Greetings and welcome to the Kornit Digital Ltd. Third Quarter 2019 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Tom Cook. Please go ahead, sir.

Thank you, Operator. Good afternoon everyone and welcome to Kornit Digital's third quarter 2019 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 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 objectives, plans, strategies, statements of preliminary or projected results of operations or financial condition and all statements that address activities, events or developments that the Company intends, expects, projects, believes or anticipates will or may 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. 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 Annual Report on Form 20-F filed March 26, 2019, which identifies specific risk factors that may 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, whether as a result of new information, future events or otherwise, except as required by law. Additionally, the Company will be making references 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. On the call today, we have Ronen Samuel, Kornit's Chief Executive Officer and Guy Avidan, Kornit's Chief Financial Officer. At this time, I would now like to turn the call over to Ronen. Ronen?

Thank you, Tom. Good evening and thank you for joining our third quarter 2019 earnings conference call. Today, I will provide a brief summary of our strong performance in the quarter, followed by some key business updates as we continue to execute on our short and long-term strategy. I will then hand over the call to Guy to cover our financials. We are excited to report our third quarter results marked a record quarter for Kornit in industrial system sales and continuation of the strong momentum we have demonstrated all year. We continue to revolutionize the fashion, apparel and home decor markets by fueling the transition to on-demand and sustainable digital manufacturing and I am very pleased with the progress we are making with our growth strategy. Revenue in the quarter was $44.6 million, net of $5.1 million of warrants related to a global strategic account. As a reminder, our guidance policy assumes zero impact from warrants. This period, we experienced a significantly larger warrants impact of $5.1 million compared to $1.7 million in the prior year, resulting from an increase in business volume with a global strategic account and a higher share price. Overall, our third quarter business volume grew 26.7% during the period, driven by strong adoption of our recently introduced Atlas, Poly Pro, and Presto systems and continued adoption of our HD platforms. During the quarter, we sold multiple Atlas and Poly Pro system as our strategic customer adopts these new platforms in preparation for the peak holiday season, positioning us well for a peak consumable revenue as these systems ramping up for full capacity. We see new strategic customer including leading brands, increasing the focus on partnering with us, as they transition to digital production. This led for example, to new wins with the key players…

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 pro forma results. Our third quarter non-GAAP pro forma results reflect adjustments for the following items: stock-based compensation expenses totaled $1.8 million; total amortization expenses relating to the acquisition of intangible assets in previous years in the amount of $249,000; taxes on income related to non-GAAP adjustment in the amount of minus $62,000; a non-cash deferred tax benefit in the amount of minus $347,000; amortization expenses relating to the acquisition of Hirsch's intangible assets of $78,000. The Company has significant operating lease liabilities in foreign currencies and incurred foreign exchange gains or losses from the revaluation of these liabilities. These gains and losses may vary from period to period and do not reflect the true financial performance of the Company. This quarter, foreign exchange losses associated with ASC 842 were $242,000. A full reconciliation of our results on GAAP and non-GAAP basis is available in the earnings press release issued earlier today and on the Investor section of our website. Third quarter revenue, net of the $5.1 million warrant impact increased by 18.6% to $44.6 million versus $37.6 million in the third quarter of 2018 and increased 1.6% sequentially. Third quarter business grew 26.7% year-over-year and 7.4% sequentially. Revenues grew to record level this quarter, driven by robust demand for our new high throughput product and strong demand from our strategic and global partners, especially in North America. Services revenues from the third quarter were $3.9 million, net of $0.2 million warrant impact, accounting for 8.7% of total revenues. The decrease in revenues of 8.3% year-over-year and 35.6% sequentially was predominantly driven by lower revenues from upgrade to HD technology.…

Thank you, Guy. Now, we are ready to open the call for questions from the audience.

[Operator Instructions] Your first question comes from the line of Tavy Rosner with Barclays. Please proceed with your question. Your next question comes from the line of Brian Drab with William Blair. Please proceed with your question.

Congratulations on another good quarter. Just - on gross margin, I'd like to just make sure that I understand the dynamics here and see if you could add any more color. So, you said mix was a headwind in the quarter. I'm wondering why we would be down still 300 basis points year-over-year. If you also have the positive effect of going direct and taking Hirsch out of the mix, that should be about a 300 basis point tailwind. So if you adjust for that, gross margin is down even more 500 basis points, 600 basis points year-over-year. And I'm wondering if you could just talk about how significant this mix shift is and specifically are you seeing degradation in gross margin in systems or you're seeing degradation in gross margin and consumables at all?

