Good day everyone, and welcome to the Kornit Digital Ltd. Second Quarter 2019 Earnings Conference Call. As a reminder, today's conference call is being recorded. [Operator Instructions]. At this time I would like to turn the conference over to Tom Cook. Please go ahead, sir.

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 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-20F filed March 26, 2019, which identify 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. A 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 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.

Thank you, Tom. Good evening and thank you for joining our Second Quarter 2019 Earning Conference Call. Today I will provide a brief summary of our second quarter performance and highlighting 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 pleased to report another strong growth quarter for Kornit, full of activities and strategic milestones. Revenue in the quarter was $43.9 million. This figure is net of $2.4 million of warrants related to Amazon. Our business grew 23.9% year-over-year driven by successful launches and adoption of our new products and focused execution of our go-to-market strategy. Our HD platforms continue to experience high levels of demand from both existing and new customers. Atlas demand continues to exceed our expectations and our pipeline for the second half of the year looks strong. The highly anticipated Avalanche Poly Pro launched end of March contributed materially to our revenues already this quarter. The Poly Pro solves a major industry challenge and the incoming level of interest is the strong evidence to the growth potential of this solution. During the quarter, we revealed our partnership with Adidas and their digital embellishment production strategy. Those attending ITMA Barcelona witnessed live on-demand production of Adidas apparel at our booth. Adidas has adopted both the Atlas and Poly Pro solution as part of our -- of their business. We are very proud to partner with this iconic megabrand and expect this partnership to expand in these quarters and the years ahead. Brands of all sizes are a growing strategic focus area for us. I am extremely encouraged with the growing number of engagements we are having with the world's leading apparel brand as they look for Kornit…

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 second quarter non-GAAP pro forma results reflect adjustments for the following items: stock-based compensation expenses, which total $1.4 million; total amortization expenses relating to acquisitions of intangible assets in the amount of $204,000; taxes on income related to non-GAAP adjustment in the amount of minus $382,000; and non-cash deferred tax benefit in the amount of minus $295,000. Adjustment related to the acquisition of Hirsch's assets were non-cash inventory adjustment of $1.2 million, amortization expenses relating to the acquisition of intangible assets of $78,000 out of $204,000. As the company has significant operating lease liability in foreign currencies, the company incurred foreign exchange gains or losses from the re-evaluation of these liabilities. These gains and losses may vary from period to period and do not reflect the financial performance of the company. This quarter, foreign exchange losses associated with ASC 842 were $203,000. A full reconciliation of our results on a GAAP and non-GAAP basis is available in the earnings press release issued earlier today and on the investor section of our website. Second quarter revenue net of the 2.4 million warrants impact increased by 22.3% to $43.9 million versus $35.9 million in the prior year, and increased 15% versus the prior quarter. Second quarter business reflect 23.9% and 18.3% growth over the prior-year period and the prior quarter, respectively. Business reflect quarterly sales prior to reducing warrant impact. Revenues grew to record levels this quarter thanks to the successful launch of the Atlas and the Avalanche Poly Pro product as well as significant growth in revenues from services. Services revenues for the quarter were $6 million…

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

[Operator Instructions]. We will take our first question today from Jim Suva with Citibank.

Thank you very much, and the details you already provided were useful so thank you. I have two questions. First, you mentioned that you're using [indiscernible] capital situation allows you to invest more in the future. How should we think about those priorities? Is it sales force investment? Is it geographic reach investment? Is it acquisitions, software or hardware or M&A? How should we think about those? And then my second question is regarding the tariffs. I know you're not directly importing a lot that impacts the tariffs, but anything about supply chain whether it be components, printed circuit board, memory, processor, steel fringe or beads or even nuts, bolts, screws -- are you being impacted by the tariffs at all because of the global sourcing of technology? Thank you.

Do you want to take the tariff, I will answer on the M&A?

Yes. I'll start with tariff. So I think we discussed that before. Part of the solution is printing systems, the other part is ink. We're manufacturing 100% of both products in Israel, the country of origin is Israel. And as a result, we have zero tariff with the United States. We do have a very small fraction of components imported from China, but we've been audited for our product by the U.S. Customs and they approve that our products are made in Israel. That said, going to September 1, already announced an additional 10% tariff for the bulk of around $300 billion and that includes apparel. So in a way, reshoring and manufacturing locally in the U.S. is pretty much going to be the trend as a result of the new tariff. And Kornit will enjoy that by selling more machines and ink in the United States.

