Kornit Digital Ltd (KRNT) 2022 Q1 法說會逐字稿

Greetings, and welcome to Kornit Digital's First Quarter 2022 Earnings Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host Andrew Backman, Global Head of Investor Relations for Kornit Digital. Mr. Backman, you may begin.

Thank you, operator. Good day, everyone, and welcome to Kornit Digital's First Quarter 2022 Earnings Conference Call. With me today are Ronen Samuel, Kornit Digital's Chief Executive Officer; Alon Rozner, Kornit's Chief Financial Officer; and Amir Shaked-Mandel, Executive Vice President of Corporate Development.

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 related 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 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. I encourage you to review the company's filings with the Securities and Exchange Commission including the company's annual report on Form 20-F filed on March 30, 2022, which identifies specific risk factors that could 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, 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 which was published today and is also posted on our website in the Investor Relations section.

At this time, I would like to now turn the call over to Ronen. Ronen?

Thank you, Andy, and good day, everyone. Thank you for joining us on today's call. I'm pleased to share that we delivered a good start to the year with revenues coming just about the high-end of our guidance and operating margins in line with our expectations.

For the first quarter, total revenues grew by 26% year-over-year to $83.3 million net of $8 million in warrants related to our global strategic account. System revenue growth was very strong and overall system contribution to the revenue mix was very high. We saw diversification across the business within our top 10 customers with very strong performance of our global strategic account that continues to execute on its aggressive expansion initiatives throughout 2022 and 2023.

We saw a record quarter in Asia-Pacific and a strong quarter in both EMEA and the Americas. We continue to make progress with major brands, including one of the largest retailers in the world who acquired several ATLAS MAX systems this quarter. This major retailer is focused on the ability to scale and automate massive quantities of production, in addition to leveraging the incredible benefits of KornitX and our global fulfillment network.

On the product side, we see a strong pipeline and adoption of the ATLAS MAX with existing and new customers. We are moving along through the initial stages of the Atlas to ATLAS MAX upgrades, which we continue to gain pace throughout the year and into 2023. We also receive tremendous customer feedback on the automation upgrades, which will be selectively available in the second part of this year with commercial availability in 2023.

We had an exceptional quarter for the Presto, especially in Europe and Asia-Pacific and see a lot of excitement and momentum around the Presto MAX, which now represents the majority of the DTF pipeline. We also see an increasing backlog for Presto MAX upgrades as customer tell us that enhancing the decorative capabilities for dark colors fabrics is a massive benefit.

On KornitX, we continue to engage in several very interesting initiatives with some of the largest digital platforms, marketplaces and brands in the world. We are particularly enthusiastic about the upcoming launch of our strategic partnership with Wix, one of the leading SaaS and e-commerce platform in the world with over 220 million users globally. Wix is a leading platform for creators and enterprises of all sizes that are looking to build a digital presence.

With KornitX, the Wix platform will enable its massive community to seamlessly add on-demand fulfillment services, opening to them exciting commerce and merchandising opportunities. We expect to go live later this quarter and are excited about our joint road map ahead. In addition to this massive opportunity in our pipeline of new partners, some of our existing KornitX customers and partners continue to scale volumes and the total GMV running on the platform, and we are very satisfied with our progress.

As mentioned on our last call, 2022 will be an exciting year of groundbreaking new product introductions. In early April, we hosted the extremely successful Kornit Fashion Week Tel Aviv, where we officially unveiled the ATLAS MAX poly and demonstrated our revolutionary game changer Kornit Apollo. The Apollo is the most comprehensive digital single-step system, targeting screen print mass production markets and the perfect solutions for nearshore mid-runs mass production with best-in-class MAX quality with the lowest TCE and the highest output per operator.

Apollo uses smart cueing from our recently completed Tesoma acquisition. We expect early customer engagement for Apollo in the second half of this year and commercial availability mid of 2023. We see strong movement in growth in the market from brands and retailers shifting traditionally mass produced offshore jobs to nearshore and onshore short-run production, supporting the lean inventory fast replenishment and in-season reactivity needs.

Our strong portfolio of mass production MAX solutions and soon to come Kornit Apollo, all powered by our unique KornitX platform, place Kornit in a remarkable position to cater to this evolving market opportunities and trends. While we see these tremendous and growing tailwinds fueling our business, our customers and us are not fully immune to the overall macro headwinds and certain post-pandemic dynamics.

We started this year with a strong backlog and robust pipeline. But as we move deeper into the first quarter, we began to see the macroeconomic volatility weighed on the pace of consumer purchases and on capital allocation decision of certain customers. As such, some of these purchases and expansion plans are now shifting out into later quarters. We remain excited with our growth plan for the full year and continue to expect the second half of this year to be much stronger than the first half in terms of both revenue and profitability.

