Kornit Digital Ltd (KRNT) 2015 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the Kornit Digital Limited third quarter 2015 earnings conference call. As a reminder, today's conference call is being recorded. After prepared remarks, we will conduct a question and answer session and instructions will be provided at that time.

I would now like to turn the conference over to Allison Cain of ICR. You may begin.

Thank you, operator, and good afternoon to everyone. Before we begin, I would like to remind you that forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other US securities laws will be made on this call.

These forward-looking statements include but are not limited to statements relating to the Company's objectives, plans, and strategies, statements of preliminary or projected results of operations, or of 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 forward-looking statements. The Company's actual results could differ materially from those anticipated in the forward-looking statements for many reasons, and I encourage you to review the Company's filings with the Securities and Exchange Commission, including without limitation the Company's final prospectus, which identifies specific risk factors that may cause actual results or events to differ materially from those described in the forward-looking statements.

Any forward-looking statements are made as of the date 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 make 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.

With us on the call today are 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.

Thanks, Allison. And hello, everyone, and welcome to our third quarter of 2015 earnings conference call.

I will begin today's call by reviewing the main aspects of our financial and overall business performance during the third quarter. I will then provide some insight into the activities of the third quarter, and finally some color on the current state of the industry as it relates to us. Guy will then walk you through the financial details and our guidance for the fourth quarter of 2015.

Third quarter revenues came in at the low end of our quarterly guidance but still represented a 20% increase year-over-year. The lower growth rate relative to the first two quarters of the year was primarily related to the timing of system orders and some delayed system buying decisions.

However, we began to see a recovery in the final month of the third quarter which has accelerated so far into the fourth quarter. This includes several recent orders which we expect to provide a tailwind into the end of the year. Given this momentum, we remain confident that overall business fundamentals remain healthy and that we are on track with our business plan.

During the quarter, we fully caught up with our corporate growth plan and filled the positions we were looking to fill, bringing our total headcount at the end of the quarter of 316 employees. Per our plans, we are continuing to bring on employees in all parts of the Company in order to put in place the infrastructure needed to support our significant growth trajectory and product roadmap.

We are especially happy to demonstrate that our robust business model allowed us to deliver close to 14% operating margin during a quarter in which OpEx increased by 37% versus last year's comparable quarter, doing this on a relatively low revenue base.

Turning to main events during the quarter, during the third quarter we also continued to progress with our Allegro roll-to-roll platform. Multiple customer demonstrations led to several system orders which we expect to install during the fourth quarter.

We were especially pleased to report the fourth system order from Spoonflower, as they take their first step of offshore order fulfillment. Seeing their three first units running 21 hours a day, seven days a week with very high reliability provides us with the confidence that we have a real production worthy solution for the market to adopt.

Last week we performed our third in-house customer demo of the Vulcan system, which will be showcased to select customers at our booth at ITMA in Milan later this month. Feedback from all three demos was excellent. Customers were especially impressed by the speed, the cost per print, and overall cost of ownership considerations, as well as the operational flexibility which the systems offers.

Discussions with the customers included very detailed comparative analysis of screen printing, with each customer laying out their specific operational considerations. These customers included both brand owners as well as order fulfillment contract printers.

All three are extensive users of screen printing. All spoke about how much of their business is evolving towards batch manufacturing, ranging from several dozens to a few hundred units of particular designs. They see this range as the real sweet spot for Vulcan and are eager to implement it in their production lines.

As stated previously, we will start beta testing the Vulcan at the end of this year and dedicate most of the first half of next year to preparing the system for general availability.

During the third quarter, we continued to proliferate with our new NeoPigment Pure inks. Customer feedback continues to be excellent. We were recently informed by one of our leading customers that the quality with this new ink has improved so dramatically that he was able to supply multiple orders to Nordstrom and Urban Outfitters and meet their high quality requirements. I will add some color on our view of the retail market opportunity and how it is shaping up later in today's prepared remarks.

During the quarter, we also continued to sign several service contracts in all three regions, as customers are learning to rely on our team of professionals to ensure system availability and enable the continuous expansion of the applications they are printing on.

Turning contract business into a significant part of our service revenue stream is of strategic importance to us as we move towards breaking even during 2016 and later moving to profitability.

Moving on to trends in our industry and their impact on us, having returned from a recent trip to China, I came back with a fundamental understanding of how that market is evolving. As you may be aware, China used to be the largest exporter of textiles. Over the past several years, much of that activity moved to Cambodia, Bangladesh, Vietnam, and other developing economies. This change was a result of the increased cost of manufacturing in China as the economy and standard of living and wages increased dramatically.

Chinese commission printers or, as we call them, contract printers and local brands now have to deal with higher average wages, ever increasing energy bills, limitations on water consumption for industrial usage, and mounting competition. As all of this plays out, the Chinese populace has become highly dependent on e-commerce and online shopping.

