Kornit Digital Ltd. (KRNT) Q4 2017 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to Kornit Digital Fourth Quarter 2017 Earnings Conference Call. As a reminder, today's conference call is being recorded. [Operator Instructions]. At this time, I'd like to turn the conference over to Tom Cook. Please go ahead.

Thank you, Melinda. Good afternoon, everyone, and welcome to Kornit Digital's Fourth Quarter 2017 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 of 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 accurate 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 30, 2017, 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 press release published today, which is posted on the company's Investor Relations site. On the call today, we have Gabi Seligsohn, Kornit's Chief Executive Officer; and Guy Avidan, Kornit's Chief Financial Officer. At this time, I would like to turn the call over to Gabi. Please go ahead.

Thank you, Tom, and hello, everyone, and welcome to our fourth quarter of 2017 and full year earnings conference call. During today's call, I will review aspects of our performance, then provide an update on market conditions and our view on the year we are entering, 2018. Guy will then walk you through the full financial details for the fourth quarter and for the year, as well as state our guidance for the first quarter of 2018. During Guy's prepared commentary, he will refer the changes in our financial reporting method as well as quarterly guidance. These changes are based on instructions we have received from the SEC. These changes are primarily associated with the manner by which we report our GAAP and non-GAAP results as a function of warrants issued to Amazon and which vest as a function of business volume between Kornit and Amazon. While these changes may initially create some complexity for investors following our business performance, we will do our best to help make our earnings as clear as possible. Although the second half of 2017 was weaker than expected, due to customer delays, the year as a whole was filled with many achievements, which position us well for solid growth during 2018. Our business in Europe and Asia grew by more than 30%. We successfully launched the R-Series technology on both the Storm and Avalanche platforms, delivering up to 80% reduction of ink waste for new and existing customers, who decided to upgrade their systems. During 2017, we also grew our Allegro customer base by 70%. In 2017, we made significant efforts to expand our market presence. We attended over 100 marketing events around the world. We added 20 new distributors. We expanded our web footprint and experienced more than 300% growth in web-based lead generation. Around the middle of the year, we initiated a significant change to our U.S. operation and go-to-market. We recruited a very strong leadership team, significantly strengthened our sales team, which is now regionally spread and in closer contact with customers and potential customers. Our service operation also grew significantly, and handled more than 7000 service calls, as it came very close to breaking even as a business for the year. During 2017, we expanded our corporate management team with 2 company veterans, which I view as a sign of organizational maturity. We also brought on board a new and very experienced VP of Operations to help lay solid foundation for future growth, as well as a VP of Corporate Development. These additions to an already strong team provide me with great confidence in our ability to continue on our path of secular growth. 2017 has been referred to by many as the year of the retail meltdown. 9000 stores are said to have been closed and 7 large-scale retail bankruptcies took place in the U.S. alone. These events are the result of a transition to online shopping and the fastest transition is clearly taking place in the apparel space. We have, on several occasions, said that this market change spells great opportunity for Kornit and the technology we offer. As you know, most of our business continues to be based on customization and personalization. These 2 areas are themselves experiencing a change. Customization now happens on a massive scale and trends change daily and sometimes annually. The impact is immediate and requires real-time production and next-day delivery. In the past year, we have gone from mostly printing one-off, to printing one-by-one repeat orders, which range from hundreds to tens of thousands many times. When discussing our vision and long-term growth opportunity, we always refer to the fact that every digital revolution is about constant reduction of cost per print. The sweet spot for digital printing always starts with printing one-offs in short runs. As the technology evolves, it is able to offer an alternative to large-scale production of discrete designs. As the retail transition continue to progress during 2017, it became clear to us that we have reached the critical inflection point and that it is time to go after a much larger opportunity. Recent system enhancements offer compelling solutions for customers to address these market challenges. Kornit customers are now competing not only for quality and rapid delivery but also on cost. These recent enhancements have generated