So, as we said in the previous call that we expect the second half of the year to be above 50% and we were above 50% without the warrants impact. We mentioned before and we still faced it in the last quarter. We launched three new products and gross margin is not perfect from this product yet due to ramping up. But we mentioned the fourth quarter in terms of product mix - as usual, due to seasonality, the fourth quarter is characterized with more ink and as a result, we expect gross margin to behave better.

So, I'll just add one more comment. Looking forward, we see gross margin improving as we discussed on previous calls. So, we continue to sell more high-end products. So, the mix is favorable in terms of the gross margin and we can see the growth coming also from impressions on the supply side, expecting in future quarter to see an improvement on the gross margin above the point that we are today.

And then, just to clarify, the new products and their impact on the gross margin, I was under the impression that the Poly Pro would be pretty immediately accretive, a tailwind to gross margin, and is it the Atlas and the Presto that are weighing on gross margin somewhat as those ramp?

The main issues on the gross margin is more on the ramping up of those systems. So, it's more on the service and support side, and this is why you see the impact on the service side which impact overall gross margin. So, it's less on the - it's not on the ink and on the hardware, a bit on the hardware, because we are still ramping up the production on all those three machine, but it's more owned on the service and support side.

Eventually as we said before, Brian, each product will carry higher gross margin than the product before. The Atlas will carry higher gross margin than the Avalanche and so is the Presto versus the Allegro. As mentioned, it take some time to ramp up.

And just my last question - just to be clear, the Poly Pro then, in terms of gross margin on the system itself is not in line with there. It's below the average gross margin for your systems. Is that fair? Is that right?

No.

No? So that is - the Poly Pro is already above it?

Yes, correct.

Okay, got it.

It's above.

Your next question comes from the line of Tavy Rosner with Barclays. Please proceed with your question.

So, this is Peter on for Tavy. I apologize for the technical difficulty earlier. My question was around strategic accounts and specifically the seasonality. Now that you have more accounts in the mix, especially large ones, how should we think about the prior seasonality in the fourth quarter in terms of mix of systems and consumables?

So, we have seasonality and we see it very clearly this year at strategic account ordering system, mainly in the second and third quarters. So, we hardly will see any of our top strategic account ordering in the fourth quarter. So, it's more medium size and small size account ordering systems in the fourth quarter. However, the fourth quarter is always the peak season for our entire installed base and definitely for our key strategic accounts. And so, we will see a mix - favorable mix into the supplies and overall impression from our installed base in Q4.

And if I could have a follow-up, is that - should we expect that to filter through on the services side?

On the services side, we expect normal behavior during the peak season.

Okay. Thank you.

Nothing special.

Your next question comes from the line of Greg Palm with Craig Hallum Capital Group. Please proceed with your question.

This is Danny Eggerichs on for Greg today. Thanks for taking my questions. Just starting with Amazon revenue, I guess just the breakdown. I was wondering if any of that revenue this quarter was from system contributions and if there was, was that a result of existing facility expansions or possible new facility openings. Just a little color there would be helpful.

So, as you know, unfortunately we cannot relate to a specific customer business and mix between hardware and supplies business with all the strategic account specific with the global strategic account is very, very strong. You can see it with the warrants as well, the impact on the warrants, it's - the relationship is as best as ever and we see great momentum moving forward.

All right, thanks. And then, I guess, looking back at the three big product introductions earlier this year, I guess, just breaking them in two categories, how much of that revenue has been driven by existing customers and I guess - and how much is that - of that has come from new customers and how are you kind of seeing the adoption and ramp-up of those new systems differ between those two.

It's a great questions. I don't have the exact number, but I would say it's about 50-50 between existing to net new and the difference is with the Poly Pro and the Presto, I would say, is more tending into net new customers that we are penetrating, net new brands that we are penetrating. Some of them big account, some of the mid-sized accounts, but we see the shift into net new accounts. On the Atlas, I would say it's more tending into our current installed base that now adding additional capacity, but we see also net news are starting with that as well.

And then, just last one from me, in the APAC region, are you seeing any impact from the macro volatility going on in the Hong Kong region. I'm not sure if you can quantify of how large that area is in the APAC region and if you are seeing any impacts?

So, our main business in Asia Pacific currently is focused on Japan, South-Pac, Korea and China, of course, less in Hong Kong. While we have the headquarter in Hong Kong, our businesses is outside of Hong Kong. So, we don't see an impact directly on our business. We do have the impact on the team of course in Hong Kong and we are taking care very closely on what's going on there and contact with our team there and supporting them. We see a very, very nice growth coming out of Japan and we see a real adoption both for our new products like the Poly Pro and the Atlas, but also the existing product.

