Kornit Digital (NASDAQ:KRNT) Q2 2016 Earnings Conference Call August 2, 2016 5:00 PM ET
Allison Cain - IR, ICR, Inc.
Gabi Seligsohn - CEO
Guy Avidan - CFO
Ken Wong - Citi
Joseph Wolf - Barclays
Jim Ricchiuti - Needham & Company
Brian Drab - William Blair
Bobby Burleson - Canaccord
Patrick Newton - Stifel
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 U.S. securities laws will be made on this call. These forward-looking statements include, but are not limited to, statements relating to the Company's objectives, plans 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 for many reasons and I encourage you to review the Company's filings with the Securities and Exchange Commission, including the Company's annual report on Form 20-F filed March 17, 2016 which identifies specific risk factors that may cause actual results or events to differ materially.
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 be making reference to certain non-GAAP financial measures on this call. The reconciliation of these non-GAAP measures to the most directly comparable GAAP measures can be found in the Company's earnings press release published today which is posted on the Company's Investor Relations site.
On the call today, we have Gabi Seligsohn, Kornit's Chief Executive Officer; and Guy Avidan, Kornit's Chief Financial Officer.
At this time, I would like to turn the call over to Gabi. Please go ahead.
Thank you, Allison, and hello, everyone and welcome to our second quarter of 2016 earnings conference call. During today's call, I will review aspects of our performance, then provide an update on market conditions and our view of the remainder of the year. Guy will then walk you through the full financial details of the second quarter, as well as state our guidance for the third quarter of 2016.
Moving onto the second quarter results, second quarter revenues of $24 million represented an increase of 12.6% over the prior year period. As you know we recently completed the SPSI transaction which had an effect on our second quarter revenues. The acquisition of SPSI's digital printing assets previously a significant customer pressured revenues in the second quarter as SPSI quarterly inventory replenishment became unnecessary. Absent these factors we would have reported revenues towards the high-end of our quarterly guidance.
While reported revenues came in on the lower side, non-GAAP gross margin actually increased to 49.5% representing an increase of 187 basis points versus the prior year period due to favorable revenue mix.
Operating profit came in at 4% around the midpoint of our guidance as we continued to expand our operating expenses to support our growth plan. During the second quarter, we started to see early signs of a significant ramp up expected during the second half of the year coming primarily from North America. The online market plays in the region is expanding very rapidly and we are experiencing increases of ink consumption at large accounts, as well as an increase of system ordering patterns. Europe and Asia remained relatively weak during the quarter.
During the quarter we also underwent some major management changes. I’m happy to report that Gilad Yron, our Executive VP of Global Business has really hit the ground running. Coming with a rich printing background has helped Gilad immensely as thus the experience he has in managing a larger business - larger business operation.
Moving services into the global business group has also proven to be the right move as it provides for a more holistic customer centric approach which has become important given the number of larger accounts we now serve and the increase in their expectations for service provision and system uptime. Our new Chief Technology Officer, Dr. Nuriel Amir who joined just a few weeks ago is already in early stages of reviewing our long-term roadmap for which I have very high expectations.
Finally the acquisition of SPSI's digital printing assets which took place towards the end of the quarter marks an important milestone for our North American operation. Judging by the first few weeks of transition and the efforts made on both sides, I believe we are off to relatively smooth process and I'm excited by the prospects of deepening our relationships with existing customers while gaining direct access to a very large community of thousands of screen printers who represent a huge opportunity for a digital transition over the coming years.
As part of this acquisition, we brought on board a couple of key people who have build close customer relations within the region for the last 20 years. We intend to build on these relations as well as that of SPSI's Chief Executive Officer who will continue to support the transition in a consulting capacity for quite a while.
Naturally we plan on adding more sales and support personnel to take advantage of the potential represented by this part of the North American region. As stated when we announced the deal we continue to rely on Hirsch as a strong partner for the other part of the United States.
In several instances, we have discussed the importance of marketing efforts as a means to expand our market reach. Investments in this area include a variety of activities such as tradeshow participation, product demonstrations in various regions, online campaigns and other. But perhaps the most effective of all our open house events which take place at our regional offices and a major part of facilities.
During the second quarter we hosted multiple open house events in all our main offices for the Allegro roll-to-roll printer. These events yielded multiple orders as well as sales leads. The interesting part of these events is that they provide us with a much deeper understanding of the various business models and technical challenges these potential customers are looking to solve for and in turn allow us to fine tune our offerings to fit those needs.