widespread enthusiasm with existing customers, looking to upgrade their systems and also large-scale screen printers. Our systems have now demonstrated the ability to perform two-color print jobs on more than 200 units, at a cost which is better than screen printing and 6-and-8 color jobs, with 450 to 500 prints at a cost which are lower than screen. These are metrics that no one in the industry has shown before and given the changes in the retail environment our servable addressable market can now be significantly broadened. During January, we announced the new Avalanche HD series. The timing of one of our largest yearly trade shows, ISS in Long Beach, worked perfectly. During the three-day event, hundreds of existing and potential customers visited our booth for a demo and were blown away by the capabilities. The new Avalanche HD6 utilizes the Vulcan's proven print engine and ink. The system's feature and functionality focuses on meeting screen printing production standards by offering a variety of functionality. A 30% to 50% reduction in cost per print versus the current R-series Avalanche system. This reduction is achieved through NeoPigment Rapid Inc, optimization of system and application setup parameters and the utilization of advanced recirculating printheads. The system also includes six colors, plus white, for richer and deeper prints, better and more uniform prints on solvent areas, an improved handfeel a higher level of print consistency when printing hundreds of repeat prints and a robust print job set-up process, with Pantone matching needed for brand print consistency and achieved through partnership with ColorGATE, a software platform, which has been integrated with our platform. I am happy to report that this week multiple Avalanche HD6 and HDK systems are being installed at customer site in the U.S. and we expect to already recognize revenues from a combination of new systems as well as upgrades during the first quarter of 2018. In recent weeks, we have been asked about the impact of the HD announcement on the Vulcan. To make clear, we view the introduction of the HD series as a vehicle to making Kornit technology and its cost advantages available to small and midsize screen printers, while the Vulcan remains focused on bigger players with capital investment budgets and production needs that are larger in scale. In order to mitigate the capital investment hurdle for some potential customers, we have substantially expanded our leasing agreements through the utilization of third-party finance companies. This proposition offers customers the ability to essentially eliminate the upfront cost and mass expenses with production. This also levels the playing field and even puts utilization of a Kornit's system in a favorable cash flow position for screen printers, relative to the higher direct labor associated with traditional print methods. The lease terms offered are typically 3-year agreements and include a three-month grace period on delivery. Our industry is engaged in a transition which will bring production and decoration of textile to develop environmentally conscious economies. This transition, called Textile 4.0, involves the introduction of automation in order to significantly reduce labor requirements as well as introduce clean, nonpolluting production methodologies. The Vulcan, being designed as a fast-moving conveyor belt, is perfectly designed in order to interface with automated garment loading and unloading, and will ultimately eliminate the need for manual operation in the future. The first quarter is loaded with meaningful tradeshows and, hence, you should expect marketing expenses to be up. Events that have taken place thus far have been very successful and combined both DTG and roll-to-roll products. We expect 2018 to be a year of significant growth for Kornit and are excited with traction we have experience in the last few weeks, given our exciting new product announcements. This year, we plan to announce multiple new products and capabilities, which are all geared toward taking advantage of the opportunities we see ahead of us as well as to secure our competitive position for years to come. During 2017, we continue to expand our operation and employee base in all parts of the organization. As in previous years, we exited the year with an operating expense run rate, which is much higher than where we started. Given that we have spent the last 3 years expanding our operation, we now expect to be able to stabilize quarterly operating expenses at around $15 million, plus or minus $0.5 million, to account for tradeshows and specific quarterly events. We also expect to continue to grow our services business, which during 2017 represented more than 10% of revenues, as more customers purchased services and upgrades from us. During 2018, we will be adding more channel partners in the U.S. in order to further expand our presence. We expect to open our new offices in New Jersey this summer and make available a state-of-the-art demonstration facility. Overall, we feel very positive about of our market position globally and our ability to continue to enjoy significant growth for years to come. I will now turn the call over to Guy for a closer look at the numbers and the first quarter guidance. Guy?