People go to shops to see what's new and then buy those items online. This is especially true in the case of apparel. China already has 600 million Internet users and more than 360 million online shoppers. $6.00 out of every $10.00 spent online in Asia comes from China. A recent survey of online purchasing trends shows that apparel and footwear are the fastest growing categories, growing 75% during both 2013 and 2014.

With these changes taking effect, printers and local brands are opting to reduce their fixed costs on employees, energy, and space, and moving to digital printing as a variable cost structure. Digital printing allows them to use much fewer employees and consume a lot less space and energy and eliminate the use of water in manufacturing. It also gives them an ability to cater to small online orders of discrete designs coming from online shoppers.

Accordingly, our operation in China continues to develop. Two weeks ago we opened our first office and demonstration center in Shanghai, while our distributors are also laying foundation to demo facilities in the south and in the north. Our staff there is continuing to grow and we already employ 10 people in sales, marketing, and support positions.

In general, we see the trend toward online shopping for apparel and fabric growing explosively. Brands and retailers are all mentioning this area as their fastest growing segment, and this goes way beyond China.

We have recently seen more cases of retailers and brands approaching our customers to fulfill their orders mostly for Web-based business but, in a growing number of cases, to fulfill brick and mortar shop needs. The method being applied for brick and mortar fulfillment explains how this works.

They start test orders of small quantities of, say, 200 to 300 units going to multiple stores. If during the first week 8% to 12% of the supply is consumed, then they know they have a winner. They then immediately follow up with a chase order and move on from there. In this model, inventory at risk is minimized, and guaranteed fast moving inventory replenishment is ensured on the discrete shop level using advanced automated order management systems.

We believe this model is gaining momentum and is starting to deliver on the much anticipated move to fast fashion. The market is evolving to rely on fast turnaround and operational excellence and high quality at a competitive price. If until a year ago we thought most online traffic was related to personalization, we now see mass customization taking off.

But, perhaps most importantly, shoppers are now seeking to choose from an endless variety of designs that are displayed on the Web, giving them the complete freedom of choice, affording them the unique shopping experience that they are looking for.

The trick is to combine economies of scale with the ability to cater to discrete customer needs and wants. Many of our customers are already taking advantage of this trend.

They are constantly evaluating what parts of the food chain they want to own. For instance, some existing customers of our DTG product are seriously evaluating using our roll-to-roll solution in a way which will require them to cut and sew fabric into accessories. By doing so, they leverage their online traffic for more applications and expand their share of their customer pocket.

Economies of scale also mean that the likes of Amazon and Baidu of China want to play in this market. Amazon recently announced the Merch by Amazon effort. Initially this effort is focused on providing game and app developers with the ability to monetize their brand by offering customizable t-shirts, but we can easily see how this effort will develop in many other directions in the future.

All this is great news for Kornit. We are clearly very well positioned as a reliable, proven provider of large scale manufacturing solutions. Both our current product portfolio, as well as what we have planned for the next six to 12 months, position us very well for taking full advantage of these trends.

The formation of strategic and key accounts with talented textile professionals joining the Company will make sure that we get in front of the right people and provide them access to our technology and solutions. We will continue to update on these efforts as we move forward.

We expect a very busy November as it relates to tradeshows and marketing activities. We have SGIA in Atlanta happening this week and ITMA in Milan coming up soon.

ITMA is planned to be our largest ever exhibition. And as was recently announced, we will be showcasing both Vulcan and Allegro in conjunction with several other products and new capabilities. We encourage investors to come see us in Milan, as we are planning a truly unique experience that takes us way beyond customized t-shirts.

As stated, we plan to continue with our aggressive hiring plans during the fourth quarter. Expect SG&A during the quarter to increase given the said marketing activities.

Our roadmap for the next six to 12 months is full of additional capabilities. We will not only be rolling out new products, but will also be offering our existing customers several upgrade options to existing systems. We believe this strategy bodes well for the importance that we attribute to customer retention. It will also offer another source of revenues for our service group.

Despite the slower sequential growth during the third quarter, we believe we are well on track to continue with the aggressive growth rates we have enjoyed in recent years. The global trends towards digital printing, our strong market position, our expanding field presence, and our differentiated products and proprietary processes, as well as our roadmap, all provide us with a tailwind for continued growth.

And with that, let me now turn it over to Guy for a closer view on the numbers and our guidance of the fourth quarter of 2015. Guy?

Thanks, Gabi, and good evening, everyone. Before beginning the financial overview, I would like to remind you that the following discussion will include GAAP financial measures as well as non-GAAP pro forma results.

Our third quarter non-GAAP pro forma results reflect adjustment for the following two non-cash items; stock-based compensation expenses, which totaled $651,000; and depreciation and amortization expenses relating to the acquisition of assets of Polymeric Imaging in the amount of $62,000; and continued amortization of IP acquired in 2010 in the amount of $56,000.

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.