Just as the very end of the quarter and rolling into July, we also hosted the first open house for the Vulcan at our Milwaukee facility. It was attended by more than 10 customers coming from both digital and screen printing operations. All were thoroughly impressed by the unique performance of the Vulcan and several are in the process of negotiating a purchase.
Continuing with the topic of Vulcan, we are seeing good progress with our three first evaluations and expect to start recognizing revenues to these systems during the third quarter. Since the beginning of the evaluation process, our customers have run an aggregate of about 70,000 sellable garments.
Customers feedback received during the evaluations strengthens our belief in the large potential business offered by the Vulcan. The fact that evaluations are being performed with several customer types has been instrumental in drawing our attention to several improvements to the product which are already in the process of being implemented.
We are grateful to these customers wanting to be early adopters and taking on the role of providing very useful real life production feedback.
During the second quarter our 10 largest customers contributed 72% of our revenues. Web to print digital - web to print DTG is continuing to expand rapidly and the process of consolidation whereby certain printers support multiple web stores is gaining momentum. This in turn leads to an expanded and deeper relationship between Kornit and its customers each of which consumes very large volumes of inks and consumables. A recent study which we performed shows that average ink consumption for system is five times higher at these large accounts than smaller shops.
Equally as important such customers must be able to guarantee a high degree of printer availability and reliable production capacity and therefore requires quote service support and a deeper knowledge of our technologies and product offerings.
Taking the approach whereby some relationships are managed by our partners and others directly and deciding on a case-by-case basis within each region what would be most advantageous for our customers is the approach we have decided to take. As the adoption of digital DTG continues to expand and in many instances involved analog manufacturers transitioning their method to digital, market access becomes really important.
Adding new customers is a very critical element of our growth strategy. Today including our owned facilities and those of our partners, we have about 40 locations around the world that have some form of our printers available to showcase and demonstrate the potential customers. Such systems are also used as a basis for an application development center in which we work with customers to help them expand their product offering. This plays an important part of our market expansion strategy.
In the area of roll-to-roll, we now have an Allegro at our U.S., Europe and Asia-Pacific offices. In many cases existing customers have also agreed to perform demonstrations for potential customers which expands our presence indirectly as well.
As communicated on last quarter's conference call, we are anticipating a very strong second half of the year. This expectation is related to a significant ramp up by multiple large accounts in the U.S. some of which have facilities that are being ramped up in Europe as well. Other factors which will drive growth in the second half included expectation of significant revenues from the Vulcan as it becomes generally available, increase momentum with Allegro, system upgrades which will start playing a more meaningful role toward the end of the year and contribute to service revenues and profitability.
During the third quarter we will be attending a major U.S. tradeshow called SGIA. As Guy will detail in a moment in our guidance we do anticipate a strong third quarter.
And with that operator, I will now turn the call over to Guy Avidan, our CFO for a closer look at the numbers. 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 second quarter non-GAAP pro forma results reflect adjustments for the following two non-cash items. Stock based compensation expenses which totaled 736,000 and depreciation and amortization expenses relating to the acquisition of the assets of Plymeric Imaging in the amount of 50,000 and continued amortization of IP acquired in 2010 and 2015 in the amount of 57,000. A full reconciliation of our results on a GAAP and non-GAAP basis is available in the earnings press release issued earlier today and on the Investor Section of our website.
Second quarter revenue increased by 12.6% to $24 million versus $21.3 million in the prior-year and increased 10% versus the prior quarter. Higher revenue versus the prior-year period was driven by several items in the quarter predominantly higher sales to our key accounts.
By geography 67% of our sales were from the Americas, 23% from Europe, the Middle East and Africa and 10% from the Asia-Pacific region. As in previous quarters, the Americas remain our largest territory and as Gabi mentioned is expected to be our largest contributor to growth in the second half of this year.
Moving to customer concentration, one of our U.S. distributors contributed 15% of our overall revenues and one of our global customers contributed 35% of our overall revenue. Overall our top 10 customers accounted for 72% of our overall revenue compared to 65% in the prior year period.
As previously stated our key accounts are also characterized by much higher average income consumption. In previous quarters, we disclosed that SPSI, one of our main distributors in North America accounted on average for around 20% of overall revenue in the previous four quarters. During the second quarter, in particular our revenue from SPSI was close to zero compared to a contribution of 21% in the prior quarter.