Your next question comes from the line of Jim Suva with Citigroup. Please proceed with your question.

Could you just revisit the topic a little bit about the margin pressures in the product ramping and maybe it's just because I'm not the smartest person on this call, but if you can help me understand that the pressure is kind of like the duration that we expect the pressures in the margin ramping. Is it kind of like three quarters or should we think about the kind of always constant - where you're always inventing and having meetings come on. So, why wouldn't it be kind of more steady state about ramp headwinds and then layering off of efficiencies? Thank you.

So, it's not - it's not a margin pressure due to competition. We mentioned that before that we will see a gradual increase in gross margin. We said it's going to be above 50% in the second half and we also mentioned in the fourth quarter due to seasonality, we expect even better gross margin. Not every year we launch three very material product and the gross margin relative decline here is actually due to cost of good, not revenue.

But we already see an improvement, for example, in the cost of goods on the Atlas and you will start to see the positive impacts in the Atlas as we are selling it in big quantities. So, we will start to see an improvement in gross margin in the coming quarters.

Your next question comes from the line of Patrick Ho with Stifel. Please proceed with your question.

Ronen, it's encouraging to hear that new customer traction for a lot of new products, which at the highlights, the ability to grow the top line over the next several years. Can you give a little bit of color on the type of buys and what I mean by that is, are these new customers buy maybe one or two systems initially to try it. I don't want to say, evaluate the system, and you'll see these multiple system buys down the road as they increase capacity or are they really starting off at a kind of multiple system buys once they see the product.

So, there is no one clear answer for that. It's different from customer to customers and from segment to segment. If you're referring specifically to the brands, what we can see on the brand side, we see big-sized brands - really that biggest size brands and also the mid-sized brands going into on demand manufacturing, needing Kornit solution working very, very closely with us. Usually, those brands are starting with a few system, one or two system, evaluating starting a pilot and then they're going to full capacity and growing. So, we are in a stage with different brands and different evaluation. Some of them moved already to full production and they're scaling up. Some of them in early stage of evaluation as for customers, there's all kinds. We have the example in Japan that I mentioned. It's a new customer that is focusing on polyester and started with two Kornit Poly Pro. We see customers that are starting with multiple Atlas's, but usually, they're starting with one or two units, taking it for about six months up to one year, scaling the business and then increasing capacity.

And maybe as my follow-up question, given your strong growth in the Asia-Pacific region, is it coming from any one specific product where you're really seeing strong traction or is it very broad-based across all your product lines?

It's across, I would say, all product line, more on the mid range, more on the Avalanche HD. The Avalanche HD has a great traction in Asia Pacific. The Poly Pro, specifically in Japan, is doing fantastically. We start to see more adoption of the Atlas's across Asia Pacific. So, it's all of our product portfolio.

Your next question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed with your question.

Just a question on the service business. And thanks for a little bit of color on that. The decline that you're seeing. I mean, clearly you had a strong comparison a year ago, but the HD upgrade. I mean, how should we think about the service business and the profitability that you're trying to achieve in that area. It sounds like there are two factors. Number one, on the revenue line, but also number two on the fact that you continue to have to increase sales and support. So, as you guys have talked about targeting bringing that business to breakeven, when do you see that occurring?

As we said in the past, we still expect breakeven in services mid 2020.

Question on the brands and I know you can't disclose customer identities in most instances, but is there a way for you to give us a better feeling for how many of the brands you've penetrated thus far, whether it's in this past quarter or year-to-date? Any color along those lines would be helpful because it does sound like you're getting traction both with Atlas and Poly Pro with the brands.

So, I can say that we really have a great traction with brands and this is only the starting point. I cannot relate to specific numbers and names, other than Adidas that we already mentioned. This is the second time that we are doing demonstration, live demonstration together with Adidas and second time we did now in United Print a month ago. But as I mentioned before, we have mid-size brands buying our equipment. We have big-sized brands that some of them buying themselves and some them working with their fulfillers directly with us buying our systems. So there is a lot of traction. I can tell you that we are working in parallel on multiple - in multiple projects, exciting projects on a global base.

And if I may, last question for me. In Europe, it looks like in the EMEA region, you showed growth, but it looks like it's fairly modest. And I'm wondering if you're seeing any sign of - any kind of macro-related weakness that might be resulting in some hesitancy on the part of customers there?

So, I think, we see a very nice growth in Europe was something that misleading. Last year, the same quarter, we had a big deal with a global account in Europe that, this is the reason why you don't see, year-over-year. It was a very strong quarter for us last year. Overall the business in Europe is doing very well. We recruited very strong talented team there. We have the momentum out of ITMA. The funnel looks strong entering Q4 with strong pipeline. So, we feel very comfortable - confident about our European business, and we don't feel slowdown like in other industries.