Third quarter revenue increased 20% to $22.2 million versus $18.5 million in the prior year, and increased 4% versus the prior quarter. Higher revenue was driven by several items in this quarter, including sales of higher margin high throughput systems, a higher volume of ink, and growing revenues from the Allegro system addressing the roll-to-roll market.

By geography, 59% of our sales were from the Americas, 23% from Europe, the Middle East, and Africa, and 18% from Asia-Pacific region. As in previous quarter, the Americas remain our largest territory.

Accordingly, our two US distributors contributed 36% of our overall revenues compared to 46% in the prior year period. It is important to note, however, that customer concentration is not indicative of our end users, as we supply our product mainly through distribution agreements.

Moving to profitability, non-GAAP gross margin in the quarter was 48.3% versus 47.6% in the second quarter and 50.6% in the prior year period. Gross margin in the third quarter of 2014 was exceptionally high and, when comparing to the first nine months of that year, amounted to a 680 basis point difference due to two large customer orders of high end systems. On a GAAP basis, gross margins were 47.6%.

Higher margins this quarter versus the previous quarter were the result of several factors, including a higher mix of high throughput systems and increased volume of ink. Gross margin in the first nine months was 47.3%, 350 basis points higher than the 43.8% gross margin in the first nine months of 2014.

Moving to our OpEx items, I will discuss these items on a non-GAAP basis, which excludes non-operating charges previously mentioned and highlighted in our GAAP to non-GAAP reconciliation in our press release.

Adjusted research and development was 13.2% of sales, or $2.9 million, compared to 12.1% of sales, or $2.2 million, in the prior year. The increase in R&D expenses as a percentage of sales reflects the increase in headcount that contributed to an accelerated development of our Vulcan system.

As part of our growth strategy, we expect to continue to invest heavily in R&D, and anticipate a higher R&D run rate in the fourth quarter and in 2016, predominantly as the result of additional chemistry scientists, software engineers, and other engineering personnel.

Sales and marketing in the quarter were $3.1 million, or 13.9% of sales, compared to $2.2 million, or 11.6%, in the prior year period. Higher sales and marketing expenses were the result of increase in headcount. We expect marketing expenses to increase in the fourth quarter by approximately $1 million, mainly due to several annual tradeshows and ITMA, an extraordinary event that occurs once every four years.

General and administrative expenses in the third quarter were $1.7 million, or 7.8% of sales, compared to $1.2 million, or 6.7%, in the prior year period. Higher G&A in the quarter results predominantly from management headcount addition and incremental expenses as a public company.

Headcount as of September 30th was 316 employees. The increase in personnel was primary attributed to addition of R&D and sales and marketing personnel. Our strategic focus is to take advantage of growth opportunities in a transitioning analog to digital printing on textile market.

To that end, we have made investment in our engineering, sales, and services teams. We expect to continue adding new system and chemist engineers, as well as additional sales, application, and service personnel to further develop and strengthen our leading position in the fast growing DTG market and support our penetration of the roll-to-roll market.

Non-GAAP net income for the third quarter was $2.9 million, or $0.09 per diluted share, an increase of $538,000 versus the year ago quarter. Non-GAAP net income for the first nine months of 2015 was $6.2 million, an increase of $3.8 million versus the first nine months of 2014, or $0.25 per diluted share.

The decrease in diluted EPS in the third quarter compared to the nine month EPS is predominantly based on additional shares and conversion of preferred shares at the IPO. On a non-GAAP basis, the denominator for diluted net EPS share count for the first quarter was 11.2 million shares and, at the end of the third quarter, 32.1 million shares.

GAAP net income was $2.1 million, or $0.07 per share on a diluted basis, compared with net income of $3.2 million, or $0.30 per share, for the year ago quarter.

Our financial income this quarter were $279,000 as a result of accrued interest of our cash investments, offset by financial expenses related to bank expenses.

Net cash used in operating activities was $4.9 million this quarter compared to $640,000 net cash provided in the prior quarter and net cash provided in operating activities of $146,000 in the year ago quarter.

Decreasing cash was mainly a result of increasing accounts receivable, driven by revenue concentration at the end of the quarter, followed by improved business conditions experienced during the first month of the fourth quarter.

Cash balances, including long term marketable securities, at quarter end were $74.4 million compared to $5 million as of December 31st, 2014, with the increase of $75.9 million attributed to the net proceeds from our initial public offering in April, offset by cash used in operating activities.

Turning to our guidance for the fourth quarter of 2015, we expect revenue to be in the range of $24 million to $27 million, and non-GAAP operating income to be in the range of 11.2% of revenues to 14.8% of revenues.

As we mentioned in our remarks, many of our new employees started to work during the third quarter. And in addition, we are expecting to accelerate the pace of hiring to position the Company to meet our long term product roadmap.

In the fourth quarter, we are planning major investment in local and global tradeshows, including initial presentation of the Vulcan system, and in addition starting new R&D projects. As a result, marketing expenses and material expenses in R&D are expected to increase as well.