Thanks, Gabi, and good evening, to 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 $1.2 million; amortization expenses, relating to the acquisition of intangible assets in previous years, in the amount of $292,000; taxes on income related to non-GAAP adjustment in the amount of $215,000; and $164,000 for restructuring expenses in the U.S. A full year reconciliation of our results on GAAP and non-GAAP basis is available in the earnings press release issued earlier today and on the Investors section of our website. As stated in the press release issued earlier today, from this quarter onward, we will change our presentation in two ways, as follows, first, with respect to our treatment of foreigns, revenues will be presented net of the amount attributable to the noncash impact of warrants issued to Amazon. In the fourth quarter, the impact on revenues of warrants was $393,000 compared to $150,000 in the previous quarter and $2 million in the fourth quarter of 2016. We are currently presenting the warrant impact for the last 4 quarters and for the annuals in Slide 11. Second, system revenues from services exceeded 10% of total revenues for the first time, we're now required to present revenues in two categories, product and services. The product category stands for printing system and ink and other consumables. In the fourth quarter, revenues attributed to services were $3.7 million compared to $3.1 million in the previous quarter, and $2.8 million in the fourth quarter of 2016. We are currently presenting service revenue for the fourth quarter and annuals in Slide 12. Service revenues this quarter are net of $27,000 attributable to the noncash impact of warranty issued to Amazon. Fourth quarter GAAP revenue decreased 6.4% to $30 million versus $32 million in the prior year, an increase 5.3% versus the prior quarter. Due to the above-mentioned changes in our revenue presentation and to ensure that our investors and analysts have sufficient access to printed information, we intend to add revenue information and disclose, separately the impact of the Amazon warrants on GAAP revenue in any relevant period, as applicable. We will take revenue net of amount attributed to the noncash impact of warrants issued to Amazon. Therefore, fourth quarter revenue of $30 million, net of $393,000, represents a decrease of 6.4% versus $32 million, net of $2 million in the prior year, and increase 5.3% versus the $28.4 million, net of $150,000 in the prior quarter. I'd like to reiterate that the warrants granted to Amazon are part of the inherent value creation and alignment of interest, designed to strengthen the long-term relationship between the company and Amazon, under a long-term commercial agreement. By geography, 58% of our sales were from the Americas; 30% from Europe, the Middle East and Africa; and 12% from the Asia Pacific region. Compared to 58%, 29% and 13% in Q4 2016, net of the warranty impact respectively. Moving to customer concentration. Our main U.S. distributor contributed 18.8% of our overall revenue. Our top 10 customers accounted for 0.8% of our overall revenue compared to 63% in the fourth quarter of 2016. For the year, our annual revenue for 2017 was $114.1 million, net of $2.9 million attributable to the noncash impact of warrants issued to Amazon, an increase of 5% versus the $108.7 million in 2016, or increase of 5.7% based on the calculation of net of the noncash impact of warrants issued to Amazon. For the year by geography, 58% of our sales were from the Americas; 28% from Europe, the Middle East and Africa; and 14% from the Asia Pacific region. Our U.S. distributor contributed 18.8% of our overall revenues compared to 20.6% in 2016, and a major customer contributed 14% of our overall revenue compared to 16.8% in the previous year. We are in line with previous years revenue presentation, we are adding that for 2017, revenues from printing system contributed 44.9%, revenues from ink and other consumables contributed 44.5%, and revenues from services contributed 10.6%. Compared to 53.4%, 39.3% and 7.3% in 2016, respectively. Moving to profitability. Non-GAAP gross margin, net of warranty, but in the quarter was 48.9% versus 52% in the prior quarter and 46.6% in the prior year. Moving to our OpEx items. I'll discuss these items on non-GAAP basis, which exclude nonoperating charges previously mentioned and highlighted in our GAAP to non-GAAP reconciliation in our press release. Adjusted research and development was 18.9% of sales, or $5.6 million, compared to 15.9% of sales or $5.1 million in the prior year. Increase in R&D expenses as a percentage of sales reflect increase in headcount and a lower revenue base versus the fourth quarter of 2016. For the year, adjusted research and development was 17.6% of sales or $20.1 million compared to 15.6% of sales or $17 million in the prior year. Sales and marketing in the quarter were $4.7 million or 15.5% of sales compared to $4.4 million or 13.7% in the prior year. Higher sales and marketing expenses were the result of increase in headcount. For the year, sales and marketing were 16.8% of sales or $19.1 million compared to 15.9% of sales or $17.3 million in the prior year. General and administrative expenses in the fourth quarter were $3.4 million or 11.4% of sales compared to $2.5 million or 7.9% in 2016. Higher G&A in the quarter resulted predominantly from management headcount addition. For the year, general and administrative expenses were 10.1% of sales or $11.5 million compared to 9.1% of sales or $9.9 million in the prior year. Year-over-year increase in G&A expenses is predominantly attributed to headcount increase and strengthening of our IT infrastructure. Headcount, as of December 31, was 412 employees versus 390 employees at the end of 2016. The increase in personnel was primarily attributed to addition of G&A, R&D and operation personnel. Non-GAAP operating margin net of warranty impact came in at 3.5% of revenues for the quarter, compared to 5.6% in the previous quarter and 9.7% in the fourth quarter of 2016. Non-GAAP net income, net of the $393,000 noncash impact of warrant for the fourth quarter, was $1.5 million or $0.04 per diluted share, an increase of $4.5 million versus the year-ago quarter. Non-GAAP net income for 2017 was $4 million, representing a decrease of $3.8 million versus 2016 or $0.11 per diluted share. GAAP net loss of $393,000 noncash impact of warrants was $369,000 or $0.01 loss per share on a diluted basis compared with net income of $820,000 or $0.03 per share for the year-ago quarter. For the year, non-GAAP net income net of $2.9 million noncash impact of warrant, was 3.5% of sales or $4 million compared to 7.2% of sales or $7.8 million in the prior year. GAAP net loss was $2 million compared to $822,000 profit in the prior year. Our financial income this quarter were $154,000, because of accrued interest of our cash investment, offset by bank expenses. Net cash provided by operating activities was $12 million this quarter compared to $2.8 million net cash used in the prior quarter, and net cash provided by operating activities of $5.3 million in the year-ago quarter. Increase in cash was mainly a result of improvement in DSO. For the year, we generated $6 million of cash from operation activities versus 1 million used in operating activities in 2016. Cash balances, including long-term marketable securities and short-term deposit, at quarter end, were $97.5 million compared to $61 million as of December 31, 2016. Net proceeds from the January 2017 offering were $35.1 million. Moving to our guidance for the first quarter of 2018. We expect revenues to be in the range of $28 million to $31 million. We expect non-GAAP adjusted operating income to be in the range of minus 2% of revenues to 3% of revenues. These numbers assume no impact of deferred value of issued warrants in the first quarter of 2018. The calculation of warrants per value is based on the combined effect of estimation of future revenues from Amazon, future Kornit share price in an unknown date, Kornit future stock volatility as well as other variables that currently cannot be predicted. Since we are not able to predict these variables, we'll assume the warrants impact at 0 value for guidance purposes. As Gabi stated, this year the first quarter is very active in tradeshows and sales events around the globe. Additionally, we expect an OpEx increase in the first half of 2018 due to personnel changes and expense implication of several hundred thousand in our U.S. operation. I'll now transfer the call to Gabi.

