Greetings. Welcome to Kornit Digital's Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded. I would now turn the conference over to your host, Allise Furlani with The Blueshirt Group. Thank you. You may begin.

Thank you, operator. Good afternoon, and welcome to Kornit Digital's fourth quarter and full-year 2020 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 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 quarterly report on Form 6-K, filed at November 10, 2020, 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 website. I will now turn the call over to Ronen Samuel, Kornit's Chief Executive Officer and Alon Rozner, Kornit's Chief Financial Officer. At this time, I would now like to turn the call over to Ronen. Ronen?

Thank you, Allise. Thank you all for joining us this evening on our earning call. I am pleased to report an outstanding fourth quarter, significantly exceeding guidance for top line growth and profitability, capping off a record second-half 2020 for Kornit. This proved to be transformative year in Kornit's history. While 2020 will be remembered for the global pandemic, it is also the year in which the textile industry hit an inflection point. The massive leap in e-commerce and the exposed inefficiency of the traditional textile supply chain creates strong tailwinds to the digital transformation that Kornit is leading. In 2018, we laid out our management goal to become a $500 million revenue run rate business at the end of 2023. Upon completion of the second year in this journey, we are more confident than ever in our ability to achieve this goal ahead of plan. Turning to our Q4 results. We finished 2020 on a very strong note with total revenue growing 49% year-over-year to $72.3 million, net of $1.8 million in warrants related to global strategic account. We delivered record gross margin and we significantly exceeded our operating possibility goal for the full-year while generating a record of $34.3 million net cash from operating activities. While traditional retail is recovering from the effect of the pandemic, e-com and online marketplaces continue to boom across verticals, including core fashion brands, athleisure, merch, sports licensing, customized apparel and home decor. As a result, key and regional accounts are adding multiple Atlases, Vulcans and AVHDs to their existing fleets. And we see multiple customers that started with entry-level system from Kornit only 12 to 18 months ago moving rapidly to purchase high-throughput systems. We also see very healthy mix in our order book of net new versus existing accounts across our…

Thank you Ronen and good evening everyone. Since joining Kornit in December, I have had the opportunity to immerse myself in the business and operations as well as get closely familiar with my colleagues and professional teams across Kornit. I am excited with the journey ahead of us as we continue to transform the textile industry and scale profitably. 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. A full reconciliation of our results on a GAAP to non-GAAP basis is available in the earnings press release issued earlier today and on the Investors section of our website. Now let's dive into the financials. We are very pleased with our strong fourth quarter results which significantly exceeded our expectations on top and bottom line. Fourth quarter results were record-high for Kornit across key financial parameters including revenue, profitability and cash flow from operations. Fourth quarter revenue increased 49% year-over-year to $72.3 million, net of $1.8 million non-cash warrants impact and an increase of 26% compared to the previous quarter. Our fourth quarter results were driven by strong demand for our industrial and mass production system mostly in North America and Europe and very high growth in consumables during the peak season. Services revenue for the fourth quarter was $10.9 million, net of $280,000 non-cash warrants impact, accounting for 15% of total revenue, an increase of 70% year-over-year and an increase of 35% compared to the previous quarter. As a reminder, Custom Gateway revenue and cost of goods are mostly included in services. We continue to improve our service contract attach rate, which is growing our recurring revenue stream. As Ronen mentioned, it was a strong quarter in the Americas with 75% of…

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

Thank you. [Operator Instructions]. Our first question is from Jim Suva with Citigroup Investment Research. Please proceed.

Thank you very much, and good evening, and thank you for all the details thus far, and congratulations on the good results and outlook. On the outlook, can you talk to us a little bit about the supply chain, specifically components? It seems like there is a lot of shortages around the world, less airplanes flying around. Kind of your ability looking forward, do you have enough components for like one quarter or three quarters? Or how should we think about potential constraints to your supply chain?