I will now transfer the call back to Gabi.

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

Thank you. (Operator instructions.) Ken Wong, Citigroup.

I think the first area I want to touch on, Gabi, you mentioned earlier that you guys saw some delays in terms of getting systems into Q3 and that that put you guys towards the low end of your guide. I guess how confident are you guys that that's something that's going to come through into Q4 and that that didn't really disrupt too much of what you guys had initially been expecting for the full year?

Yes. Again, I think that, as we said in the prepared commentary, we're very strongly opinionated that we're continuing to see the positive trend that we've been enjoying for the last several years.

If you look at a few of the numbers -- just by way of example, if you would look at the first nine months of the year where we are versus last year, we're up 29%. If you would look at the three year CAGR for that period, we're at 34%.

Indeed, there was delays in orders. I think, and from talking to several customers and actually to our people, some of it was related to a little bit of a feeling of uncertainty from a economic standpoint. Some of it was specific to specific businesses.

But, as Guy had said, the end of the quarter and also the first month of the fourth quarter have been a change of gear. So, we feel confident with the guidance that we've provided here. What it brings in the overall year-end result is adding the $61 million plus what it is in the guidance. That brings it to the number which I think is pretty close to what we were planning.

So, I think we're on track. We're continuing to grow generally at the same rate that we were. And I think also what's very important, as I pointed out, that we're able to generate this I think very good operating margin despite the fact that OpEx also grew about 37%. So, the business model again demonstrated how strong it is.

Generally, the (inaudible -- technical difficulty) positive (inaudible -- technical difficulty) products is helping us quite a bit. The Allegro is now starting to be part of our revenues. And seeing the repeated activity there is quite helpful as well.

Got it. And then, I guess maybe kind of looking at little beyond the push out of systems, maybe can you help us understand whether or not there was any other impact from these push outs? I know Q3 is typically your strongest ink quarter. Was the ramp in ink sales consistent with what you guys were expecting there?

Yes. Yes, actually it went very well from that standpoint. Obviously we don't break it down specifically, so I won't provide too much color on that. But, generally yes, which shows us that fundamentals, business fundamentals in general continue to be quite good and quite strong.

And so -- and again, if you look also at the margin profile, the gross margin profile, again, if you look at the comparable quarter, and that's what Guy was trying to describe in his prepared comments, Q3 of last year was an exceptional quarter where we exceeded the 50% gross margin mark. And if you would look at that, that was quite an anomalous situation.

Obviously, we think we're going to be there in the very near term from a gross margin picture. Q3 and 2014 was exceptional because there were two very significant customers ordering multiple systems of our highest end during that quarter, and that obviously impacted the gross margin there.

But, if you would look at the gross margin picture even on a three year basis, you can see over 400 basis points growth. So, I think things are on track. Again, we've very responsible, looking at each quarter specifically, looking at the overall trend. But, I think we're still on a very good growth trajectory. Nothing changes from that standpoint.

Got it. And then last thing for me, you touched on signing some additional service contracts with customers. Were these of the -- kind of the multiyear variety that you guys were hoping to push into your base longer term?

So, the stuff that we spoke about in the past is two things, selling service contracts to existing customers and then also starting to sell second year warranty with the initial system acquisition, if that's what you're talking about.

Yes.

It is starting to become more and more significant as we go. Obviously it's something that's growing. As you can well imagine, its impact on revenues gradually becomes more significant because you recognize as you go following a service contract being signed.

And as I said, this is very strategic for us because, in our long term model, we want to see much more significant revenue coming from service contracts. And much like many things we do in the market, once you start doing this more and more, it creates an impact and creates momentum.

So, that's what's been happening. It also helps us and solidifies our plan to reach the break-even level during the first half of 2016. So, yes, that is something very important for us.

Okay, great. Thanks for taking my questions, guys.

Joseph Wolf, Barclays.

Thank you. I wanted to focus in a little bit on the account receivable number. I think, Guy, you mentioned that there was a concentration at the end of the quarter there. Better trends in 4Q, but there was a -- how should we be looking at this going forward in terms of if you're modeling -- if you're pushing towards a DSO number or this was something that you think you can -- that will reverse right away, or is there something going on in the mix of business towards outside of the US which is going to keep this at a higher level that we should be thinking about going forward?

So, again, as we mentioned in our remarks before, it was backend loaded type of quarter. So, that brought us to around 70 days DSO.

Forward-looking and based on what we're seeing in Q4 in new customers, direct and non-direct, we're seeing longer credit terms. Very good customers, but we're going to extend our credit terms.

So, we expect DSO in Q4 to be a bit higher than 70 days, like 72 or 73 days. And as we look at 2016, that's pretty much going to be our DSO.

Are those global? Are those geographically consistent across Americas and external?

Well, I was actually referring to global customers, let's say headquarters in the US but global customers. And we're seeing these credit terms in terms of days going up globally.