Thank you, Guy, and with that, operator, we'd be happy to take any questions.

[Operator Instructions]. And we will go to Joseph Wolf with Barclays.

I guess, thanks for the fourth quarter breakdown of inks and consumables. Are we going to be getting that going forward?

We are giving that on an annualized basis. The reason why we provided the breakdown for the fourth quarter, it's the first time that we're including services revenues, because we crossed the 10% mark. So the way you're going to see revenues from now on is two buckets, on a continuous basis. I mean, it will be a bucket of products, which will be systems and consumables and then there will be a bucket of services. And then for the annual, we have been requested to break it down, basically, into the 3 figures. But on a quarterly basis, it will be those 2 buckets that I mentioned.

Okay. And then I don't know how much commentary you can give about Amazon one of the top customer, but I'm wondering, if you could just give us some insight into just the trajectory or the progress that's going on over there? And how that relates to the guidance?

As previously communicated...

Well, I'm trying to figure out if the assumption of 0 is because you can't estimate -- how does that tie into expected revenues from them?

So, first of all, I'm glad that you raised that part of the question, and I'll also try to answer with best of my ability, the previous one. So you know, the challenge that we have, is the fact that we've been guided by the SEC to reflect the impact of the warrants. The issue, and basically we have only one type of revenue, not GAAP and non-GAAP revenue, which was problematic before. The problem is that, as Guy said, the way that it is calculated is not just associated with the amount of business that we do with the customer, but also associated with share price that we cannot predict and various other volatilities. So the challenge here is that, it's not predictable. When looking at that, you have either a choice of putting a number, which no one can really stand behind or apply what we have applied, which is a 0 number, but actually drawing the attention of investors to the fact that there could be a trend upwards or downwards associated with that. For instance, it could be -- there could be a case where business is very strong, but share price is lower than where the warrants were issued. And as a result of it, you would see a warrant impact, which is completely different than the opposite, right? So that's been the challenge of as a result of it we feel like, in order to make things simple, we provide guidance as we did, and we refer to the fact that it reflects a zero value. So you should not, and no investor should deduce anything as it relates to business that we do with the customer as a result of that zero number being used. It's being used because we cannot speculate or envision a specific number so we prefer to put a zero number there. As for your question regarding what's going on with our largest customer, I can only reiterate what I said before, which continues to be the case. When we were asked about the permitting issues at the site, we said that we expect the permitting issues to be resolved in the fourth quarter. It's been published, actually publicly, so there's no problem in saying that the permits issues have been resolved and I'll just reiterate what we said in the previous calls, where we expect to deliver the incremental systems before the end of the second quarter, or before the end of the first half, as I said before, and that continues to be the case.

Okay. And then just to kind of frame when you talk about significant growth for 2018, is that something we should put in line with historical growth rates, not including '17? Is it more than that? What does significant mean to you?

Well, we don't articulate exact numbers or guides for the year, as you know Joseph. So that continues to be the case. Significant growth means significant growth. As far as we are concerned, it's definitely the only thing I'll say is definitely double-digit growth, but I do not want to state what it is. When I say significant growth, it's associated with what I see happening in the market right now and it's a variety of things. Number 1 is, what we spoke about extensively on the call, which is the addition of screen customers, the fact that we've reached an inflection point in the industry that we can now address a much broader audience of customers. The deployment of our systems, we believe will be more extensive than it was before, because of the fact that the cost per print has gone down so the cost efficiencies make it more lucrative to use our system than it was before. And we plan to announce multiple new products this year, also, what I spoke about in the U.S. is very, very significant. The changes that we've implemented in the course of 6 months are night and day where we were before as far as coverage of the market, as far as the feet on the ground that we have, and the sales professionals that we now employee. And the customer interactions have been very, very significant. I mentioned in my prepared commentary that at ISS we had hundreds -- literally hundreds of visitors and a very, very strong demand pipeline for systems coming as a result of it. So we feel quite confident about that and that's why I am saying significant growth during 2018, but without articulating specifically what it is that I mean.

And then just finally on housekeeping, Guy, you mentioned $15 million or so plus, minus $500 for operating expenses, that's a GAAP number? A non-GAAP number? That compares to the $15 million of GAAP?

No. That's a non-GAAP number -- this is a non-GAAP number, but it's not related to the warrants. And we'll just talk of OpEx now. $15 million Plus minus half a million [indiscernible]

So that compared to the 13 point -- in the fourth quarter the non-GAAP number was $13.5 million?

Yes.

So it's $15 million compared to $13.5 million?

Yes.

That's correct and we said that we expect to stabilize around that number, plus or minus $0.5 million on a continuous basis in the 4 quarters of 2018.

And we'll go next to Jim Ricchiuti with Needham & Company.

Maybe to not speak specifically about Amazon, can we perhaps broaden this a bit, and ask how should we think about the progressions of revenues from your larger customers, not just that one customer in 2018, just based on the introduction of the new equipment. In other words, should we see a -- are you anticipating what were historically your larger customers, a ramp in those revenues in the early part of 2018?