Moving to profitability, non-GAAP gross margin in the quarter improved and reached 49.5% versus 48.7% in the prior quarter and 47.6% in the prior year. On a GAAP basis, gross margin were 48.8% higher margin this quarter versus the year ago quarter was a result of several factor in the quarter including higher mix of high-throughput systems and increased volume of ink.
Moving to our OpEx items, I'll discuss these items on a non-GAAP basis which excludes non-operating charges previously mentioned and highlighted in our GAAP to non-GAAP reconciliation included in today's press release.
Adjusted research and development was 16.8% of sales or $4 million compared to 11.9% of sales or $2.5 million in the prior year. The increase in R&D expenses as a percentage of sales primarily reflects an increase in headcount to support the accelerated release of the Vulcan as well as several other development projects which are on their way.
As part of our growth strategy, we expect to continue to invest in R&D and anticipate a high R&D run rate in 2016 as a whole, predominantly as a result of additional chemistry scientists and engineering personnel. Sales and marketing in the quarter were $4.1 million or 17.3% of sales compared to $3.2 million or 14.9% of sales in the prior year.
Higher sales and marketing expenses were the result of increase in headcount in the sales department to support the growth in sales. Following the SPSI deal we will be moderately increasing sales and marketing expenses in that region in order to take full advantage of the opportunities.
General and administrative expenses in the second quarter were $2.7 million or 11.4% of sales compared to $1.7 million or 7.9% in 2015. Higher G&A in the quarter result predominantly from management headcount additions, additional HR expenses as well as expenses related to IT infrastructure and incremental expenses as a public company and increase in bad debt provision.
Headcount as of June 30 was 374 employees. The increase in personnel was primarily attributed to additions of R&D personnel. Non-GAAP net income for the first quarter was 716,000 or $0.02 per diluted share, a decrease of 1.7 million versus the year-ago quarter.
GAAP net loss was $127,000 or less than $0.01 loss per share on a fully diluted basis compared with net income of $718,000 or $0.02 per share for the year-ago quarter.
Our financial expenses this quarter were $18,000 as a result of accrued interest of our cash investment offset by financial expenses related to bank expenses. Cash balances, including long-term marketable securities, at quarter end were $66.2 million compared to $70.7 million as of March 31, 2016.
Net cash used in operating activities was $3.7 million this quarter compared to $3 million net cash used in the prior quarter and net cash provided in operating activities of $640,000 in the year-ago quarter.
The decrease in cash from operations was mainly a result of an increase in account receivable and inventory versus the prior-year period. Importantly, higher inventory is entirely attributed to inventory in support of R&D and customer demonstration systems, which have played an excellent role in our marketing efforts described by Gabi.
We expect the investment in working capital to moderate in the second half but anticipate an elevated level of capital expenditure in the third and fourth quarter as we executed a lease-hold improvement to our facility in Israel.
This project will increase faith for research and development and to accommodate our large team in Israel. As previously communicated, we expect CapEx related to this project to approximate $4 million and to be completed in 2016.
Turning to our guidance for the third quarter of 2016. We expect revenue to be in the range of $27.1 million to $30.7 million and non-GAAP operating income to be in the range of 6.7% of revenue to 12.3% of revenue.
I will now transfer the call to Gabi.
Thank you, Guy. And with that operator, we’d happy to take any questions.
[Operator Instructions] And first we'll hear from Ken Wong with Citi.
Hi, Gabi, now that we're a month into the SPSI acquisition or the asset acquisition, can you give us a sense for what kind of feedback you've been getting from customers and from Hirsch?
And then second, just on the leads that you get from the screen manufacturers, was that a market that you felt you guys just weren't getting enough access to with purely a partnership relationship?
Yes, thanks for raising that question. I think the most important part of the transition of this type given the fact that SPSI has been a partner for a very long time and also serving the market for quite a while is the support that their management has provided to this process.
If I ask myself what’s the most important thing, it's exactly, it’s also the staff that has been transferred. So the relationships are there. What we have done with all customers in a continued process is communicate, talk to them, lock them through the implications, the transition from a day-to-day standpoint is also gradual, they're helping us also with logistics obviously and billing and things of that nature.
So generally, I think it's been accepted quite well. I think for the larger accounts, obviously there is a clear understanding that this is a good move. For the smaller accounts obviously we need to establish closer relationships with those levels that we have had less of a contact historically. To be able to do that obviously, we will add a few more headcounts not that many, but a few in order to properly cover the region.