Just one thing to add here, Joseph, is the fact that, now that we're seeing more and more bigger customers coming online with us, they come with certain credit term expectations. And so, that is also included in Guy's thought process.

There are now more significant customers that are starting to order multiple, multiple systems, which is good news for us. And still, obviously DSOs were very low for us historically. As far as the way we view it, even around the 70 days is pretty reasonable. And credit behavior actually -- customer behavior has been very good to date, and we have all of the reasons to believe that's going to continue.

So, is it fair to say, or maybe this is something you hinted at, was -- the percentage of new customers, is that expanding versus existing customers? And should we look for that to continue, or can you give us some sort of feel for what's going on there?

It's both things, right? It's existing customers that are growing their business. And let me give you an example.

If you remember, in my prepared commentary I spoke, for instance, about a customer who is an order fulfillment shop for online Web stores. He's now working with the retail market, for instance, and buying quite a few systems, becoming a Vulcan customer, he's hoping, in the beginning of next year as well.

So, we're seeing more customers like that that are adding more capacity because they're very successful because they now have an operation that's been running very successfully for a few years. And now fulfillment is being concentrated more and more with specific fulfillment shops. Less people are doing both the Web store as well as the fulfillment, so that's one aspect.

The other aspect is that we're having more large customers joining the pack here, because they come with fulfillment experience sometimes from other industries and they want to join this -- excuse the language, this party that's going on with very profitable fulfillment of textiles.

So, it's both. We're adding quite a few new customers and we're seeing repeat orders from existing customers.

So, just one last question for Guy then. How comfortable are you with the cash burn rate? Could you take that down another $10 million over the next two quarters, or is that -- you think the cash will be stable here?

The cash will be reduced, but low single digit.

Okay, perfect. Thanks, guys.

Thanks a lot, Joseph.

Brian Drab, William Blair.

Hi. Thanks; just one clarification first. Guy, I think you just mentioned that 3Q is backend loaded quarter, if I heard that correctly. Is that a little bit of a surprise following the FESPA show?

FESPA was actually in Q2.

I know. And I would have thought that you would have seen more --.

No, it has nothing to do with it.

Momentum going into 3Q.

No, what we saw was, let's say, a lower than expected August. September bounced back. At the end of September, we supplied most of the orders we received. And we -- the momentum that we started to feel in September actually continued in October.

Okay. Is that typical seasonality? The nature of my question is, just to be clear, coming out of a big show like that, on the 2Q call it felt like we had a lot of momentum going into 3Q. And then, it sounds like what -- the way you're describing it today is that September was the strong month. I mean, I guess you just tell me. Was that expected or was that a little bit more backend loaded than expected?

It was a little bit more backend loaded than expected. And I think as I had mentioned, it was a little bit delayed decision making processes.

I've been doing capital equipment for 20 years. There are situations where people look at macroeconomic trends and say do I want to wait a minute. I think that was part of it.

The good news about that FESPA show was that we walked away with a lot of very valuable leads that are going to be turning -- a lot of them are going to be turning into -- already some of them have turned into actual sales and others in the future.

So, I think this was more an event. Basically Q3 this year was a little bit different. As I had mentioned also, we're still at a size where we don't necessarily see linear growth from one quarter to the next.

If you look at our behavior in the last couple years, you may see ranges between 20% and 50% from one quarter to the next. And what we keep on looking at and alluding to is the overall annual view, which is well intact, as I said, with 34% CAGR for the first nine months.

So, Brian, my answer is this was really something that evolved during the quarter, something that, when we looked at July -- and even during the conference call in August we did not realize that this would be so significant that a lot of it would pouring in to September. But, that's really what happened.

Okay. No, makes a lot of sense. And on the second quarter call, I brought up the topic of potential macro headwinds and you hadn't seen anything like that yet.

Right.

But, I mean, we're seeing with companies that sell valves to companies that sell 3D printers. There's a big pause. I would say that it's a positive and kind of a departure from what we're seeing with other companies, that you actually saw the rebound in September. So, that seems like a really good sign.

Indeed.

One other clarification. Guy, you mentioned that R&D run rate would be a little bit higher. That's in terms of percentage of sales?

No, it's going to be more or less -- in terms of percentage of sales more or less the same since we're expecting to grow sales. So, dollar wise R&D will grow.

Okay. And as a percentage of sales, should we look for something more in line with third quarter or a little bit lower than that -- or, sorry, a little bit higher than that, because it was a little bit lower than expected, at least --.

More or less the same as Q3.

About Q3, okay.

As a percentage of sales.

Okay. And then, can you just drive home the point that you made about the share count? Because I don't know that I understand what drives it toward the low end or the high end of the range, the 32 to 34. That seems like a --.

Yes, it actually depends on employee stock option plans and how many employees will actually exercise their options during 4Q. So, that's why we made it a range.

Okay. You mentioned the preferred shares, but that's a historical issue, right? That has nothing to do with --?