Yes, so as we said, I will not say anything specific to Amazon or specific customer names. I'll say a general comment. The introduction of the HD has been met with a lot of enthusiasm from all of our large accounts. When I mentioned that multiple systems are being installed, there are indeed multiple systems being installed and multiple large Kornit accounts in the U.S. and actually in the next couple of weeks, also in Europe. And so this is going to be meaningful as far as new systems that they need to take, those various large customers as well as a significant retrofit opportunity on their fleet of Avalanche 1000 and Avalanche Hexa. So we expect this to be a good source of revenue for the company during 2018. The enthusiasm is definitely significant, as I said 30% to 50% reduction in cost of print is very significant. I would even say, without getting ahead of myself, that in many cases, customers want to move quickly in order to take advantage of this as quickly as they can. Also, one of the things that I'm very proud of is that our development team was able to turn around this new product introduction in a matter of very few months. This was a program that we only initiated after coming back from New Orleans. If you remember, Jim, in the last conference call, I mentioned specifically that we came back from New Orleans enthusiastic about how interested screen printers are in moving to digital. And I have to say that what happened at ISS was truly a demonstration that our marketing group and all of us got it correctly because the interest level has never been as high as this. Many of them being visitors of a digital company for the first time. So it will be, to my mind, both a combination of our large accounts taking on systems, as well as upgrades, as well as new customers that are coming on board.

Yes, that's helpful. And Gabi, you also alluded to 2018 being an active year for new products, presumably beyond just the new HD models being introduced. Can you talk a little bit about, perhaps, where you stand with Allegro? You had, what, a 70% increase in the number of placements, I believe, in '17. How does the pipeline look in 2018 and are those -- are your expectations for 2018 based on the current Allegro? Or are you making certain assumptions for a new roll-to-roll machine?

So we expect a continued growth in 2018. We started the year on a very strong footing with Allegro as well. In Europe, very strong and starting to gain more momentum again in the U.S., so we expect growth. As far as timing for announcing the next version of Allegro, I don't want to share that for competitive reasons. We feel very solid in our growth potential in 2018, even before our new product is released. So right now, we're not going to say specific timing. We are also expecting to introduce another roll-to-roll product, which is different and that's going to happen during the year as well. And there will be more DTG capabilities coming out to the market, from a combination of systems as well as consumables. So it's going to be a variety -- without mentioning timing. One of the things that we are always very cautious about is when we are planning to introduce a new product, the speed of ramp-up of that new product. I would say that a unique situation is the one that we are experiencing with the HD. Simply because what we did with the HD was, on the one hand, take a proven platform, which is the Avalanche and add to it the print engine of the Vulcan, which has been proven, plus various other aspects. So that allowed us to release a product and ramp it up into actual revenue, making opportunity on a very short term. But other than that, our big growth, that we are talking about in 2018 takes very, very minimal and cautious approach as far as new product introduction and still at the same time, shows meaningful growth.

And we'll next move to Brian Drab, William Blair.

On the $15 million in OpEx, I think it's clear, but that only applies 2018 and not beyond 2018, is that right?

That's correct. I wouldn't like to predict that far into the future. We could be in a situation where there's other opportunities that we want to address. So right now, we decided that we'd like to give investors some visibility as to where OpEx is going and therefore, we are providing this number, plus or minus $0.5 million, because there will be some variability from one quarter to the next. Also, very important to draw your attention, Guy mentioned in passing, but just to clarify a point here, because of the changes we are making in the U.S. there is a period of time in the first half of the year in which we are going to have, what we call, duplicate cost, in the sense that there's still leasing that's taking place, rents -- excuse me, that we are paying, as well as some duplicate employees as we transition to a new employee base. Therefore, the expense rate, which I would say has duplicated is a few hundred thousands of dollars during that period. So overall, we feel comfortable with that number of $15 million per quarter, plus or minus $0.5 million, but yes indeed, that reference is 2018.

The duplication of expenses is in the first half of the year? So maybe it is fair to conclude that second half expenses tick down about a few hundred thousand?

No, not necessarily, because there's other activities that are going on they're not associated with new product introduction. Various marketing events et cetera, so this range that I provided of plus or minus half a million provides us the range that we need in order to mitigate for various things and include various expenses when we need to.

Okay. And then, can you give us any sense for the balance of the year to at least directionally, how you expect things to progress, for example, do you expect sequential improvement from first quarter to second quarter in terms of revenue and anything else you can give us in terms of how you see the year playing out?

As I said, I don't -- we don't provide guidance beyond the quarter that is coming. And that's what Guy has mentioned, the $28 million to $31 million, net of, without referencing warrants impact. Right now, what I can say is that the launch of the HD is very, very successful. We see a continuation of that in the second quarter and also in the second half of the year. There could be, obviously, as you heard from me saying several times as I did in this conference call, we expect the incremental supply of systems that we spoke about, to the large customer to happen before the end of the second quarter. So that will have an impact on the second quarter. But beyond that, I wouldn't like to go into too much detail. I think that suffice it to say that we are starting at a good point as far as the revenues that we are predicting. It is some growth year-over-year, but very important to see that it's very minimal, if any reduction of revenues from the fourth quarter to the first quarter, where usually there is a more significant reduction which is helping us to do that is the fact that we have this new product announcement and the momentum with which we left ISS and three other tradeshows that we attended in the last few weeks, provide for a good start for the year. So that is much as I can say right now, Brian.