As far as Hirsch is concerned, Hirsch is a very valued partner of Kornit and continues to be. They’ve also represented us for quite a while. We work hand in hand and continue. As we communicated this process, they have been communicating to their own people and to their customers. We're continuing to support them. They're actually investing in market growth and market retention as we're going and which is a great sign that they want to continue to be a valued partner and I think they see the benefit as much as we do.
As far as the screen printing question, yes I do think that historically we have had some access obviously through the distributors, but not as close to that I like to see. I think that because of the fact that when you're talking to a screen printer offering a digital offering is really a disruptive solution, a more technical selling process does make sense and I think that with our own marketing and sales people, there is a better shot at that.
As well as the access of course, as we mentioned when we announced the acquisition of the assets of SPSI, this provides access to thousands and thousands of customers with whom SPSI has had historical relationship. So a lot of the process is going through those lists starting to make initial communication, profiling these accounts, understanding what needs and what each of them have. So overall I think a very positive process for us and for the customers.
Got it. Thanks for that. And then just one more for me. In terms of the open houses that you guys have had, you mentioned the Allegro open houses and then the one Vulcan one, and two new applications from customers developed. Anything that you might be able to share with us? And I guess coming out of these open houses, it sounds like you guys feel at least as good if not better about the prospects in the second half?
I think so. I think that first of all let me start with Allegro actually. I think that as we mentioned several times, we see digital printing shifting over time to pigment and we've always said openly that the pigment extensive usage in digital printing is still on the small side, it’s early innings. And so having a demonstration capability on each of these regions with customers and in the areas of pixel people are form of artist if you will sometimes giving them the access to spend days on end with the system running their own product, seeing how well it runs.
In some cases by the way we’ve even ran extensive runs for production for one of the customers makes a ton of difference. And therefore when Guy mentioned the increase in inventories, I believe that this is a great way to spend when you create this kind of market access it makes a big difference. It did create POs and it did create more valuable leads.
As far as what we learn and understand, we learn and understand the different applications, what kind of performance they want to get from the different fabrics both on the color side, as well as hand feel, durability of fabric et cetera.
With the Vulcan I think what was interesting in the open house is that we got a combination of existing digital customers, as well as people that are really screen printers and want to see what this all means to them. And the feedback was both from the production environment, as well as looking at the artistic capabilities or the graphic capabilities that the system offers. The feedback has been very, very positive. Clearly this is highly differentiated opportunity and I will reiterate to our investors that this plays a different role in the world of DTG and opens a new world to us.
So having an open house with more than 10 customers each of them spending quite an extensive amount of time with us physically at the facility has made a difference. So overall quite pleased with that.
Mr. Wong, do you have any further…
No. Go ahead and pass along. Thank you.
All right. Next from Barclays we’ll move to Joseph Wolf.
Thanks. I had a couple of questions. You mentioned the North American strength which is driving what's going on. Could you address the global trends on the Allegro and the Vulcan? And is the North American strength because of the relatively stronger economy? Is there an adoption curve which is faster in North America? Is there an ability to scale at Kornit which is having you focus on a region? Just a little bit more color on what's going on globally.
Yes, I think Joseph at DTG as we’ve always said if I compare it roll to roll for instance and then I’ll answer the question in a broader sense because of the fact that it is a direct to consumer business model enjoys much greater market access and as a result of it you can see exponential growth rate that you’ve seen with e-commerce in various different market segments.
And so we’re riding that wave I think quite well. It is indeed the case that in the U.S. it’s being used in the most extensive manner when you look at e-commerce. We have spoken about the importance of e-commerce in Asia as well as in the past but I think what we see in the U.S. is that which is different is that players in the U.S. that are serving e-commerce are becoming large sites whereas in Asia what we’re seeing with DTG is that the customers are discreet customers serving smaller opportunities each of them discreetly rather than becoming larger accounts.
And so for instance for Vulcan the best place to start with as a result of something like that is the U.S. The next would be Europe because e-commerce is strong there but we’ve said in the past that if I would compare what type of systems we sell in each of these regions the U.S. is clearly an Avalanche land that is opening up now to Vulcan and I would say that Europe is more of a storm now storm now Storm Hexa meaning the mid tier system because the production sites are generally smaller.
There are certain discreet examples which are different. We do have a very few very large customers in Europe as well but if I look at a trend the trend is stronger in the United States. So those are the reasons, I think it’s e-commerce related. I think it’s the business model that has developed much more extensively in the U.S.
Then I will say another thing, the advent of very large e-commerce players into this market has created I think a marketing momentum and business to a scale that didn’t exist a year ago.