Considering the near-term volatility of the top line and the continued investment in major marketing events and the sales activity this quarter, we expect operating profitability in the second quarter to be lower than the first quarter as Alon will discuss it shortly.

We are extremely energized heading into Kornit Fashion Week London, which will take place next week. We expect over 600 brands, designers, retailers, influencers, investors and press to attend where we will demonstrate how virtual and physical fashion walls intersect. This coming event as well as the FESPA event in Berlin at the end of May will be a catalyst to develop our funnel and pipeline for the coming quarters.

In summary, we remain focused on our mission to build the operating system for on-demand fashion and the massive opportunities ahead. And as I mentioned, while we are not fully immune to overall macroeconomic headwinds and near-term volatility, we continue to expect to deliver ahead of plan the $125 million run rate business we originally targeted for the fourth quarter of 2023 and remain confident in our journey to become a $1 billion business in 2026.

We are working extremely hard to mitigate the external macro factors, and I remain extremely confident in our team and the value we deliver to our customers. Thank you again, and we hope to see you next week in London.

With that, let me turn the call over to Alon for a closer look at the numbers and the guidance. Alon?

Thanks, Ronen, and good day to everyone. We are pleased to report first quarter revenues of $83.3 million, net of $8 million noncash warrant impact related to a global strategic account, which is just above the top end of our guidance range of $87 million to $91 million.

As a reminder, our guidance assumes 0 impact from warrants. As Ronen shared, we saw good diversification across the business in the first quarter. Systems revenues were very strong, primarily due to very strong sales for both Atlas and Presto. Services revenues increased 32% year-over-year to $10.8 million and were 13% of total revenues, net of noncash warrant impact of approximately $350,000. Top 10 customers accounted for approximately 53% of total revenues this quarter.

Looking at the regions. Asia Pacific had another record quarter with good mix of both ATLAS MAX and Presto systems, including several Prestos in Japan and its first Presto MAX system in India. We continue to see very good interest in the region for both DTG and DTF systems in addition to KornitX with opportunities unfolding in Korea, China, Japan, Australia and India. EMEA delivered one of its best quarters ever, including upgrades from ATLAS MAX.

Building upon the strong go-to-market foundation executed over the past several years, we saw continued interest and momentum across the entire region for both ATLAS MAX, Presto MAX and KornitX. In the Americas, new customers included a major swim and sports apparel company who will be utilizing our Atlas Poly, a licensee for major professional sports leagues and direct mailing solutions provider, both utilizing Atlas. We continue to see strong momentum in Central America and Mexico as a result of new shoring, including additional wins for ATLAS MAX and a robust pipeline for Presto Systems.

Moving to margins. Non-GAAP gross margin, net of the impact of the warrants was 41.5% compared to 47.1% in the same period last year. This was due to several factors, including a higher mix of systems as a percentage of total revenues, including sales to our largest strategic account, who has experienced significant growth in and beyond the U.S. and higher DTF sales in both Europe and Asia Pacific. In addition, we had lower consumables revenues as a percentage of total revenues.

During the first quarter, we moved to mass production in our new ink manufacturing facility. We believe as consumable sales pick up throughout the year, we will gain operational efficiencies on the fixed cost in the business.

Looking forward, we expect gross margins in the second half of this year to revert back to similar levels we saw in the second half of 2021, primarily driven by new product introductions and increasing percentage of revenues from our recurring revenues consumable business, operational efficiencies and longer term, the acceleration of KornitX and other software-driven initiatives.

Looking at macroeconomic issues and supply chain. We, like our customers are not fully immune to overall macro pressures, including impacts from inflation and higher interest rates. In this environment, we are working hard every day to proactively address and mitigate these impacts on the business where possible. These include focused cost reduction projects, continued supply chain initiatives, including dual sourcing strategies and long-term commitments, design adaptation as well as selective price increases.

Given our proactive supply chain initiatives, we remain confident in our ability to deliver on all our 2022 customer commitments and utilizing our strong balance sheet, continue with our efforts to secure our 2023 supply chain requirements.

Turning to expenses. Total first quarter operating expenses were $35.2 million, a decrease of 8% from the fourth quarter and an increase of 43% year-over-year. As I stated last quarter, we continue to invest in R&D to support our array of industry-leading NPIs as well as in sales and marketing as we see meaningful opportunities to generate long-term acceleration in revenue growth.