Okay. Just so the last one then, I'm looking at the slides and you show that ink and consumables revenue was 38% of revenue in the fourth quarter and 44% for the full year. I'm surprised to see a fourth quarter ink and consumables figure below the full year number. I thought the fourth quarter was always the strongest for ink and consumables? Why is that?

It is indeed the strongest then it was this year.

Q3 was very strong in...

Speak louder I cannot...

Q3 was very strong for us in ink this year, so that's the reason. Plus there's always the impact of the warrants. So we were not breaking down per quarter, so we cannot go into more details. But definitely, the impact of the warrant changes were up.

Okay, I'll take a closer look here. But even if I put $15 million in the third quarter, the rest of the quarters kind of average to $12 million and you only did $11 million in the fourth quarter, ink and consumables, but there is nothing specific -- in the quarter. Yes. Go ahead.

But Brian, we're only giving -- I don't know how you got this number, but the only time we are breaking down systems versus ink is on an annual base.

I'm looking at what I think is Slide 12, right, just the fourth quarter of '17. Show's $11.29 million.

Yes. So again -- I'll say it again. The impact of the warrants definitely changed the -- definitely changed the revenue of the incomes for some specific quarters.

And we'll next go to Bobby Burleson, Canaccord.

Just got a couple of quick ones. So can you touch on the profitability expectations for services in 2018? I'm assuming there's some efficiencies that will start to positively impact that business, even more, this year?

Yes, so I think -- first of all, the starting point is good. Remember, we spoke about reaching a breakeven point and given the economies of scale, meaning the revenue that we saw in the fourth quarter, which I believe was $3.7 million, we were marginally profitable for the first time. So that's a good indication, first of all. For the year, there is going to be some growth, but not significant growth in the size of the service operation and we expect service revenues to be up year-over-year, given the extent of upgrades that we envision taking place, especially in light of the announcement that we recently made. So without stating a specific number, but it should be for the year somewhere between breakeven and single-digit profitable for 2018.

Great. And then you going to break out annually at least the systems and inks mix. And I'm curious, directionally, with all the new products coming out, what's your sense of how that mix will shift in 2018?

Mix between services -- sorry between systems and consumables?

Yes.

I think it will -- it should remain at a similar ratio. Perhaps systems could be higher this year because of the fact that the introduction of this new platform and the demand that we are seeing for the Avalanche HD, I think, it's going to result in more system sales and the average selling price of those systems is quite high. So I think it'll probably trend a few percentage points in favor of systems. Again, just to remind everyone, until today, we used to speak about systems and services combined, and then consumables and the ratio continuously was around 40% or 40-something percent, for consumables and the rest 55% to 60% was always the systems and services. So now with services being broken out, separately and exceeding the 10% mark, I expect, probably this year because of the strong system sales that we predict, that it will be a few percentage points higher than the ink consumption if we compare systems and inks and consumables, one against the other.

Okay. And then the language was, I believe, significant growth this year and you talked about some of the recent products introductions and leasing programs, opening up a smaller size customer potentially. Any sense for how much that customer category needs to contribute in order to get that significant growth? Or do you expect a significant growth with kind of in the poor customer base? And anything that happens with a smaller customer is more the 2019 or kind of upside to your expectation this year?

Is going to be a combination. So we have a large number of large existing successful customers that are very interested in moving on and taking advantage of what is that we offer now. But walking away from the show, one of the interesting statistics that I can provide is that 80% of the sales leads, when we say sales leads, these are serious leads, 80% of them were new customers. Very interesting to be in that situation. And so truly when I mentioned that the interest level was very high from the screen printing market and that some of these people were showing up for the first time to see digital printing, the reason why these people want to become customers, and many of them will become customers in 2018, is because we showed them real numbers of how we compare against what they do, day in day out. And since what we compared it to were real numbers of how much is costing them, the level of credibility is very high and they want to jump into this thing, because they are being asked to do for retail they are doing 200 to 500 units and are not making money doing it with screen. So I believe there's going to be a very nice contribution from new customers as well this year. But also there is solid foundation in our expectations from existing accounts that really want to take advantage of this new capability and the reduced cost per print. Also, one final comment here, the market that our customers compete in has become highly competitive. In the last year, price competition has become very serious. And so everyone is looking for ways to reduce their cost, in order to gain market share. And this offering that we have, comes at a very, very relevant moment for that market and the level of maturity that it's reached.

And we'll next go to Patrick Newton, Stifel.

I guess two growth related questions. I guess, the first one Gabi is, if we look back at the negative preannouncement in September. I think the push out of your guidance was about $8 million at the midpoint. And so I guess, my question is, is that the right level of catch up we should see through the June quarter as kind of a bogey? And embedded in this March quarter guidance, which appears to be above seasonal, is there any of this catch up from either the Vulcan or Amazon embedded? Or is this purely from the new product momentum that you've spoken to multiple times?