Your next question comes from the line of Chris Moore with CJS Securities. Please proceed with your question.

Yes, maybe more of a big picture question, I mean 2019, obviously it's been an exceptional year rolling out new products and platforms. When you look at the $500 million run rate goal for 2023. Does it assume significant additional new product rollouts or does the kind of existing base really get you there?

So first of all, we are tracking, as you mentioned, 2019 very well on a direction for the $500 million run rate in 2023. And at this point of time, we feel very confident that we will continue this structure in the coming years. And the growth is coming from different areas. One is from the current new portfolio that we just released. We're just starting the growth on the Atlas. We're just starting the growth on the Poly Pro. And the Presto, we just released it and we have great, great traction on the Presto. So each of those products will bring growth. Of course, we will continue to innovate and bring new products and new solution to different market in the coming years. And we are building the growth also on new system that will come in the coming years as well. Major growth is coming from new segments that we are entering. The brands are a big, big growth engine for us, working directly with the brand now, we can really suit. We have a solution that meet the needs for the brands. We can see all the brands are moving to on-demand manufacturing. They're talking about it. All of them talking about sustainable production and the way to do on-demand in sustainable way is really using digital manufacturing and Kornit is the only solution that they have today in the marketplace. So, this is a major growth for us. Also, penetrating the polyester which is 20% of the global apparel market is about - is polyester. So this is a new market for us. And we continue to see a huge growth from the online segments. We can see new players are coming into the online and existing player going really, really fast, both on the global strategic account, but also mid range key accounts that are going very, very fast on the online production. And the last segment is promotional items. We can see as well their growth penetrating to net new screen printers that focusing on the promotional item. This is another growth engine. On top of all of that, we of course working very hard on the workflow and other solutions that we are bringing around our systems and we will start to see growth in this direction in next year. And the last point is really the growth that's coming from expansion of our teams, feet on street. We were very, very small team, selling the Presto or selling the DTG. Now, we're starting to have much better coverage. We're still missing coverage in many potential - big potential territories and we will continue to expand our team and services and the growth will come also from geographic expansion.

[Operator Instructions] Your next question is a follow-up from Brian Drab with William Blair. Please proceed with your question.

Had to take a quick break from emailing back and forth with the data aggregators trying to clarify what your real earnings result was. About 20 emails back and forth already regarding the warrants. My last question is just, if you look at next year because I know that this is a third quarter call, but I mean it's November and we're all trying to model 2020. So far, since you announced, Ron, in the target of the $500 million and that requires 25% to 30% revenue growth you're delivering on that. And if you were to do that in 2020 which I assume is roughly the plan, what kind of growth rate would you expect for operating expense just relative to revenue growth. Is it the year 2021 revenue growth will far exceed operating expense growth as those level off or is that investment in the team going to continue significantly, in the 2020?

So, Brian, first, as you know, we're talking about next quarter only, but since you mentioned the warrant before. So, just to let you know that November 2019 - actually very recently, Financial Accounting Standard Board, the FASB, issued final guidance that requires entities to measure and classify SBC shared-based compensation that are granted to customers in conjunction with revenue arrangement and are not exchange for distinct goods and services in according with ASC 718. What it means actually that it's going to be much easier for us and for you guys to predict the warrants impact in the future. This new standard is actually going to be effective next year, but management can have an early adoption. It is permitted based on the ASC 718. And obviously, we will give more data in the future regarding the warrants. We will be able to discuss OpEx of 2020, leverage and other things in the next call.

You can't - you won't even go directionally above or below revenue growth at this point. Sorry to push on that, but it would be helpful.

As Ronen mentioned, when you look back and when we guided for $500 million, you could imagine some CAGAR and this quarter the CAGR was above 26%, which means we're on track or above track actually. That's the plan.

Okay, all right. Thanks very much.

As for the OpEx, as we mentioned in the past, we will continue to grow to the $500 million run rate in 2023 while improving our gross margin and improving our operating profit, okay, during this period. So you should see continued improvement on the operating profit as well.

Ladies and gentlemen, we have reached the end of the question and answer session. And I would like to turn the call back to Ronen Samuel for closing remarks.

So, thank you everyone for joining on today's call. Again, I would like to thank all of our employees for their hard work and dedication and our customer for the continued support and finally for our investors for the trust they have in Kornit. I look forward to updating everyone on our fourth quarter call and I wish you have a beautiful and good evening. Thank you very much.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.