Thank you, Jim. Good question. We don't see any constraints on supply chain. As you know, we produce our systems in Israel, working very closely with our contract manufacturer, both Sanmina and Flextronics. We just about to move to our new ink plant that has capacity well above what we will need in the next 10 years. So we don't see any constraints on supply chain. The only negative side on supply chain, as you know, the cost of shipping is going up everywhere and we see it as well in our business, the cost of logistics is going up.

And then my last question is, on your meetings with customers, typically shaking hands, in-person meetings and trials, are those getting better now that there are some parts of the world such as Israel that are opening up with a vaccine a little bit sooner than, say, North America? Or it’s still kind of pretty challenged, because your results are really strong? I am just wondering if things are starting even getting a little more visibility from where you sit for demand?

Yes. So again, great questions. Bottom line, when we are looking at Q4, actually, the mix that we have between net new customers to existing customers is very healthy. So we see many net new customers joining our business. And we are gaining this momentum, actually meeting with them, in many cases, through Zoom meetings, going to visit other customers or reference sites. We are doing live demonstration from our experience center all around the world and including in Israel, live with our customers and it’s very, very efficient. They are sending us the material in advance. We are doing all the testing. We are sending them back the material after it was produced and printed. So it's working quite well. Actually, in terms of productivity, I can tell you, even from my end, I find myself sometimes having three, four Zoom calls with - on one day with key customers and it's very, very efficient and beneficial.

Thank you so much for the details and congratulations.

Thank you.

Thank you.

Our next question is from Tavy Rosner with Barclays. Please proceed.

Hello. This is Peter Zdebski on for Tavy. Congratulations on the quarter and welcome to you, Alon.

Thank you.

I was wondering if you could give us some color on the consumables mix for the year or the quarter. What I am wondering is, typically, in the fourth quarter, you would have mix skewed a bit towards - more towards consumables than the rest of the year. I am wondering if that's changed at all given the sort of accelerated pace of system sales you have been seeing? And then also, I am sorry if I missed it, but did you mention any greater than 10% customers in the quarter?

So - hi, this is Alon. So yes, I mean, typically Q4, we have – in Q4, we have higher demand for consumables. And this quarter, it was the same and even stronger. We had very strong demand for consumables, which supported our business very well.

I can add that in this quarter Q4, we broke the record in terms of the supply growth, really, really strong supply growth. We are not sharing the numbers, but it's well above what we expected and we see the momentum moving into 2021. In terms of your second question about customers that has more than 10%. We have only one customer that had this quarter more than 10%, and it wasn't our global strategic account. It was not a global strategic account.

That's great. Very helpful. Thanks so much.

Our next question is from Brian Drab with William Blair. Please proceed.

Hi. Congratulations. Thanks for taking my questions. I am wondering if you could talk a little bit more about the automation solution and when might we hear more about that? How much does it speed up the process? Is it applicable to machines across your portfolio? Is there anything else you can share today on that?

Yes. Brain, thank you very much for the question. So the automation, it's a breakthrough solution. There is nothing like this in the market. It's one-of-a-kind. It’s - we have a strong IP on the solution and we are planning to release it in the mid of the year. This solution is an option on top of the portfolio that we have, will serve the Atlas portfolio, including the new systems, the new portfolio that we are going to release in the second-half of the year. And in terms of the efficiency and the productivity, so it really depends on the operators that are running the systems. So today, for example, the Atlases can run at above 100 impressions per hour. But the limitation of running constantly 100 impression or above per hour on the Atlas is actually the operator. Sometimes the operators are taking breaks and they are tired and maybe they can do it in one hour, but the second hour they will go down to 80. The automation enables the operator to do his job in a constant way, much more easy and in constant quality in the end. So it will improve the quality. It will improve the ease of use and the productivity. We expect that the productivity will be increased by around 20% on average.

That's really helpful. Thanks. And so it's a solution, just to be clear, that doesn't completely remove the need for an operator, but it makes an operator much more efficient.