Research and development expenses were $12.8 million in the first quarter or 15.4% of revenue as compared to $8.9 million or 13.5% of revenue in the first quarter of 2021, primarily due to continued investments in new product introductions and KornitX. Sales and marketing expenses were $14.6 million or 17.6% of revenue as compared with $9.9 million or 14.9% of revenue in the same period last year due to continued expansion of our go-to-market strategy and capabilities in all regions, including the transition to direct sales model in some regions, including EMEA.

We continue to invest in brand awareness initiatives, including Kornit Fashion Week, Tel Aviv and Fashion Week London as well as other customer-focused events, which will impact sales and marketing expenses in the second quarter. General and administrative expenses in the first quarter were $7.8 million or 9.4% of revenue as compared to $5.8 million or 8.8% of revenue in the first quarter of 2021. The increase was due to staffing and other investments to support the overall business infrastructure.

Non-GAAP operating loss was $0.7 million, net of $8 million of noncash warrant impact. Excluding the impact of the noncash warrants, operating margins were in line with our guidance of 7% to 9% for the quarter, which again assumes 0 impact of the warrants. We ended the first quarter with 913 employees, a year-over-year increase of 213 and an increase of 31 employees from previous quarter, primarily in R&D and sales and marketing.

Non-GAAP net income for the first quarter was $0.2 million or $0.00 per share on a fully diluted basis as compared to $7.7 million or $0.16 per share in the first quarter of last year. First quarter GAAP net loss was $5.2 million or a loss of $0.10 per share as compared to GAAP net income of $5.1 million or profit of $0.11 per share for the first quarter of 2021. Adjusted EBITDA for the first quarter was $9.5 million as compared to $10.8 million in the first quarter of 2021.

Our cash balance, including bank deposit and marketable securities at quarter end was $734 million, a decrease of approximately $64 million versus last quarter, primarily due to cash used in operations of $47.1 million and capital expenditures of $7.5 million in the first quarter. We came off a strong peak season in the fourth quarter and ramped order during the second half of the first quarter. The timing of sales later in the first quarter to our largest strategic account grew receivables materially quarter-over-quarter, producing a drag on cash flow.

I want to emphasize that we see no collection issues in our receivables, and we anticipate cash collections to improve over the next several quarters. We also used our balance sheet to secure our supply chain, including building up key categories of inventory due to long lead times and shortages. This includes components for ATLAS MAX and automation upgrades, which we expect to begin materializing in 2022 and into 2023. We also made advanced payments for key go-to-market programs.

Turning to guidance. As Ronen mentioned, given the macroeconomic impact on consumables and capital allocation decisions of certain customers and overall near-term volatility, we currently expect second quarter revenues to be between $85 million to $95 million. We expect revenues in the third and fourth quarters to be stronger than the second quarter.

In addition, considering the near-term volatility on the top line and the continued investments in the business, including investments in multiple NPIs and significant events like Fashion Week Tel Aviv and London and industry events, including FESPA, we expect operating profitability in the second quarter to be lower than the first quarter. Specifically, we expect operating margin in the second quarter to be between minus 2% to 2% and EBITDA margins of 0% to 4%.

Further, we expect higher operating margins in the second half of the year with operating margins in the third and fourth quarters to be in the low to mid-teens. I want to reiterate that all guidance assumes 0 impact from fair value of issued warrants in the quarter with our global strategic account.

With that, let me turn it back to Ronen.

Thank you, Alon. Operator, we are now ready for the Q&A session.

(Operator Instructions) The first question comes from Jim Suva from Citigroup.

I have a few questions. When you mentioned the slowdown, is the slowdown primarily related to your global strategic customer or is it not that and it's actually absolutely not that and its more the other accounts and customers that you're dealing with? Then I have a follow-up.

Actually, it's a mixed view. The slowdown that we see is coming mainly from the e-com segment. We have many customers that are building the business based on the e-com. And we see different view from different customers. You were referring to our global strategic account. Actually, in this case, we see a tremendous growth, tremendous growth in Q1, tremendous growth in Q2, and we have very high expectations of continued growth, not only in 2022, but also in 2023.

On the other hand, we see some other customers they saw during Q1 and now during Q2, a slower growth on the e-commerce, which impact their business. And by that delayed decision of the acquisition of new systems, and we saw a slowdown in specific customers also on the supplies during Q1 and now also during Q2. On the other hand, we see a very strong tailwind in other segments that we are serving.

For example, in the retail market, customers that serving the later space, we see a major growth. We see momentum moving job from offshore, from China, from Bangladesh to onshore and near shore and those customers enjoying it and growing really fast. We see also other small customers and strategic customers that working with both retail and e-commerce that continue to grow.