As for the M&A and activities that we are doing around it, we are looking in different areas in order to accelerate the Kornit growth. Of course, we are looking both on go-to-market, on auxiliaries. Our main focus as of today is around software workflow. This is where we believe we need to invest. This is what we communicated in the past and I really hope that in the next coming month quarters, we will be able to announce some development in this area.

Our next question comes from Brian Drag with William Blair.

I just wanted to start on the gross margin. You mentioned a couple items here, product mix was one of them. New product intro I understand. But what exactly was happening with the product mix that held back the gross margin?

In terms of product, we're not really breaking down system and ink. You can see that we had high volume of services, and we have negative gross margin on services.

Okay, yes. Thanks. And then you also do have the high margin Poly Pro in the mix, and that was material, Ronen mentioned in the prepared remarks. So is that something that can help, you know, as the Poly Pro gains traction is that going to help the gross margins maybe in the second half of the year, move up from here?

Yes, definitely. We mentioned it in previous calls that all our new product that include the Atlas Poly Pro and Presto versus the Allegro. They all carry higher gross margin. That said, due to the launch we're still not totally ramped-up so we're seeing higher cost of goods sold.

Okay. I'm just trying to get a sense if this is the level of gross margin, you know, if services is going to be 14%, 15% of revenue. By now we should see the benefits of taking out Hirsch pretty completely in the mix here. So I'm just wondering what, you know, if you could give us a sense for like, where we should be modeling gross margin relative to this quarter in the back half of '19 and into 2020?

So regarding the second half of '19 we expect to be above 50%. Ronen mentioned before, we have a very good demand for all the new product and we expect the second half of the year to see more ink consumption based on Atlas and Poly Pro that will drive gross margin higher. So we said during the call that we expect second half to be about 50%.

And I had missed that. So then above 50%, just to be clear, is adding back any impact of warrants, correct?

It's without any warrants impact.

Okay, so ignoring warrants [indiscernible] -- it's above -- yes, without any impact from warrants.

Exactly.

Okay. And then I guess just the last thing for right now is, can you -- I'm guessing the answer to this is no, but can you tell us anything further about the [Technical Difficulty]? Anything in terms of, is there a signed contract, how many machines are they using? Like, less than 10, more than 10? Anything you can tell us about the nature of that relationship?

You're referring to Adidas?

Yes, Adidas --

It wasn't clear. You're referring to Adidas, yes.

Yes, Adidas.

We have a very close relationship with Adidas. Of course, we cannot unveil, as you suspected, the number of units that they already acquired from us. We just can mention that they acquired both the Atlas and the Poly Pro, and we expect them to continue to grow with us in the coming -- in the next quarter and in the coming years.

Our next question comes from Tavy Rosner with Barclays.

I got disconnected for a minute so sorry if you already touched on that. Could you comment a little bit about the R&D expense? It seems to be a deceleration during the quarter. So is that because you're comfortable with the product launch that you've had and therefore you can just enjoy to spend a little less for the current quarters?

No. Actually the reason, and we mentioned it in the call, we capitalized around $0.5 million for software development and we expect the second half of the year to capitalize another $0.5 million that would be depreciated from 2020 on.

And then just a question on Konnect that you launched earlier in the quarter. Do you expect any monetization around that, or it's simply just part of your ecosystem, something that comes with it that helps, you know, with utilization and just makes your machine fit in better within your customer?

The first stage we are not expecting any revenue out of -- directly out of the Konnect. The Konnect will help to boost customer success, print more, enable us to provide better services and connectivity to our customers, based in many, many other advantages. In the second phase and third phase, we are going to add additional value-added services through the Konnect and then you will see additional revenue coming through the software.

Maybe just a short last one, you mentioned the gross margin of the service component being low in nature. Is there anything that you guys can do structurally to just change that and boost margins of the service component?

Yes, so there are many, many areas that we are working to improve profitability on the service business. Of course, the service business has to go with the growth of the business. We launched many new products. We are growing very, very fast on the installation, on new customers, on big accounts, across different regions. So we have to continue to invest in the services while we are working very closely with our team to improve productivity of our team and reduce costs. One example is the cost of spare parts and the use of spare parts in the field. So we're aiming, as we mentioned in the past, doing second half of 2020 to reach breakeven on the service business.

Our next question comes from Chris Moore with CGS Securities.

