Good day everyone and welcome to the Kornit Digital Ltd. Fourth Quarter 2019 Earnings Conference Call. As a reminder, today's conference is being recorded. After the prepared remarks, we will provide instructions to conduct a question-and-answer session. At this time, I'd like to turn the conference over to Kelsey Turcotte of The Blueshirt Group. Please go ahead.

Thank you, operator. Good afternoon everyone and welcome to Kornit Digital's fourth quarter and full year 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 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 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 Security and Exchange Commission including the company's Annual Report on Form 20-F filed March 26th, 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 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. 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, Kelsey. Good evening and thank you for joining us on this afternoon earning call. I'm very pleased to report that we delivered a strong fourth quarter 2019 which cut off a year of outstanding growth and progress for Kornit. It also marks completion of the first year of our five-year journey to become a $500 million revenue run rate business and objective we are very much on track to achieve. The industry we serve is undergoing a perfect storm into on-demand textile manufacturing in a sustainable way. As a look at everything the team accomplished in 2019, I believe that our leadership position to capture this opportunity continues to widen. 2020 outlook looks very promising and I believe it is time for us to continue investing and accelerate our efforts across the Board in order to execute on the huge market opportunity ahead of us. Before we continue with our Q4 results, I would like to highlight a few key achievements of this remarkable execution year for Kornit. We delivered extremely strong financial results driving both growth and profitability. We successfully launched the innovative Atlas Poly Pro and Presto system all are experiencing great momentum and open new market for us. We made significantly progress with some of the world's leading brands. We significantly grew our business with strategic accounts while penetrating many net new customers. We accelerated our DTF business. We scaled and professionalized our go-to-market across regions and we executed successfully on our go-direct sales model in North America. Turning to Q4, we finished 2019 on a very strong note, delivering revenue of $48.7 million net of $1.1 million of warrants related to a global strategic account. Overall, it was a very strong close to the year as business volume grew 27% during the period, driven…

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 fourth quarter non-GAAP pro forma results reflect adjustments for the following items, stock-based compensation expenses which totaled $2 million; amortization expenses relating to the acquisitions of intangible assets in previous years in the amount of $108,000; taxes on income in the amount of $331,000; and $376,000 for expenses relating to acquisition in 2019. The company has significant operating lease liability in foreign currencies and incur foreign exchange gain or losses from the reevaluation of these liabilities. These gains and losses may vary from period-to-period and do not reflect the true financial performance of the company. For the fourth quarter, foreign exchange income associated with ASC 842 were $530,000. A full reconciliation of our results on GAAP and non-GAAP basis for the quarter and for the year is available in the earnings press release issued earlier today and on the Investors section of our website. On November 11, 2019 the FASB issued ASU 2019-08 which clarifies the accounting for share-based payment issued to a global customer that are not in exchange for distinct goods or services. Under the new guidance entities should use a fair value-based measure to calculate such incentive on the grant date rather than upon the vesting date. We early adopted the new guidance as of January 1, 2019 and will use the fair value of the unvested warrants on the adoption date rather than on the later vesting date in order to determine the reduction of the transaction price. The adoption of ASU 2019-08, resulted in adjustment of $4.6 million to increase our Q1 to Q3 revenues. We are restating the first three…

Thank you, Guy. With that, we are ready to open the call for questions.

Thank you. [Operator Instructions] We'll take our first question from Patrick Ho with Stifel. Please go ahead.

Thank you very much and congrats on a nice 2019. Ronen, first can you provide a little more color on new products traction? And whether you're seeing a greater existing customer base leveraging the new products into additional markets? Or are you seeing more new customer adoption of these solutions? And maybe just kind of a follow-up on the existing customer and given that they've been Kornit's customer for some time, how quickly can you turn those I guess new product adoptions into volume orders?

Okay. Good question. So regarding the momentum, we see actually great traction or momentum on all new product introduction. Starting with the Atlas, we already mentioned that we sold more than 70 units in -- during 2019. We see the momentum continue very, very strong into Q1 and the rest of the year. So Atlas is really, really looking very strongly followed by the Poly Pro that opened for us totally new market getting into many, many net new customers that we couldn't reach before. Now with the Poly Pro really a unique solution, not only compared to digital, but even better than the conventional solution in the market. The Presto is really hot. We had a very strong Q4. We are starting with a very strong Q1 on the Presto. We are entering into a totally new market. Mainstream fashion manufacturers are using it. Brands are behind it. We see really accelerated goals. We have a very unique solution best-in-class. This is really on-demand manufacturing in a sustainable way and we see a huge acceleration on this front. As for the mix, we see our customers adopting the new products some existing customers adding on top of the Avalanche -- HD Avalanche they're adding the Atlases and also the Poly Pro. We have customers that prefer to stay with the Avalanche HD. So we continue to see also growth on the Avalanche HD. So overall, we see a very, very nice mix of products turning to more the high-end side of the product.