DTF specifically and the Presto MAX specifically is growing very fast. It was a very strong quarter for Q1, and we continue to see momentum into Q2 with the Presto Max. Interesting to see the momentum that's coming from Asia. Asia is the second quarter, a record quarter for Asia, but also in EMEA, while other businesses see a slowdown in EMEA, we actually see a major growth coming from EMEA, and we expect a very strong Q2 also from EMEA due to some of the major activities that we are doing there with Fashion Week in London and FESPA.

ATLAS MAX, we see adoption, we see great feedback from customers. And we're also starting to see a very nice growth coming from KornitX and with the announcement today on the Wix partnership and few other partnerships that we are developing. We expect continued growth into H2 and material revenue coming into 2023. So Jim, to summarize, is a mixed view but definitely, we saw and we see now in Q2, a few customers that serving in the e-com and deciding to delay purchase of new system in Q2 to a later stage. Some of them will buy in H2, and some of them will be late even to 2023.

Okay. And then my last -- my follow-up is, you talked about an improvement in the second half of this year. What gives you the confidence or the conviction of that as opposed to what you're kind of giving for Q2 right now because about 3 months ago, it seemed like this downshift wasn't likely to happen. And so I'm curious about your second half conviction.

Yes. So actually, we see Q2 kind of a bump on the road. We believe in the $500 million run rate earlier than expected than Q4 2023. We believe in the long-term vision of the $1 billion in 2026 or before. All the fundamentals of the business are growing and accelerating. We see the offshore moving also. We see the consumer trends to have unique clause. We see overall e-commerce is growing. It's just slowing down versus last year where it was growing very, very fast. So all the major trends that we were talking and definitely the sustainability and short trans printing, short-term production is a major driver to our growth.

And you were asking why we believe in H2 that it will be stronger, it will be much stronger than H1 and will be much more profitable, as Alon mentioned, in H1. First of all, we have a line of sight to major orders. Some of them is from our global strategic account. So you will continue seeing from the global strategic account revenue coming not only in Q2, but in Q3 and Q4 and definitely also in 2023. We have major product introduction during Q2, which is the Atlas Poly and the Presto MAX that we already got orders and the implementation will be doing H2. So we have very high visibility on orders. And remember that H2 always is much stronger in terms of in consumption. Q4 is always peak season. So you will see a much stronger H2 versus H1.

The next question comes from Tavy Rosner from Barclays.

I wanted to first talk about the progress with brands. You mentioned in the opening remarks that you're seeing significant progress. How does it compare the level of interest compared to last quarter? And I'm just curious to also get a sense of the conversation you're having with brands. Are they still talking about why adopting Kornit or they're moving into rather when to adopt Kornit?

So we see accelerated engagement and growth on the brand side. We specifically see a very strong growth in EMEA with some of the biggest brands of the world. The brands that I mentioned in my opening remarks is one of the top fashion and one of the top 5 fashion brands of the world. And they decided, first of all to go vertically. They acquired few ATLAS MAXs and they're running them and picking up production. And they also will start working through KornitX. We see different behavior from different brands. Some of them adopting KornitX as the main vehicle, some of them would like to be fully vertical and some of them having kind of the hybrid mode.

We are working with, I can tell you tens of major, major brands and hundreds of midsized brands across the world, many of them will be next week in London Fashion week and are fully, fully engaged with the vision to transform the business directly to consumer on demand and sustainable. So the main driver for the brand, first of all, nobody wants to deal with the supply chain crisis that they were dealing in the last 2 years, both in terms of the waste that is being generated in terms of being able to forecast what they need to deliver and when they're going to get and they increase cost.

So they all want to move production locally on to nearshore. They would like to control the supply chain, and they would like to do it in sustainable way without waste and is sustainable production, and this is why they would like to use digital and specifically Kornit. So those are the major, major trends. And of course, the entire behavior of the consumer is totally different from what it was in the past. Consumer today and people today would like to be unique, would like to have different clothes. And by that, the brand needs to react to be proactive and to allow the consumer to choose much wider SKUs, even up to customization and personalization and we see it across the board. So those are the main drivers for the brands to adopt digital and specifically Kornit.

One more thing that I would say why they're adopting specifically, Kornit and why Kornit is the one that talking with the brand is quality. We are the only one that has the highest quality, the brand quality, both in terms of the appearance, in terms of the durability that the brand needs. In the past, it was almost there. It was difficult to get there. Screen was better quality with the MAX technology for the first time, Kornit surpassed the screen quality and we are by far better both in terms of appearance, durability, application range, and now it's being very, very attractive with all the tailwind of the different market trends to adopt digital.