Just maybe one or two on the Poly Pro. So I'm just trying to get a feel for how you're thinking about the system sales moving into 2020. I know you don't give guidance to that, but if I was to say 25% of system revenue in 2020 could come from Poly Pro, is that -- would that be an aggressive statement, or would that be reasonable? Or any thoughts on that?

I would say that you are not far away. I would probably go more into between 15% to the 20% guide?

Yes, makes sense.

Yes. Probably around the 15% to 20%.

Got it, that's helpful. And then I'm just kind of trying to get a better feel for the relationship of the Poly Ink to the Poly Systems versus non-poly ink to the non-poly systems. Given the Poly Ink is more expensive, higher margin, polyester shirts use maybe 2.5 times as much ink as cotton. And then the other side is the throughput is a little lower than on, say, the Poly Avalanche. Is it reasonable to think that the dollar value in a kind of Poly Ink system could be 2 to 3 times that of non-poly? Is that too simplistic looking at the basic inputs?

It's definitely going to be higher and you touched the right point. Definitely the list price is higher and ink consumption per similar image is higher as well. But not necessarily the same type of images will be printed on cotton and poly. So we don't know the exact number but definitely lifetime value of poly machine is going to be very high compared to any other machine.

Our next question comes from Jim Ricchiuti with Needham.

This is Mike Cikos on the line here for Jim Ricchiuti. Wanted to follow up on the new products that you guys currently have out there. Have you seen any change as far as customer behavior or their purchasing decisions now that you guys have launched these newer products?

So in general, as I mentioned before, we see great success with the new product we manage to penetrate totally new type of customers that we couldn't penetrate before. We are penetrating the mainstream screen printers, really big accounts. We are penetrating sports, the sports industry, athleisure industry, penetrating brands. This is a major focus for us. With our current customers we see a mixed direction. So we have customers that really, really happy with they're using Avalanche HD and they continue to acquire additional Avalanche HD. We see customers moving into the Atlas. We see customers adding on top of that, also the Poly Pro. So it's kind of a mix, a mixed bag. But all positive. In the past, you know, there were questions if we see cannibalization of the Atlas on the Avalanche. We actually see a great mix of customers buying both the Avalanche and now they're buying the Atlas. So we don't see really cannibalization in this area.

And then there was also a comment earlier on the EMEA region, I guess you guys are currently scaling your go-to-market infrastructure there. Can you further elaborate on what, exactly, you guys are investing in in that region?

Yes. So first of all we brought a new leader, a new President for EMEA joined us about two months back. And he's doing great progress on just building around him a new management team. We investing in the key accounts manager working with big accounts, strategic accounts. We're investing in the after-sales in the service organization, in business development, in teams that focus on the supplies business and the after-sales. And we're investing in personnel within the countries working with our China partners, closely and helping to open doors and close deals with our China partners.

All right. That's helpful. And then the last thing, I may have missed it, when you guys were breaking out the revenue contribution by region I think Americas was 57% of revenue. Did you give a year-on-year growth rate for that region?

No, we said 57%. You can actually pick up the numbers from the call last year and extract it. We also mention in the script the year-over-year, let me just get it here.

And our next question comes from Patrick Ho with Stifel.

Ronen, maybe first off, given the success you had at ITMA this year, you've talked about in the past that a lot of the new products were being purchased by existing customers transitioning over. Can you give a little bit of color in terms of potential new customers that follow the ITMA event this June?

Yes. So we saw many new customers that bought both the existing product, like the Avalanche HD, but also the Atlas and the Poly Pro. So we see interesting type of customers that we didn't see in the past. One group of customers is from the graphic arts. We see more and more adoption from customers that used to be only the graphic arts and they have web-to-print online or marketplaces that now adopting only going on also for the textile market and adopting our solution. So this is kind of a totally new type of customers that we are acquiring. We see, as I mentioned before, the brands working very, very closely with the brands, adopting it for themselves. Some brands working with their own fulfillers to adopt digital and to adopt out our technology. We are starting to really engage with the biggest screen printers of the world for adoption of our technology both on the Poly and the Atlas. So many, many new customers and yes it's going very fast.

Maybe as my follow-up question in terms of some of your other businesses, you talked about improving the services gross margins. Obviously consumables has a very, very good gross margin contributor. Aside from product mix what are some of the other variables, Guy, that maybe you can continue to improve gross margins, especially as you look at 2020?

In terms of short-term, we went there before we launched the Atlas and the Poly Pro and the Presto recently. So we have some significant basis points that we can increase just by reducing cost of goods when these products will be fully ramped up, and that's going to be this year. So mix is number one, but number two is improving cost of goods sold which is just, you know, short-term economies of scale.