Correct. It doesn't remove totally the operator. It helps the operator to load and unload from the systems in a consistent way. In some cases, we can see one operator running two systems with this system - with the automation.

Got it. Okay. Thanks. And then can you help me envision this 3D embroidery application a little bit better? And also talk about how much that expands your addressable market, as you alluded to in the press release?

Yes. So we are not ready to share too much information at this stage. We are going to share much more information in April. And, of course, we are going to show it to the market in June. It will be part of the new portfolio that we are releasing to the market. Again, it's a breakthrough solution. There is no other digital solution that can enable those application. That - some of those applications will never exist before. So what the system, the new system will enable to do is to print actually on garment, on any type of garment, it could be polyester, it could be cotton blended, 3D images. So actually, we can build 3D images which can go up to 700 micron above the surface and to emulate all kinds of application. One of the application is embroidery. And we are getting excellent result and excellent feel of embroidery. Another application is high density vinyl which is very, very important, for example, for the sports and athleisure market. And also for heat transfer, which is also relevant very much for the sports market. So we believe, at this point, that in terms of the addressable market, it will increase Kornit's addressable market by about 25% to 30% from what we have today. So it's a huge increase for our TAM. And we believe that on top of that, it will create new application that were never been able to produce before.

That's great. And just one clarification. Is it a system that embroiders or it simulates embroidery as part of the solution?

It simulates embroidery. It's a printing but it feels and looks like embroidery with many, many additional advantages, okay. But we will keep it a bit later in April we are going to share a bit more information about it.

Right. Thank you very much.

Our next question is from Patrick Ho with Stifel. Please proceed with your question.

Thank you very much and congrats on the nice quarter and to the year. Ronen, first off, you posted some very strong services numbers and in your prepared remarks you talked about the increasing attach rates. Can you give us a little bit color if some of those attach rates are now for multiyear type of service agreements? Or are they still kind of close to year contracts which you have to get quote renewals with these customers?

So we are already about year-and-half ago we moved to a full contract. Every machine that we are selling, we are selling with a contract. There is no other way to buy from us a machine and it's not for one year. It's for multiple year contract. And we see a very nice recurring revenue coming from the services business.

Great. That's helpful. And maybe as a follow-up, Alon, in terms of the operating model. You guys posted very strong gross margins. Obviously, products mix had contributed to that. As you look at 2021, you talked about OpEx increasing to help grow with the business. One, can you talk about some of the focus items in R&D? Are they for the embroidery product that's going to be released? Or are they for others that are yet to be seen until, say, 2022 and beyond? And how much do you need to add more in terms of the sales and marketing front to support these new initiatives?

Okay. So as we said, we continue to invest in the organization. As you mentioned, the focus is R&D and sales and marketing, the go-to-market. In regard to R&D, we invest actually across the board. We are enhancing our capabilities in the core occupations in R&D, in software, in new projects, in workflow. So there is a massive investment in R&D. We did it in Q4 and we will continue in 2021. And the same goes with sales and marketing. We increase our coverage with professional salespeople across all regions. And yes, I mean we will continue to invest in 2021 the same.

Let me add one more point. As we mentioned, on our mission for the $500 million run rate goal, we said and we are committing to expand our gross margin and to bring leverage also on the bottom line of the operating profit. So you will see during 2021 leverage on operating profit. We will bring small leverage on the operating profit. We don't want to maximize it because we see a massive opportunity in the marketplace and we would like to invest as much as we can while maintaining our commitment to the market. But we would like to invest as much as we can in more feet on street, in more R&D and other parts of the businesses because this is the time to invest and to grab the market and not to milk the cow to the maximum.

Thank you very much.

Our next question is from Jim Ricchiuti with Needham & Company. Please proceed.

Hi. Thank you. Good evening. A question about, clearly it sounds like you had a very strong quarter for supplies. And you did call out the strength in Presto. And I wonder if you could talk a little bit more, Ronen, about what you are seeing there? It sounds like utilization is at a pretty high level. Is that [indiscernible] or is it just certain customers have really begun to deploy this?