All right. I wanted to talk about KornitX. So you mentioned the partnership with Wix. And I'm assuming that this will be helpful on the front end of the business. I'm just looking down the road, what are the next stages for KornitX and the ramp-up?

Yes. So on KornitX, we see really a nice progress. The progress is both from the demand generation companies like Wix and I will touch maybe in other areas that we are focusing, but also on the GFN, the global fulfillment network that's fulfilling it everywhere around the world in consistent quality. So we see progress on those 2 fronts. And of course, we are all the time improving the platform and the capability and the ease of use of the platform.

In the last few months, we have many, many discussions, management discussion about areas of focus. We are focusing right now with KornitX, our main focus was on the fashion, the fashion industry, the fashion brands, but we're also focusing on major platforms, platform like Wix. We are also now starting to work with a major gifting platform, one of the leading gifting platform of the world starting to use us.

Canada is a great example of a platform that's already running through KornitX. So we're starting to see major adoption. We are talking with, I can tell you with all many, many of platform around the world, I think about music platforms and TV platform and movie platform and so on. All of them have potential to use KornitX to do -- to monetize their platform to create merchandise mainly around the fashion industry, leveraging KornitX and we see major progress. As I mentioned in H2 this year, we will start to see meaningful revenue coming from KornitX and we expect KornitX really to accelerate goals in 2023.

And just the last one, if I may. After that competition, I'm starting seeing more press release from screen -- the manufacturers of screen printing equipment going into digital DTG solution. Is that something that you're seeing as well? Are you concerned at all?

The answer is that I'm not concerned. Actually, I believe that we build a very, very strong new mode around our technology, around our products in the last 2 years, actually, we've developed our products and we created much bigger jets versus any of our competitors. We always had competition, and we always will have competition. This is a very interesting market space. But I don't see anyone else there with, first of all, the quality that we have by far, nothing to compare to the print quality that we have with the MAX, the durability that we have, the ease of use, the automation, the productivity now that we are bringing also with the Apollo, the mix of the platform that we have, both DTG and DTF with the leading Presto technology.

On top of that the KornitX platform that's really connecting demand to fulfiller, we are creating something different to many of our competitors. We are creating a platform. We are creating an operating system end-to-end operating system and none of our competitors really looking at these [solistics]. We're already dealing with most of the major players in the market. It are the fulfillers, brands, marketplaces, fully committed to us.

And I believe this is just the start. The technology that now we are launching this quarter with the Atlas Poly with the Presto MAX with unveiling the Apollo, which will be ready next year, which is a game changer, not only in the current segments that we're addressing, but really going after the replacement of the screen market, this is a game changer. This will accelerate the growth of Kornit and I'm more confident than ever in our technology and ability to reach the $1 billion in 2026.

Claudia, next question, please.

The next question comes from Rod Hall from Goldman Sachs.

Yes. So I wanted to dig into the demand situation a little bit more with you, Ronen. It sounded like there were large e-commerce customers that pushed out purchases. Do you think that they're seeing lower demand for products themselves, their revenues are being impacted by macro and then they're pushing these out? And I guess the reason I want to dig into this is we thought that as people travel more as they get out more this year that demand for T-shirts and fashion more broadly would probably go up, not down. So I just wanted to dig a little bit more into what you think is going on with that dynamic and what those customers are seeing on the ground? And then I have a follow-up.

It's an interesting dynamic, and I'm not sure that I have the full answers. And in terms of the demand, consumer demand, we see different behavior in different segments. As I mentioned in the retail environment, we see customers that's serving the retails that actually see a massive growth. So I wouldn't say that the consumer demand is declining on t-shirts and hoodies and across the board. And as I mentioned also, with our strategic global customers, they see tremendous growth, okay, across the board, not only in the U.S. but also in Europe.

We have some customers without getting to names that are mainly driven and driving the business on B2C, we see a slowdown. Some of them really gaining a capacity during the last 2 years, they purchased additional systems and capacity. And they just don't see the same level of production that they used to see. Some of them seeing as a plateau, some of them seeing a decline in their business. They were planning, a few of them were planning to place order in Q2 to be ready for the peak season of Q4.

And at this stage, we decided to delay this decision due to the current situation that they see. And of course, if it's a bump on the road, they will continue to purchase during H2. If not, it will come in 2023 from those customers specifically. Again, e-commerce is not going to disappear. E-commerce is growing now. It will continue to grow. This is the right direction. It's just a bit of a slowdown that they're feeling right now and I'm sure that we will see it coming back.

And then I wanted to ask you, Alon, if you could talk a little bit more about the margin mix in the quarter. I get that Amazon -- or I should say, the strategic customer was stronger than we thought it would be. So that was very strong. So I get that mix effect. But then I wonder what happened to ink and consumables. Did you see lower ink and consumables demand than you thought? And can you quantify what happened with ink and consumables at all for us?