I wouldn't say purely from new-product momentum, because there's other products in the mix, there is Allegro's, there is Storm systems, there is Breeze. So, first of all, it's coming from various directions. I'm glad you bring this up, because what we are seeing in Europe, where we've had multiple tradeshows is a very, very strong economy for our customers. So a lot of interest, we've already had tradeshows in the U.K. A second one happening in Germany already this week and the one in the U.S., and then I think another one. And so what we are predicting now for revenues includes various types of systems and yes, indeed, as I said, we will recognize our revenues for new HD as well as upgrades for HD systems. So the service organization is very, very busy this quarter with moving rolling out these systems. As far as the impact you said that impact in the third quarter indeed was around $8 million and then in the fourth quarter, there was also some impact of a few million dollars if you remember that we had mentioned as well. So a big portion of catch up should take place in the first half of the year.

All right, that's helpful. And then Gabi, just kind of drilling down on the significant growth, you did you won't give us a number, I respect that, but you did mention double-digit growth and I'm curious, if we ignore the snapback that we just spoke to, is it fair to assume that the rest of your business is double-digit growth and that snapback is just additive?

Snapback, you mean catching up on the business that was delayed, what is snapback?

Correct. Just as you alluded to in the prior question, the $8 million in Q3, and the couple of million in Q4.

Yes, so it's a combination of the catch up as well as very strong momentum with these new products. So it's a combination of both right now from what I see.

I guess, the crux of the question is, if we eliminate the catch-up effect, is the underlying business a double-digit growth for this year?

Well, yes.

Okay. And then Guy, a couple of modeling questions. One is just pertaining to the new pro forma methodology, you did provide us a reconciliation on our revenue perspective. Will you guys be providing the tax impact, I believe that's the only other change to the pro forma numbers? And then second question is, just on the shekel appreciation, I'm assuming that's been a negative headwind to OpEx and COGS, if you could just speak to what your FX assumptions are that are embedded into that kind of $50 million, plus or minus $500k that you're guiding to for calendar '18?

Yes. So regarding the adjustments, obviously, we discussed a lot the impacts of the warrants. The adjustment GAAP, non-GAAP protects us, we actually started in the previous quarter, which is not that material. Regarding U.S. dollar versus the Israeli shekel, we can say that our assumptions and the number Gabi mentioned before about the OpEx, pretty much matches the current situation of the U.S. dollar versus the shekel, which is at about 3.5 rate.

So any ongoing appreciation will move that -- the number upward?

As usual, we are hedging more or less at the same level of 3.5, which is the current level. All the assumption and everything we talked before is based on the hedging assumption.

And we'll go next to Greg Palm, Craig-Hallum Capital Group.

I guess, first, you mentioned in the release, improving trends in Europe and Asia and I guess they're coming off, I guess a combined 30-plus percent growth in those regions in '17. So by improving trends, are you saying that demand is accelerating or just kind of stabilizing around this sort of level of growth here?

Well, both territories, Asia as well as Europe, exceeded the 30% mark for growth in 2017. We expect to have a strong year in 2018 as well. The reason is we've laid very solid foundation in those 2 regions. Very strong management team and sales force in both territories as well as very good distribution capabilities. A lot of the additional 20 distributors, actually most of them were both in Europe and in Asia, so we have better coverage. And also leadership in each of the main countries that we are operating is much stronger than maybe 2 or 3 years ago. So yes, we expect strong performance in 2018. To remind everyone, of course, these 2 regions are the smaller ones. The U.S. historically has contributed about 60% on average and Europe about 25% and Asia about 15%. So from a contribution standpoint, no comment yet about how much they're going to contribute for this year, a little bit too early, but both have pretty aggressive growth plans for this year as well.

And do you see that growth being driven by primarily new customers, or maybe existing customers that either expand operations there? Or start to build out sort of new operations in those regions?

It's a combination of both. So I'll say that, in Asia, most of the business historically was -- a lot of it was one-offs. In the last 1.5 year, we see a trend of many customers moving to multiple systems which is a good sign that they are moving to high-volume production than before. Web-to-print is starting to catch on in China, which is a good sign for us. Japan has improved quite a bit for us in the past year, making some initial good strides in South Korea, Australia is looking pretty good. So in Asia, actually, we are seeing more customers with multiple system than we did in the past but at the same time if I would have to say, what are the regions which add the largest number of new accounts every year, I would have to say Asia, then Europe, then the U.S.

Got it. Okay. And then on the HD technology, you talked about some installations going on now. Curious if you could comment on the upgrade opportunity there, whether you've seen any upgrades thus far? Whether you think some of your large key accounts will decide to upgrade existing fleets, maybe existing fleets, maybe you could just comment there, please?

Yes. Many of our existing accounts are in active stages of ordering upgrades. So we expect, as I said, to see revenues both from upgrades and new systems meaning, we're already at very advanced stages of receiving orders and preparing for those shipments. So it is happening, both with new systems as well as upgrades. The customers that we decided would be the first customers are all existing customers that know exactly what they want to get and how they want to get there, which is great, because it's to demonstrate to the industry, the capability of live production in a very short amount of time and that's why they were chosen very carefully.