Yes. So we have tremendous success on the Presto. Now let's ask on the success, from where it is coming. Actually, these inflection points are going on in the textile market as we have discussed. We can see the move to onshore production on the textile, if it is on the fashion markets or on the home decor market. We can see it across Europe, U.S. and also in Asia really moving to onshore or nearshore production. We have a system which is the Presto, which is the one of the kind and we are the only one that enabling onshore production in a full sustainable way without any pretreatment, without any posttreatment. I can tell you, this week we have many, many designers preparing here in our facility in Israel for the Kornit Tel Aviv Fashion show. They are amazed with what they can see coming out from the Presto. They are actually designing on the floor their ideas and they can see it immediately going out of the press ready to just cut and sew. This is unheard of and we are gaining huge momentum. The ability, the quality and the hand-feel is nothing like you can see in other places in the market. And we believe that the entire market, entire textile world, the fashion market and the home decor market is moving into on-demand production on onshore and we have the right solutions to address this market.

Thank you. It appears that you are pleased with the progress at Custom Gateway. And I guess you have only had the business for less than a half year. Can you say, Ronen, looking out at the second-half of 2020, how many of your the existing Kornit customers have you been able to bring into the Custom Gateway solution portfolio?

So, Jim, we are not ready to share numbers at this stage of it's performance. But middle of the year, we will be able to share a bit more numbers on the business line and also target for the future that we expect from this business. What I can tell you, there is a huge excitement, both from the marketplaces, from brands, from retail, from online players and also from our customers joining to the Custom Gateway solution. We really enable our customers to be more efficient on the production flow. We enable our customer to connect to major brands. We can see huge increase coming in case of volume of impressions that are coming from brands and marketplaces directly to our customers. And we see very, very nice increase of impression that's coming from this system. So we see a big potential of revenue and margin growth coming from this business moving forward and we are very optimistic about this move.

Thank you. And last question, if I may, just with respect to the new products, the ones that you are most excited by. For the most part, the contribution that you are anticipating for these products this year, are they skewed more to the second-half? Will we see a contribution in Q3?

Yes. Absolutely. In Q3, we will see contribution form the new products, also from the automation and also from the application. So we will see it already in H2.

Thank you.

Our next question is from Rod Hall with Goldman Sachs. Please proceed.

Yes. Thanks for the question. I wanted to start off with the revenue that you printed in the guidance, a lot of long ways ahead of your guidance for the Q4 and really strong guidance in Q1. Could you maybe highlight the one or two things that surprised you there and pushed that way above the high end of your guidance range for Q4? And then I have a follow-up.

So a few things. First of all, we discussed already on the growth on the supplies. So it was a very, very strong supplies quarter, the Q4. It was also a very strong quarter for the service growth while our systems was also very strong. So it's a combination of all those three businesses. And what we see on the system is things that we have never seen before. We see relative new customers have just joined Kornit about a year ago, increasing capacity volume very dramatically and purchasing multiple systems. When I say multiple system, we see few cases of more than 10, more than 20 and even 50 systems of orders without getting to names of customers and even more than that. So surprisingly, what surprised me is the magnitude to seeing so many customers are ordering multiple, vast many multiple of systems.

Is that just, Ronen, a critical math thing, do you think? :Like, do you feel like just kind of point of recognition that these things that are out there and what could be done with them that's driven this acceleration all of a sudden?

The acceleration is coming from the inflection point that we were talking about two quarter ago. It's really about the move into the e-commerce. The online marketplaces are booming. The move into onshore. We can see the growth in the strategic account and existing account. Our systems, you know, the growth in the Atlases, the Vulcans, the AVHD, the Presto, which is relative new segment for Kornit, new product for Kornit. The business is growing fantastically. We can see the mix between the new customer to existing customers. The recurring revenue is very, very strong. And it was a very, very strong peak season. So it's a combination of all those together.