Great. Maybe as my follow-up question in terms of the services business. You talked about the consumables growth on the call in terms of growth as you get more systems into the marketplace. How do you look at the services growth given that services typically follows on about a year after warranties fall off? How do you see that business growing in 2020 and beyond?

So we have changed our policy regarding the contract -- service contract starting -- beginning of 2019 and actually we are selling all our products with a contract. So it's a bundled contract into every sales of new units and we see a major increase in contracts -- service contracts in the field also for installed base that are using our systems are moving into service contracts. By that we have much better view on recurring revenues that will come from the service. And as you can see, you can see, the growth over the whole year-over-year on the service side. And as we mentioned, we believe that 2020 will be the year that we will end breakeven on the service side overall.

Great. Thank you.

Next, we'll move on to Peter Zdebski with Barclays.

Hi. This is Peter on for Tavy Rosner. I wanted to ask about some of the product traction on the Poly Pro. You did disclose the number of Atlas shipments that you've delivered. Can you give us a sense of how well the Poly Pro has been tracking compared to that? And then I have a follow-up.

Yes, we did not disclose the number of units we sold on the Poly Pro. I can say that we sold more than we planned during 2019. We expect to see a major acceleration during 2020. We are dealing with few major brands fashion, but also sports and athleisure brands, but starting to adopt the Poly Pro and will accelerate the adoption and the business during 2020. So we expect this business to grow. Plus we are putting a lot of effort to penetrate faster in this market. We believe as I mentioned, we have a unique solution. There are hardly any competitors definitely not on the digital side, but also we believe that we have a very strong value proposition versus the analog side. And due to the margin advantage that we have on this product, we are pushing it very strongly to the market. And we have focused into continue to grow the market with existing customers, but we're working very closely with many brands to accelerate the growth.

Great. And then I have a follow-up on services just specific to the fourth quarter. It looks like you had a record quarter in sales there. But would you attribute that to the new plans? Or is it more service on the more industrial systems that you're selling? And how would you account for that?

It's actually all of the above. One there is an ongoing growth in services. We -- only three or four years ago we started to sell services. So there's a lot of catch-up on the installed base. And what Ronen mentioned before, it's a bundle. You cannot really buy a high throughput Kornit machine today without committing for a service contract.

That's great. Thank you.

We will next take Brian Drab with William Blair.

Hi. Thanks for taking my questions. First on the hiring. So you hired about 100 people in 2019. Can you just break that down roughly give us the rough number of hires by function, marketing, service et cetera?

The number 103, this is actually net. We're not really breaking it down to department, but we can say that predominantly most of the new -- or most of the increase in headcount is related to customer-facing and services activities. So you can see it both and if you look at P&L, you can attach it both to OpEx and COGS.

Yes. I would just add that we have managed during 2019 to attract really strong talent to our organization. Kornit is becoming really a company that's attracting many, many experienced people into the company. And we are very, very pleased with the growth and the type of people we've managed to hire doing this.

Okay. Thanks. And what percentage of revenue would you estimate DTF might account for in 2020? Maybe of system revenue or total revenues…?

Yeah. Yeah. We are not disclosing. We are not breaking it down. We are not breaking it down between DTG to DTF at this stage. We -- as I mentioned, we can see as very strong growth on the DTF, but DTG by far is a bigger business and we can see also a very, very strong growth in the DTG. So it's great to have another pillar of course, but the DTG has continued to grow very fast. So I don't think that the mix overall in terms of revenue will change much.

Okay. Is it fair to say though that DTF wasn't really material to overall results in 2019, but would be in 2020?

So DTF was very material for Q4 results. As for 2020, it – overall, it will be material.

Okay. Okay. And then maybe just one last question for now. You mentioned that you have some good visibility for 2020 through discussions with some of the larger strategic customers. Do you expect that you'll have any lumpiness in your revenue as you move through 2020? Are there any quarters that you can already tell are going to be bigger quarters than others in terms of revenue? Or does it kind of increase sequentially throughout the year?