Yes, that's just a remark if you want to compare it to the previous year, the EPS for the previous year prior to the IPO. So, it's just to try to make some sense into the denominator. But, it's doesn't really help you to get any figures about 2015.

Okay. If it's just stock options, then I guess, if you hit the high end of the revenue range, does that get us, I guess, into high end of -- what you're expecting for profitability I guess would be key as well. But, does that get you to the 34? It just seems like a pretty big step up in shares. It's like 5% of the share count between 32.5 and 34.

No, the number of shares has nothing --.

34 seems like a high number -- yes.

The number of shares has nothing to do with our revenue guidance. And it is --.

We're not guiding to EPS, if you remember.

Right.

We're guiding to operating margin. So, we didn't reference --.

I'm saying -- I'm wondering --.

The EPS number, yes.

No, again, I'll explain. Maybe I was not clear enough. The number of shares, the spread is actually based on something that we cannot really forecast. It's how many employees will sell how many stock options during the quarter. So, it's pretty much related to share price and what they want to do with their money.

Okay. I'm -- what I was getting at is it seems like you would be issuing more options, right? And what would lead to issuing more options would be better performance. But, you're saying -- aren't the options they already hold in their -- I mean, that's in the diluted share count already.

It depends on what's going to be the share price at the end of the year. That is why --.

Well, okay. So, it's depending largely on the share price.

Right.

Okay. Okay, I'll talk to you more later. Thanks for answering my questions.

Okay.

Thank you.

Patrick Newton, Stifel.

Yes. Good afternoon, Gabi and Guy. Thank you for taking my question. I guess starting on Allegro, you've talked quite openly about Spoonflower and that it's obviously an early stage success story in roll-to-roll, but they have a relatively unique business model. So, I guess my question is can you comment on how customer engagements or your pipeline for the Allegros is trending outside of Spoonflower?

Sure. As I had mentioned, a few orders were received during the quarter. We also recognized some revenues during the quarter from previous sales, and as well as received multiple orders that are going to be installed during the fourth quarter.

The types of customers are a variety of different customers. So, obviously there is the Spoonflower business model that we've spoken about in the past. But, others are, for instance, an existing direct-to-garment customer that wants to expand their offering. That is a provider that works with very, very high end brands as a contract printer and now wants to add a wide format capability because he wants to capture more of his customers' business.

There is another customer here which is doing a military application which I'm not allowed to describe in any detail whatsoever, unfortunately. There is customers that are focused on activity that's around toddlers and babies, some of it online, some of it more retail oriented.

There is really a variety of different kinds of customers. Another one is an existing contract printer that is printing wide format but likes the fact that they have a all in one solution that allows them to do both cotton, cotton blends, polyester, anything they want on a single system without the need to do a variety of different things in different processes.

Just a little anecdote here. When I visited China now, we went to a few digital printers, wide format printers that work with other systems. And on their top floor reside the digital systems. And on the bottom floor, if you would see the pretreatment, the washing, steaming, drying 30, 40 meter type systems that they have there, huge energy bill, huge amounts of steam and water, it's amazing when they talk to us about what the Allegro could do for them. It's a whole different ballgame.

We could, in a huge ballroom set up, basically set up multiple systems, whereas now they're doing -- really each system needing multiple of these huge systems that come from yesterday's world.

So, it's a variety, Patrick. And that's one of the nice things I'm seeing here, that it's not just let's do the Spoonflower business model. It's more than that.

Great. Thank you for the detail there. I guess just kind of dovetailing off the comment of other wide format solutions requiring a significant amount of pretreatment, when you go head to head with the likes of an MS or a Reggiani, how are you faring? When you do win head to head, what's driving that win? And when the competitors win, what's driving the competitor win? And if you could, layer in in your answer a little bit on NeoPigment. Just how important is pigment, and does your Allegro roll-to-roll need to move beyond pigments to other types of ink?

Yes. So, the situations that we're in right now, we're being brought to the table because what we're offering is truly different and unique. And here what's important to realize is that Kornit offers a proprietary process.

The other companies that you've mentioned are offering very similar processes. And what they compete on, which is very valid, is things such as efficiency, cost per print. Very, very significant and critical for manufacturers, but at the same time not a proprietary process, for instance not a process in which there's only one set of inks and consumables, but there's a variety of different inks and consumables.

The reason we get called in when we do, or the reason we get an audience when we call upon customers, is that this is basically a different approach. We don't try to go after EFI right now, which used to be Reggiani, or MS when they want to sell a system that runs 600, 700, 800 meters an hour of a specific application.

We go and talk to customers that either have done that but want to have a variety included in a single system with a completely different use case, or those that want to set up a business that inherently requires you to have the versatile capability that Allegro offers.

So, as I had said in the past, this offering is very different. It's very unique. It's not necessarily competing head to head against those other options that exist in the market. It truly is creating a branch of its own.