I think that it was not only our customers preparing their infrastructure for the peak season but they kept investing and we got strong demand also during the peak season until the very last day of the quarter. So we see, again, as Ronen mentioned, I mean this is absolutely related to the inflection point and not just the short term peak season.

Okay. Thanks for that. And then my last question was just on Poly Pro. Could you maybe give us a little update on how things are going there?

Yes. So on Poly Pro, we are getting a very nice demand. We are starting to see very good traction of the current Poly Pro solution. Part of the NPI, the new product introductions that we are bringing in the middle of the year is the additional solution, expanding the portfolio of the Poly Pro and taking it to the next level in terms of productivity, in terms of the quality, in terms of the efficiency. You will see an amazing quality, durability coming out of this new product that we are bringing to the market. It will really going to open for us the athleisure and the sports market. And we are very optimistic about the growth that we will see next year from the Poly market.

Okay. And that's the same thing as the 3D printing thing? Or is it totally different? I thought they were different but is it the same thing you are talking about here?

No. It's different.

Okay. Thank you.

And our next question is from Greg Palm with Craig-Hallum Capital Group. Please proceed.

Yes. Thanks for taking the questions and congrats on the results here. I know you don't usually give full-year guidance but looking back at history, Q1 tends to always be the low point of the year and usually you see a kind of a step-up in revenue in the second-half versus the first-half. So I am just curious, is there anything unusual that we should expect this year? Or would you expect the sort of same seasonality trend to hold this year as well?

Greg, you are absolutely right. You should expect the same seasonality.

Okay. Great. And if we think about that specifically, maybe help us bucket out what the largest drivers of that is? I mean you have kind of alluded to this new customers and I am curious if that's outside your core business? Or is that sort of incremental customers in sort of that core area? Is it capacity expansions from existing customers and then maybe what the contribution expectations are for new product as well?

Yes. So what we can say is that our existing customers and even customers, they are adding capacity because they expect 2021 to see it as a growth year for them. They see the demand and they see the volume coming. They are actually on constant peak season already from April, May timeframe, then constant peak season. And during December, it was the peak of the peak and this peak continue into the Q1 and they are adding more capacity. So for example, our strategic accounts and our key accounts are adding more capacity, many of them opening additional sites if it's across the U.S., if it's across continent, moving to the Europe and even into Asia. So we see expansion of additional sites and expansion within the site of additional capacity of more systems. And also they are moving to higher capacity systems. So many of them are moving from the Avalanche into the Atlases. We see also growth into the Vulcans. So this is one area we see the growth coming also from totally net new customers. Digital customers that are entering, they see the opportunity in this market and they are starting and they are gaining momentum very, very fast. And as I mentioned, the Presto is relative new. The DTF is relative new business for us, which is another big, big growth engine. And on top of that, the Poly one-and-half-years ago was not exist at all. And again, we are now gaining momentum as well on the Poly side.

Okay. And if I could just sneak in one clarification. I think your answer to a previous question about Q4 and what drove sort of the upside. I think you mentioned that the growth rate or at least the answer almost implied like the growth rate in the consumables business surpassed the growth of systems. Was that right? Or did I mishear something?

No. I think that the growth was in all fronts. I mean we had nice growth in systems, in consumables and in service. And we had very high growth in consumables as we highlighted. But that the growth was in all different types of business we have.

Okay. Great. Thanks for all the color. Best of luck going forward.

Thank you.

Thank you.

And that does conclude our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Great. So I want to thank everyone for joining us on this afternoon call. I would like to take this opportunity and to thank our employees for the dedication and their passion to our customers. I would like also to thank our investor community for their trust and partnership. 2021 will be an exciting year for Kornit and we are more confident than ever in our ability to execute on the massive opportunity ahead of us. We would like to wish all of you a good health and hope to see you soon face-to-face, not through Zoom in 2021. We wish all of you good night from Tel Aviv. Thank you very much.

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.