No. At this stage, we -- as I've mentioned we have a very good visibility. We are working with few of our strategic accounts on a major expansion globally and we started production on those systems. So we really have a clear direction when we need to deliver them. We feel very, very, very good about 2020 about the growth. And no, we don't see any lumpiness during the quarter -- between the quarters.

Okay. Thanks very much.

Thank you.

Thank you, Brian.

Next we'll move on to Jim Suva with Citigroup.

Hi, there Ronen and Guy. This is Michael Cadiz for Jim Suva, Citi. As we look into 2020, would you mind giving us some color on the depth of your brand pipeline with which you were talking with or you'd like to work with? And any expectations that you may have in converting those conversations?

Yeah. So, we are working with many top-tier brands both on the DTG and DTF. We see engagement also for midsized brands across the board, across the world. We see growth there. A few of those big brands already using our systems few of them in trials and few of them are scaling up their businesses. I recommend you to come to our event in April in Israel. You will have the opportunity to see those brands and to understand who is behind it, and I'm sure that they will share much more information when -- during the event. So it will be a great opportunity to have much more color on what's going on.

Okay, Ronen. Thank you very much. Have a good day.

Thank you.

We'll move next to Jim Ricchiuti with Needham & Company.

Hi. Thanks. So I'm trying to get a little better understanding of how we should be thinking about the investments you're going to be making in 2020? You're clearly starting the year at a much higher level and you ended 2019, I think at a higher level than some of us were expecting. As we think about the investments you're making, maybe Guy can you give us any color as to how that is comprised in R&D and sales and marketing? Where should we be thinking the heavier investments are going to be made in sales and marketing mainly?

So as mentioned before across the board. So it starts even higher. So we mentioned before that we're growing very fast. And as a result, we're growing our services personnel. So that will impact cost of goods sold. And then in terms of priority, we mentioned that before. So the number one priority for us is customer facing. So it will impact sales and marketing and then R&D and then G&A. So we do expect to see more and sooner leverage on G&A, then R&D and only later on sales and marketing.

Okay. And the support that you're providing to prospective customers, as you go after these bigger brands, is that requiring more intensive support that's driving some of this OpEx? Or are you adding -- making these investments with the objective of just expanding the broader customer base? What I'm trying to find out is -- as you go after these brands is the investment higher and support higher and more intensive than what is normally required?

Absolutely, yes. I mean, they are much more demanding in terms of machines operation. And as a result, we are investing more efforts before the sales and during the first phase of the sales.

And in that first phase, is that -- should we assume that some of that payback starts to flow through in the second half of the year? Or are these investments really being made with the idea that you're looking for a much stronger return in 2021?

So we also mentioned in the prepared commentary that we will see, let's say, a lower operating margin in the first half, but we expect to catch up the year, we expect increase in operating margin year-over-year. Obviously, we expect 2021 to see more profits from the investments that we did in 2019 and we will continue to do in 2020.

So the investments then sounds like begins to taper off in 2021 where you get some of the benefits -- a greater benefit from these investments that you're making this year?

Yeah. Normally we're guiding for one quarter only. But when we said five years, five $500 million we also said that we expect to expand margin including gross and operating margins and that still is the plan.

Okay. Thank you.

Thanks, Jim.

Thank you.

Next we'll take Greg Palm with Craig-Hallum Capital Group.

Hey, thanks. Good evening Guy and Ronen. Congrats on the good end of the year here.

Thank you.

Thanks.

So, I guess following up on the Q1 guidance. I'm curious are you assuming a higher level of contribution from shipments from your larger customers here? I mean, I think normal seasonality or I guess buying patterns is kind of that Q2, Q3 timeframe. But I'm trying to reconcile Ronen your earlier comments about global expansion and some of these units that are already in production?

The Q1 will be mixed between first of all DTG and DTF, but we will see another strong quarter for DTF. But it also will be a mix between regional accounts to strategic accounts. So we already have a few expansion -- biggest expansion during Q1 with strategic accounts, but many of the growth in Q1 is coming from regional accounts and net new accounts.

Okay. Understood. And then just following up on the commentary around China and associated supply chain risks? I mean, are you assuming any related impacts here in Q1. I don't know whether that's increased lead times or higher component pricing? I guess, what's the risk if factory production of some of these components remains delayed here for the near future?