The beauty of what's starting to happen now is that even existing customers of those other systems are saying I want to layer this in because I understand it can do something different for me. And that's the way you should look at that, as well as startup greenfields that see this as an opportunity to get into the printing on fabric market without being experts in the area.

Great. And I guess just two gross margin questions for me for Guy. One is I guess -- or Gabi, you can answer this as well. You guys made several comments on the progress with your service business. So, if we just boil that down to service gross margin break-even, is that still on pace for the first half of 2016?

Yes, that's that focus. And what's going to help with that is not just the service contracts. It's also the upgrades that I spoke about that are going to start rolling out in the beginning of next year.

Upgrade business is very important for us, very important for the customers as well. And we've known ever since we started talking about this that this is the roadmap that we're building. We've been working on this. It's both hardware upgrades as well as software upgrades that are going to start being offered.

At the same time obviously, as we've communicated several times, we have increased the headcount in the service provision, basically because we want to have the presence in the field as both application and service people. We've increased quite a bit. We're going to temper that down a little bit because we think we're starting to reach the critical mass that we were looking to reach. And then, with the growth of revenues, we should reach those levels that I had been describing before.

Great. And I guess just the last question on gross margin, Guy, is if we think about the strategic shift Kornit made to kind of move to higher speed high, throughput machines kind of in early 2014 and look at the gross margin results, you've pretty much been linearly up and to the right outside of kind of that Q3 pop where you had some very high number of orders. So, as we kind of take the September quarter, 48% and change gross margin, and march it through 2016, is it right to think that there should be a linear increase in general be the trend from now through calendar 2016?

Yes. And again, we're looking at our growth, both top line and gross margin and gross profit, linear growth between the years. Between the quarters you can see, like Q3 last year and Q3 this year, that the growth is not really linear. But, on an annual basis, yes, we're seeing continuous growth in gross margin.

Thank you for taking my questions.

If you remember just -- sorry, go ahead. What was that?

I was just saying thank you, but go ahead.

Yes. Just to reiterate for everyone, as we had mentioned previously, when looking at gross margin, we're working on five elements continuously. It's the move to higher throughput systems. It's more inks and consumables being consumed as we make that transition, and also help with application, make people use more. It's going to be the transition to service becoming break-even and later on becoming profitable. It's COGS reduction, and it's going to be additional software and upgrades, as we had described.

And again, working on all five cylinders basically continuously is what's going to help us deliver what Guy's just described to you.

Great. Thank you for taking my questions. Good luck.

Thanks a lot.

(Operator instructions.) Bobby Burleson, Canaccord.

Hi. Thanks for taking my questions.

Sure.

So, I guess it's really exciting that the brand owners and retailers are getting more involved on the brick and mortar kind of fulfillment. And I'm wondering, are there any metrics on growth for that type of model and the potential size of that business?

So, what's interesting is, if you listen to some of the conference calls of the global brands, those that are public companies, the first thing to say, and I'll make a few comments here, is first of all their online business is the fastest growing business.

That's what they're all talking about. Many of them take very unique measures such as Under Armor and their efforts, or if you look at Nike that's in the sport area, even if you look, by the way, at retailers like Target that are set to have more than 350 million online shoppers worldwide.

So, first of all, the online aspect is very significant. And the likes of even Target and Walmart are starting to look for fulfillment that happens on the store level. Rather than having lengthy turnaround times, they want their providers to be able to do replenishment cycles or what we call chase orders on a continuous basis for the stores as well as for the online shopping.

So, first of all, I think as far as quantifying this, it's too elaborate for me to quantify, Bobby. I will say that I think it's a vast opportunity. I mean, I have been -- and I tried to relay that. Hopefully I was successful. I'm extremely excited by the early signs I'm seeing right now, because what I'm realizing now, as I had mentioned, is that this is going way beyond personalization.

This is really about moving to fast fashion with all the benefits that we've been discussing. Everyone's been talking about it. Now they're really starting to do it. So, it's tough for me to quantify. What I always allude to is we're addressing an end market which is monstrous, $170 billion worth of printed matter annually. This is yet another step in that direction.

And what we want to do be a serious player in that transition. And the way to do that is going to be a combination of relying on existing relationships, and the examples I gave are actually from existing customers that are moving in those directions, as well as starting to embrace these opportunities with very good textile people.

We've started bringing people on board that have the knowledge and the relationships at some of these brands. And we're going to be doing that in all regions.

So, I have really high expectations. My problem is unfortunately it's tough to quantify. But, it definitely supports our story.

In terms of what you see out there, guys that are doing this now, where do you think your market share is of digital solutions? And do you think you're better competitively positioned there than elsewhere, or just kind of what's your sense of how much of that opportunity Kornit can capture?

Well, there's been a few approaches towards us recently of very, very big names that I'm not allowed to share at this point. And the reason they come to us is because the reputation is that we are the only provider of an industrial solution out there that is worth looking at when you want to have a reliable business.