Our next question comes from Greg Palm with Craig Hallum Capital Group.

So looking at results by geography, really strong results in the Americas, Asia-Pac, year-over-year declines in EMEA which presumably is -- was maybe caused by a lack of system deployment in that region from your major customer. Is that a fair assumption, and do you by chance have a maybe an apples-to-apples comparison excluding the impact of that large major customer?

No, so it's actually, we have a great result in EMEA as well. The decline that you see is due to one big deal that happened last Q2 from our largest account which is a one-time event that happened last year. And we didn't see such a magnitude deal this quarter from this account in EMEA.

Okay.

So we actually mentioned it, if you take out the business with this specific customer in Europe, take it out in Q2 2018 and take it out also in Q2 2019, then you'll see increase of 19.1% year-over-year and that's actually reflect the real increase in business in EMEA.

A lot of companies are talking about sort of the macro slowdown over in that region or at least specifically in Europe. Are you seeing any macro softness yourself, or not?

Actually, we are coming out of ITMA with a very strong pipeline for EMEA so we feel very confident for at least for the next quarter, the next two quarters the performance will be very, very strong in EMEA as well.

And then Guy, you made some comments surrounding tariffs earlier on the call and I'm curious if you have any tangible examples of maybe customers accelerating the strategy to reshore here or just kind of curious if you're seeing any positive impact yet or not.

We're talking with some of the let's say third party manufacturers for large brands. And they have, let's say, manufacturers in China as well as the other low-cost countries. And they're totally going to shift to other local countries as well as bring back home. That's what we hear.

And do you think that's the result of the recent announcement for the new set that goes into effect September 1, or was that conversations you were having previous to those, to that new announcement?

That's very, very fresh. I think that's actually driven by the last announcement that will actually start September 1. So that's a new thing. The new tariff actually touch directly apparel, so it's very relevant to our business.

[Operator Instructions]. We'll take our next question from Brian Drab with William Blair.

Hi sorry, I'm just going to ask on gross margin again. When you say higher than 50%, can I just ask, are you contemplating that for third quarter and for fourth quarter? In both quarters you'd have gross margin above 50?

Yes.

Okay. And then -- and I guess typical seasonality should be expected with mix meaning more consumables usage in the fourth quarter? So maybe a fourth quarter, a little bit higher gross margin than third quarter?

Yes, you're right. Normally we expect some seasonality this year. More ink in the fourth quarter. And as a result, even higher gross margin.

Okay. And then can you talk a little bit more about the Presto and you know, how you expect that to impact the second half of the year? Is that more a 2020 ramp in demand for that product?

Yes, so the Presto was, I would say, the biggest surprise during ITMA. We came with this new product, we had high expectation, but the feedback we got from customers that saw it for the first time and those that saw it for the second time after unveiling of the products in some of the [indiscernible] events was actually amazing. People that came to ITMA went around, looked at the competitors' solution and was extremely impressed by the quality of our pigment inks, by the durability of the pigment inks that we have, by the hand feel, by the productivity. And we got quite large number of orders during the show. Our pipeline is very, very strong moving forward. So we are very encouraged. We actually accelerating our investment in this area, in the go-to-market both on the pre-sales and the post-sales. And we believe that it will be material contribution moving forward for a business already in H2 and definitely in 2020.

So Ronen, last question for me, but do you -- so do you feel now with the Presto that you have a product that can compete directly with players like MS and REGGIANI, Durst, whereas in the past you weren't really able to compete head-to-head with those products?

So the feedback that we were getting today from our customer is definitely yes. In our own segments, in our own volume, we see mainstream manufacturers that order this machine already. So we see different type of customers ordering it. We were targeting a lot of the home decor and we got many orders from the fashion industry, due to the hand feel. We are coming with additional solution around the systems that will make the image even softer compared to what we presented at ITMA. So we are very encouraged that this will be a big success for Kornit.

It appears there are no further questions in the phone queue at this time. Mr. Samuel, I'd like to turn the conference back to you for any additional or closing remarks.

Okay. Thank you very much to everyone. I would like to thank again all our employees for their dedication and for sharing the common goals with us. Our customers for the continued support and of course, our investors for the trust that you have in Kornit and the trust in us to be able to deliver on our important objectives. So thanks a lot, looking forward to meet all of you soon. Good evening, everyone.

And this will conclude today's conference call. Thank you so much for your participation. You may now disconnect.