Yeah. So first of all, we are monitoring very closely the situation in China. We have a small team in China and bigger team in Oncor. We are working very closely with them making sure that they are safe. We're providing them all the masks and other things that they need to protect themselves. So this is the first priority for us. As for the business, we do not anticipate any impacts in Q1. As you know, China, we see China as a growth region for us, very important longer term. But short term and midterm we don't see China contributing materially to our revenues. So we don't see an impact on -- major impact on -- long term in China. Manufacturing is being done in Israel for the systems and the inks. So we don't have any manufacturing in China. And as for the supply chain, we are monitoring it very, very closely. There are some components that have been made in China, some material we are looking for all kinds of mitigation. But this is more midterm into Q2 and Q3 and we feel we are reasonably assured that we will be able to mitigate all those supply coming from China.

Okay, great. And last one, going back to the commentary on your kind of large global customer. So if my math was correct, revenue in Q4 looks like it was down year-over-year, quite a bit actually, given a much higher installed base now versus a year ago. I am having trouble reconciling that. I don't know, maybe there was some modest contribution from systems a year ago. But if there wasn't, what am I missing here?

Well, yes, your assumption is right. When you do Q4 with Q4 last year, Q4 included printing system as well. And that's actually the reason for the decline year-over-year.

Okay. Fair to assume that excluding those systems, so just looking at consumables, it would have been up on a year-over-year basis?

A good assumption.

All right. That’s it for me. Thanks.

Thank you.

[Operator Instructions] We'll move next to Chris Moore with CJS Securities.

Hey, good evening, guys. Yes, just a question on the ink sales. Guy, you had talked about kind of the expectations on consumable growth in 2020. This HD transitioning slowed things down a little bit. Can you just repeat that? I wasn't able to write and quick enough.

Yes. So we actually discussed this issue only on an annual basis. So what we've said in terms of ballpark numbers, that printing system grew very nicely year-over-year close to 40% in terms of business and ink and other consumables grew close to 10%. And the reason was, during 2018 and 2019 we shifted most of the installed base, but the installed base in terms of throughput, not number of machines, to HD technology. Meaning, at the end of the day the machines are more efficient. And as a result, we saw dollar-wise less growth in revenues from ink and other consumables. That said, because we believe that most of the upgrades were done already, we will see a much stronger growth in 2020. At the same sentence we also said, it's going to be a strong double-digit growth, but we also expect printing system to grow even faster than that.

Got it. I missed that piece. All right. Appreciate it.

We'll take a follow-up from Jim Ricchiuti with Needham & Company.

Just a question on the M&A pipeline. You've talked in the past, more recently, about an acquisition pipeline, some acquisitions you may be looking at, it looks like there may have also been some expense in the quarter associated with some M&A work you're doing. How does that impact your overall commentary regarding the improvement in operating margins that you're looking at for the full year 2020 over 2019?

Well, Jim, we cannot really comment about that right now.

Can you talk at all about how active the pipeline is?

Yes. So, on the pipeline, we have a very strong pipeline. Our team was working for the last few months on building the pipeline. We feel very good about what we have right now. And we are progressing very well. And I hope in the next few months that we will be able to disclose the direction that we are taking. As we mentioned in the past, our focus is mainly around workflow solution in the market. We believe that workflow is super important for brand, connecting brands with consumer, work related to providing the production -- the on-demand production in a sustainable way.

And, Ronen, I think, you had also talked about potentially something and it sounds like more in the automation area. Are there two tracks you're looking at in terms of M&A?

So there are a few tracks. One of them is workflow, another one is in the go-to-market. And another one, as we've mentioned in the past, on ancillaries, automation color, management. So in this direction as well, we have good coverage that we are looking into.

Sounds like it's pretty active one. Okay. Thank you.

Thank you very much.

Thanks.

That does conclude our question-and-answer session at this time. I'll turn the call back over to Ronen Samuel for any closing remarks.

Okay. Thank you very much. Thank you for joining today's call and we appreciate your continued interest in Kornit. We are very pleased with our progress until today and I want to thank our employees for the hard work, for the dedication throughout this exciting time for Kornit. I want to thank all of you and I look forward to speaking with all of you and to see you in Israel in the event in April, which is going to be very important for all of us together. So looking forward to see you. Thank you very much.

That does conclude today's call. We do thank you for your participation. You may now disconnect.