Yes, sure. So first, just to continue Ronen's answer from -- for previous question, which also relates to the margin. We don't see any dramatic change in the megatrends and the fundamentals in the market. I mean we clearly see growth and we have very solid business model to support this growth, and we are strong to deal with some volatility and uncertainty. And yes, we see some uncertainty now in the market, mostly related to the macro processes, the global economics and then goes deeply into our margins. I think that the results in Q1 of margin is related to mix, to volume and the timing of the deals. And the mix in Q1 was a lot towards system, which is very good for us because it increases our installed base.

And we saw very strong system sales, both for DTG and DTF. We had very strong quarter for DTF. And then in terms of volumes, consumables were lower in terms of percentage. We saw growth in consumables. It was lower than we expected. And there entered the volume factors into the game and we have the capacity in our new ink manufacturing. And when we're manufacturing less, we get the heap of the fixed cost. And that's why we say that as we go throughout the year where consumables portion will be higher, then we will go back to the levels of margin that we saw in the second half of 2021.

So our business, when you look at H2 will be similar to H2 2021, which means around the 50% plus on the gross margin. We are fully confident that we will continue to see expansion into 2023 on the gross margin on the way to reach to the 54%, 55% gross margin as we promised to our investors.

Claudia, next question, please.

Yes. The next question comes from Jared Maymon from Berenberg Capital Markets.

Congrats on the good quarter and great news on Wix, that's really reassuring for the next business. First question for me. So yes, absolutely. So first question for me, just on the excess capacity that you guys have mentioned. I remember back in -- I think it was Q3 '21, you guys mentioned that you had placed the entirety of your order for 2022 with your contract manufacturers? And I'm wondering if you thought this kind of excess capacity could be a problem back then when you made that order or if there's been kind of an incremental shift since then? And if it's impacted that order and then I believe this is kind of weighed on your near-term guidance.

Yes. So we don't see any dramatic change in our plans going forward. There is a timing issue now and we have higher raw materials, our inventory at the end of Q1. All of the increase in inventory was raw materials. We are not stuck with a stock of systems that are waiting for sale. We are building our raw materials to be ready with the NPIs with the upgrades. And then we are ready for growth in second half of this year. We don't see any risk at this point for excess inventory.

And then I'm just curious with the kind of near-term volatility that you guys are seeing, I'm wondering, is there any kind of decrease for appetite in M&A or do you think maybe you're even a little bit more eager now that valuations have probably come down in the private margins?

So we are engaged and looking very closely onto all kinds of opportunities, mainly on the software side on the M&As. The market now is more interesting. And of course, we are looking deeply into that. Our strategic direction is very, very clear. We are not changing anything from the direction that we are taking as a company. We believe in the future. We believe in becoming the operating system for the fashion industry. An area that we need to invest in M&A, we will continue to invest. There is no change in our plans.

And then just one last quick one for me. I'm just curious, what -- sequentially, it looks like service gross margin declined. So I'm just wondering what happened there? I assume maybe it's related to the Atlas-to-Atlas MAX upgrades, but curious what happened there and what the outlook is for the next couple of quarters?

The decline year-over-year, sequentially, quarter-over-quarter.

So in service business, there are different components and it's very much related to which projects we do at each quarter. Overall, we are investing and building our service organization, and it very much depends on specific projects. Overall, we continue to see continuous growth and improvement in service profitability and this is the way we plan it going forward.

This year, we expect to see major growth on the service, both revenue and margin, you will start to see more adoption of the upgrade kits in Q2 and definitely in H2, which will influence the service P&L, both on the top line and bottom line on gross margin. So you will see a major improvement there.

Claudia, next question, please.

The next question comes from Brian Drab from William Blair.

I just want to clarify one thing. I know you said you're seeing some customers in the second quarter, delaying decisions. Are you -- it sounded like Ronen that you're saying you're not sure what some of those customers are going to do in the second half of the year or are there some of those customers that are saying we're delaying second quarter, we'll see you in the third quarter or with all this economic uncertainty, is it really an unknown? And then getting back to the -- where does the confidence come for the second half of the year? I guess is it more related to some of these customers knowing that they're coming back or is it more related to just the overall momentum from all the new product introductions and seasonality, et cetera?

Yea. It's -- Brian, thank you. It's a mix. Look, it's a few customers that we're planning to purchase in Q2 and decided to delay the purchase. It's not a big amount of customer. We see overall the supply some kind of slowing down in Q1 and some slowing down also in Q2. Actually, in the last week, we started to see a different trends on supplies.