And just in terms of capacity there, I mean, how long does it take to upgrade the machine, I mean, how many can you do, let's say, in a quarter?

Well, the upgrade vary in the length of time depending on where the system is as far as generation. So let's say if I have an Avalanche 1000 R-series, then the upgrade is not that significant. If I have an older Avalanche 1000, which is not R then the upgrade is bigger. So it will range between 1 and 3 days, but the way to do this in a site that has multiple systems is to have a team that works in parallel and reduces the relevant downtime as much as possible.

And we'll go to Chris Moore, CJS Securities.

So maybe just starting I know you're not going to talk too specifically about Amazon, but looking at the agreement, it references the Avalanche 1000 specifically and others. So trying to get a sense as to the likelihood that Avalanche would be purchasing the HD's as well.

I don't want to comment on anything relating to their choices. You can well imagine that they're privy to the information of the benefit and, you know, it's for them to consider what they want to do, but we've been asked specifically not to comment on that. What you see and what's been made public, obviously, for public filing reasons where we refer to what the agreement was referencing, it was indeed the system at the time of the agreement being signed. But this being an arm's length relationship for many years, you can anticipate that there will be different versions and models coming in at various stages. But I'm not allowed to comment specifically on the configuration and what they would want to use in the future.

It looks like inventory came down a little bit this quarter and I guess, part of that question was, if you had built up some inventory for safer Amazon, that orders didn't go through, just wanted to get a sense as to are there any concerns in terms of that inventory level moving? Or I know they can be upgraded, I'm just trying to get a sense of how you're looking at the inventory levels at this point in time?

Obviously, we are happy that the inventory came down a little bit. We are seeing no risk with building inventory for Amazon.

Got you. Just two more, on the Allegro, most of that growth is outside the U.S., is that correct, in '17?

In '17 mostly outside of the U.S, in '18 I predict that there's going to be some nice growth in the U.S. as well.

Got you. And just one other in terms of, kind of looking at the NeoPigment, I'm just trying -- want to make sure that I understand completely in terms of the ability of somebody to go ahead and use non-Kornit ink in the system. Obviously, the first line of defense is the warranties. But beyond that, can you just kind of walk me through real quick again, what the -- why would it be so difficult to do that? And it's an argument, I've heard, made and just want to be able to talk about a little more intelligently.

Sure. So most important thing to realize before we talk about what use of other people's ink can do as far as detrimental steps that we would take is that Kornit provides an end-to-end solution. It's a system with consumables as well as software and it operates in its most optimal manner when you're using Kornit-original ink. There have been attempts in recent years and also in the past year to offer clone ink, alternative ink, which runs the risk of -- and phrasing Kornit IP, which is very strong in this area. But also most importantly, runs the risk of damaging the system and many times at the moment that you most need them during the season et cetera, where you could start seeing head's clogging and problems emanating as a result of the ink not being Kornit-certified. So some customers have made the attempt to go in a direction of alternative ink. The way that we deal with that is a few things, number one, is indeed, a warranty will expire, we cannot take responsibility for someone else's ink, especially when it affects the ink heads et cetera. Number two, there's an RFID on the system that basically disallows that to take place, and actually slows down the system in order for you not to damage the system. Number three, the announcement that we just made on the HD technology implies the use of a new type of ink, which is with 35 picoliter droplets, so one of the ways from a competitive standpoint for us to deal with the attempts that are being made once and every once in a while, is to go to the new type of ink and this is completely mix of what's been developed irrelevant because you need new printers as well as a very different ink altogether, which has a different level of pigment load and so even when someone has tried to come with a lower price with this new ink capability that we have, the cost of efficiencies are just night and day working with the Kornit ink. So we feel comfortable that this is the right way that it serves our customers' best interest to work this way, that it protect their investments and very importantly, also, when people come with clone ink, they do not meet all the very stringent standards that exist with for use of textiles, which includes standards for babies and standards for environmental impact, et cetera. Hopefully, that helps you. Operator, we would like to make one clarifying comment before the end of the call. Guy would like to speak about a mistake I think that took place in his prepared commentary. Guy, please go ahead.

Yes, actually we had two types. One was related to the -- Slide 17 the slide was correct regarding cash flow comments. The right comment was supposed to be at the end of the paragraph. For the year we generated $6 million of cash from operating activities, versus $1 million generated in operating activities in 2016; and the second one actually refers to Brian's question before on Slide 12. I'll read the right numbers. So there are typos in the column regarding the quarter and the annual for system in the quarter $11,290,000, ink $14,921,000 and services $3,731,000. And for 2017 systems $50,498,000, ink $51,455,000 and services $12,135,000, obviously, all the numbers are in thousands.

We shall apologize again for the mistake. We will amend the presentation and load it to our website for people's convenience and we apologize for that mistake. With that, Operator, I believe we will conclude our call. I want to thank everyone for joining today's call and that I look forward to speaking to you again. Thank you.

Thank you. And that does conclude today's conference call. We thank you all for joining us.