You need to realize that when these bigger guys want to rely on you, you're going to have to prove day in, day out that you have a system and multiple systems that can actually deliver these orders.

So, I think that we're in a really unique position. And here I'm talking obviously about direct-to-garment, right? We're really the only one that is able to provide sustainable high quality manufacturing capability day in, day out around the clock. And that's why they're coming to us.

Now, they take it very seriously. They do extensive demonstrations. They look for high quality. They want to see sustainability over time. So, it's not as though they come and they just deliver the order. They evaluate very carefully our ability to do this.

And I have to admit the fact that we've become a public company, that people are aware of who we are, of our financial strength, etc., also helps to make these decisions, because they need to rely on this as a critical component in their supply chain.

Okay. And then, I guess the last one for me is it sounds like you're getting some -- there's a lot of potential, obviously, with e-commerce for apparel in China. And I'm wondering -- China is always a concern in terms of IP protection. I'm just wondering if you can kind of cover what you guys are doing there to make sure that you don't compromise your IP in any way.

Well, we -- as far as IP, we've -- our IP is also PCT. We've always looked at the global picture. So, from a formal standpoint, I think we took the right measures.

But, you know that China is a place in which these things do happen. And a decision to be aggressive if and when those situations show up needs to be made not emotionally, I would say, but with business thought behind it. So, on the one hand strong IP with the protection that is relevant there, on the other hand you need to decide what battles you want to do.

The more successful we become, the more interest there will be, no question about it. I think what's going to continuously differentiate us is the proprietary process that we have. That's the most critical aspect.

So, it's not just about the IP, it's more about the trade secrets and knowhow of how to really do this successfully. And that, I think, is really what we're relying on to help us be unique in what we do also in China.

Okay, and just one more quick one. In terms of the delays in Q3 and the timing of shipments, any particular types of systems that were affected? And just wondering what the mix was, kind of, of what those delays were system wise. Thanks.

Yes. I mean, we're still in the same mode of most of the systems are industrial also -- I'm looking at Guy right now, also in the third quarter. It's still the same picture that most of the revenues are of the industrial type, right?

But, you need to remember also that the industrial is a wide ranging arena for us that right now ranges from about $180,000 all the way up to above $400,000. So, within that there's quite a big range.

Nothing specific to comment here. It's really I think an overall softness that had changed gears in September. The softness was in the sense that people were delaying decisions, but nothing major on the revenue mix from a system standpoint to report.

Okay. Thank you.

Thanks a lot.

Jim Ricchiuti, Needham & Company.

Thanks. Gabi, just going back to some of the commentary and color you're providing on how you're seeing the development of the market, the increased interest from the brands and whatnot and the move toward fast fashion, has this changed your view of the potential for a product like Vulcan?

Yes. One of the things that was really interesting in the three demos that we've done, and as I said two major brands were doing this demo, they surprised us by sharing with us in intricate, intimate detail the cost per print that they're looking at and comparing this with. And remember when I mentioned the sweet spot ranging from several dozens to 200, even 300 units? That's what they're looking at.

So, not only are they looking at this system as having extremely high throughput, but with the new technology we're using, it's cost advantageous even to move in this direction. And that's what was so exciting about this.

So, yes, I think that Vulcan is a big step in the direction of significant brands. I'm even more bullish on that opportunity now that we've had more and more discussions. I believe ITMA is going to be even more significant in that sense, because we have had requests for demos that have reached already, believe it or not, a hundred requests at ITMA, some of which are also brands.

So, I think yes. I think that this is -- it has the potential of making a big change. At the same time, what we're seeing right now is that some of the retailers and brands are approaching existing Kornit customers that have, let's say, an Avalanche 1000 and able to cater for those needs.

And this is something very important that I was trying to explain earlier on, a very critical point to understand. I've always been asked by investors and analysts, can you really penetrate these big brands because they buy at huge quantities of tens of thousands.

What's happening now with the brick and mortar shops as well as the online is actually they order small quantities but very immediate chase orders. And the reason is they want to better manage their inventories. So, that market is really becoming accessible, but I believe even more so with the addition of the Vulcan.

That's helpful. Thank you. And last question from me is just with respect to that hesitancy that you saw in August, the pick up in September. Is there any thing geographically that you could share with us, whether it came more from the US or Europe or perhaps Asia?

It was more from Europe and Asia. And ever since, there has been improvement in both those regions.

Okay. Thanks a lot.

Thanks.

And ladies and gentlemen, this does conclude the question and answer portion of today's call. I'd like to turn the call back to Gabi Seligsohn for any closing remarks.

Thank you, operator. I want to thank everyone for joining today's call; look forward to meeting you, hopefully any of you that can make it to Milan. We'd be happy to host you and show you the variety of new additions to our product lineup. Thank you and have a good day.

And this does conclude today's conference, everyone. We thank you for your participation. You may now disconnect.