Hopefully, these trends will continue a positive trend. But those customers have decided that we were planning that they will buy in Q2 and decided to delay. A few of them, we have a date with them for H2, but a few of them didn't decide if they will buy at all this year or it will be delayed to next year. The confidence that come for H2 is not based on those customers. The confidence that come for H2 is based, first of all, we have recurring revenue. Almost 50% of our revenue is recurring and its H2 is higher than H1. This is the basic of our tendency of the business.

On top of that, we have a few strategic customers, including our global strategic customers that we have already the orders and commitments, and we are producing the systems. And so we don't see any risk on those. We see a growing pipeline on the new product introduction, mainly on the Presto MAX that we are now producing them, and many of them will be shipped only in Q3 and Q4. The same thing on the Atlas Poly, which we are going to release it only by the end of this quarter, Q2 and the main impact will be into H2 revenue.

Also, we start to see revenue coming from KornitX, mainly into H2. So all in all, our confidence level into H2 that it will be much stronger, both in topline and operating profit and also gross margin will be looked totally different, very similar to the gross margin we saw H2 last year is very high.

Okay. And then there's been some discussion around in the past. You've had certain customers attend your Analyst Days and highlighted some strong relationships that you've had in the past. And I'm curious, can you update us on any specifics around the strength of your relationship with Fanatics and Delta Apparel?

I was anticipating it. So first of all, we have a great relationship, both with Fanatics and Delta Apparel specific DTG2Go. I cannot get into the specific of their business. I recommend you and I'm sure that you're approaching them, they will give you all the answers. In general, Fanatics decided to change their business model. Fanatic is a brand and they decided actually instead of being vertical and produce by themselves to outsource their production and outsourcing it both to DTG2Go, but also to other customers. And I think this is the direction that we were foreseeing. And this is exactly why we have KornitX to enable those brands like Fanatics and like many others to fulfill through a network of fulfillers but using Kornit technology.

As for Delta Apparel, Delta Apparel is one of our largest customers. They have a fleet of Kornit. In the last 2 quarters, we are aware that they decided also to acquire a few systems from one of our competitors, mainly they look at it as more of a replacement for screen, not for short runs, not for one-off, not for direct-to-consumer, more for the long run. We know that they are testing it. We know a bit more on that, but I will not get into it. We, again, we believe that our solution and definitely what we are bringing to market with the Apollo will be the best solution. And I'm sure that we will work closely with Delta Apparel and Fanatics and others to make sure that they consist that they continue working with us in strong partnership. We like them. They are customers, and we continue to support them for many years to come.

Claudia, next question.

The next question comes from Jim Ricchiuti from Needham & Co.

I wanted to go back to this global brand that purchased Atlas machines. Is this -- how are they using these Atlas machines? Are they using it for an e-commerce application or are they using it as kind of a hub to supply some of their retail stores? I'm not entirely clear on that.

It's actually the -- I can't get into too many details because then it will unveil the who is the customer, who is the brand, and they would like to be -- to keep it confidential at this stage. They're actually building a unique business model combining both. But in the end, they would like to address also directly the customers. It's a hub that they are building, but I cannot say more than that.

To what extent, Ronen, can you say if some of the ESG-type benefits of your technology played at all into their decision?

Yes. I would say 2 things that played in the decision. First of all, is quality. They would like to have the best quality on printing on garment. They were testing our solutions. They're developing special garments for those solutions to have the best quality in the market. So quality is number one, definitely, sustainability is a key issue in supply chain, making it closer onshore production is also very important for them.

And I wanted to also a follow-up question, just with respect to the upgrade of the Atlas fleet, the installed base, in light of some of the changing dynamics that you're seeing in the market. I think in the past, you've talked about as much as 3/4 of the existing Atlas fleet potentially upgrading to MAX. Has that -- correct me, if that's correct or not or are you seeing any change in light of the market environment? And just with respect to the market environment, am I correct in assuming this is mainly in the U.S.? It sounds like you're seeing good momentum in APAC and good momentum still in EMEA. And I'll jump back in the queue.

So in terms of the momentum, Q1 was very strong as well in Americas. And we actually seen Americas into Q2, a different, again, mix. We see actually a very, very nice growth in Latin America coming from Brazil and Mexico. So more of the nearshore production is growing. We see a few customers that we are producing for retail in Americas is growing. But we see also some slowdown in Q2 from customers, but mainly in the e-comm side. And indeed, it's more right now in the Americas. But again, I believe it's a very short-term bump on the road.

