samuel
Maybe I will add one more thing on that. And just to start on what Alon was mentioning. We had a long discussion with the Board of Directors and the discussion was, do we want to move back to profitability already in Q3. We could have done it by cutting even more cost it was clear with the Board and the management that the potential of the company, the market, the place that we are, this is not the time to cut. We see a massive growth ahead of us in front of us. We’re coming with new products. There’s a lot of development in R&D in many aspects, and we need to be very careful where do we cut in order able to sacrifice in our growth trajectory moving forward. So we’re doing it in a responsible way where we can cut, but we are committing to moving back to profitability as soon as possible. You will see an improvement in Q3. You will see an improvement in Q4 and definitely in 2023.
Rod Hall
Great. Okay. I appreciate the answers, guys.
Operator
Jamie, the — at this time, we have no further questions. Thank you very much. Ronan, let me turn it over to you for some closing remarks.
Ronen Samuel
Yes. Thank you, Ed, and thank you, operator, and thank you all again for joining us today. As mentioned earlier, our vision remains unchanged. We are taking actions to successfully navigate current market dynamics, and we have huge confidence in the long-term fundamental of the business. I would like to thank all the amazing cone team and express appreciation for the continued support we have received till now on the investment community. We are working hard to execute on our plans to capture the massive opportunities ahead of us.
And I would like to thank you again and hope to see many of you in the upcoming investor conference content that we are having in September. Andy, the floor is yours.
Andrew Backman
Thank you, Ron, and thank you, Alan, Laurie, and everyone for joining us today. As always, please do not hesitate to reach out to me directly, should you have any follow-up questions. Tammy, can you please close the call.
Operator
Ladies and gentlemen, at this time, we’ll end today’s conference call. We do thank you for joining today’s presentation. You may now disconnect your lines.
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