As for the upgrade of the Atlas-to-Atlas MAX, we are on a journey right now. First of all, we are not changing our forecast of 75% of the installed base upgrading their Atlas-to-Atlas MAX. We are on the journey to create a new standard of quality. We believe that the MAX will be a new standard of quality for the industry, working very closely with the major brands to decide that this is the standard. KornitX will be based on the standard of ATLAS MAX on the MAX technology. And therefore, we are putting a lot of emphasis on that, and you will start to see more adoption of the upgrade kits during Q2 and mainly in H2, while we're ramping up our service and support organization to implement it with our customers.

Your next question comes from Chris Moore from CJS Securities.

It's actually Dan in for Chris. You've talked quite a bit about nearshoring on this call. Can you give some specific examples? Is it happening yet? Where do you see it accelerating? And how big of an impact do you see it having long-term on the business?

Yes. We see it a lot, both in EMEA. We see it definitely in the U.S. inside but also in Mexico very strongly. So we have a few customers in Mexico that's growing very, very fast and doing nearshore for North America, but we have a few customers inside North America they're starting to get bulk jobs that they never been used to get those in the past, moving actually directly from brands that used to produce in China and in the Far East and producing now onshore or nearshore. It's very obvious, it's very clear the trends. We see it both on the digital side. But when we're talking to our customers, they see it also on the conventional side. So a lot of the large orders are moving now onshore, both in EMEA and in Americas.

And one more for us. Given the slate of new product introductions, MAX, Poly, Apollo, others, can you talk about the impact on Kornit's ASP and gross margin profile over time?

Yes. So on ASP, actually, overall ASP of system in Q1 went up. Our focus is to sell more high-end products and you will continue to see the ASP improving along the year because we will sell more of the Atlas Polys and more of the Presto MAX and even the ATLAS MAX, of course, is the ASP of ATLAS MAX is higher than the ASP of the Atlas. As well, unfortunately, we had to do some price increase, which also impact the ASP. So you will see it. In terms of the gross margin, I think what you've seen in Q1 is, I would call it a one-off, and it came mainly from a very low mix between supplies to systems.

We had a very low -- relative low revenue on supplies in Q1. Some of it already because customers were acquiring supplies in Q4, they were focusing Q4 to be stronger and they had supplies being -- using it also for Q1 for order less supplies in Q1. We start to see as I mentioned a new different trends right now. We start to see an improvement and starting to get larger order for supplies. So hopefully, let's wait a few more weeks to see that these trends continue. So this is the major impact on gross margin. Gross margin for Q2 will be much better than Q1 and H2 will be very similar to last year. So around the 50% or 50% plus in terms of gross margin. And you should expect in 2023 expansion on gross margin as well.

And just to add, longer term, we keep our target in the long-term model to have gross margin between the 50% to 54%.

The final question comes from Greg Palm from Craig-Hallum Capital.

I guess on gross margins specific to systems, it sounds like shipments were better than expected. I know there were some mix issues between Presto and Atlas, but just trying to get a sense on how system margins were relative to expectations or prior quarters.

Yes. So system margins was according to our expectations. Actually, it was a bit better than we planned. We plan for a mix, DTG and DTF. We said it also in previous quarters that we invest a lot in DTF. So we had good order for DTF. We plan for it. And overall, systems margins was even slightly better than what we planned.

And then on the receivables comment for my follow-up, I think you blamed that on late quarter sales. I think you said specifically to the global strategic. Was that a pull forward of activity into Q1 from Q2 or was it, I don't know, maybe a pushout of shipments from maybe mid-quarter to late quarter? I wasn't exactly clear what happened there?

No, it was a timing issue of making decisions and getting the paperwork. So the start of the year and the quarter was relatively weak after a very busy peak season, so people took some time off to elect. And then we saw the quarter building up at the second half of the quarter, when we got the POs of the planned business for the quarter, and then we shipped relatively close to the end of the quarter. And just in a matter of timing, most of the AAR is just not due and will be collected mostly in the second quarter.

Thank you. Mr. Samuel, you have no further questions. I will turn the call over to you for closing remarks.

Yes. Thank you, operator, and thank you all for joining us on today's call. As mentioned earlier, we remain laser-focused on execution across the board to capture the massive opportunity we see in front of us. I would like to thank all of you, and I would like to thank Kornit team for amazing work and hard work and passion and to all the stakeholders for continued support and confidence in us. I'm looking forward to seeing many of you next week in London. I would like to thank you, and have a great day. Thank you very much.

Great. And thank you, Ronen, and thank you, Alon, and thank you all for joining us today. As always, if you should have any follow-up questions, please do not hesitate to reach out to me directly, and we hope to see you in London.

You may disconnect your lines at this time. Thank you for your participation.