Okay, that's helpful. Just a question on margins. If you look at the favorable gross margin in the quarter, and some of it was attributed to ink, as you think about the second half that you're expecting, which I think includes a lot more hardware, should we be expecting gross margin to come down a little bit, or is there enough ink growth for that to maintain its high level?
I’ll get directional information I think gross margin stays relatively solid is what I’ll say without giving you those specific numbers because we don’t go into that granular detail but directionally speaking I don’t see dissipation or pressure on the gross margin side in the remainder of the year.
Ink consumption is moving higher. You need to realize on the one hand there is a ramp up of more new systems coming in but at the same time as I have alluded and when I said that in Q2 for instance 72% of revenue is coming from large customers it means that they are utilizing those systems extensively and adding more systems. So, we do expect very good ink utilization rates with the advent of the holiday season et cetera.
And then just one final question. I don't think I caught it properly, but you said there was some sales slippage, I think connected with the distribution deal that would have meant you were at the high end of -- would have put you at the high end or above the high end of the guidance. Does that revenue make up some of the third quarter guidance, or is that revenue that's gone?
Just to explain what this and to put things more accurately I am glad you raised the question. As you know, SPSI historically played about a 20% role on average for Kornit in a quarter in which we’re busy doing an acquisition where we move to be a direct provider to customers, you stop working your quarter cycle which is an ongoing process which includes supplying systems, inventory replenishment, moving on to the next quarter that did not happen in the second quarter.
As a result of it we said that had the deal not happened at the timing that it would have happened, we would have arrived toward the high end of our guidance that’s the way you should understand that.
Okay, thank you.
Our next question comes from Jim Ricchiuti with Needham & Company.
Hi, just a question on the revenue guidance for the quarter. It's a somewhat wide delta, and I wonder if you could talk a little bit about the variables that get you to the upper end. For instance, you're assuming, I think, a pretty good pick up with a large customer. How big an impact does that have in the range? Maybe you could just spend a little time on the guidance.
Yes, obviously I won’t provide specific information as it relate to specific customers. I’ll say that indeed there is a range there and I think that the only thing you should read into that is revenue timing meaning there is strong momentum for the second half of the year. We feel very good about that.
Timing of revenue recognition is what can sometimes get in the way and that’s why we left ourselves a little bit flexibility with the range that, if you think about it as a little bit wider, not that much wider than what we usually do in this past quarter was $3 million range in this instance I believe it’s about $3.7 million or something like or $3.8 million.
So not that larger distribution but still we do give ourselves some flexibility and the only thing you should read into that is revenue timing. Momentum is very strong to the second half as we’ve said before.
And revenue timing, is that revenue timing in relation to some of the newer products like Vulcan?
It could be related to that and to some other products sometimes as well. So it depends on sometimes with larger accounts that has to do with when we actually recognize revenues versus when we ship it so it is a variety of things that sometimes come into that.
Asia and Europe, does that -- how much does that play into the variability? I'm kind of trying to get a sense as to what you're anticipating in those regions, which have been a little soft.
Yes, I think that this quarter is going to be somewhat better in Europe. In Asia I am still expecting it to be slower but there are very interesting opportunities in Asia as well as for the second half particularly with Allegro. So I would say as I said more than anything the U.S. is the most significant part of the H2 uptick or significant uptick that we’re expecting. Europe is suppose to improve somewhat and Asia could hover around the same levels as far as percentage of revenues that it represents for us.
Okay, thanks a lot.
Next we have Brian Drab with William Blair.
Hi, so the first question I have is just around the guidance. This is sort of just a nuance, but, I mean, in the past your guidance has included rounder figures than you have today. Can you just talk a little bit about did you change, by any chance, your methodology for generating that guidance?
No, not really. We looked at it and we said to ourselves what do we feel comfortable with and that’s what we arrived at. There was no hard fast rule in the past to put a round number. So I wouldn’t read anything specific into it.
Every quarter we look at carefully as we possibly can in order to predict our business. I think that I have said and I will take this opportunity again to say that you’ve been with us only for three months and I’m already seeing great signs of processes that improve visibility and understanding of our opportunities etcetera. So that’s the only thing that has changed, but as far as prediction methodology around the numbers etcetera there is no, no specific thing should read into that.
Okay. And then I think early in the call that you indicated there are several significant customers ramping up in the US. And you also mentioned it in Europe. That's somewhat different commentary, right, from the commentary in the first quarter call where the headline story was around one major customer. Can you add some detail there as to what you're seeing in terms of adoption by some big customers?
Yes, I think without mentioning specific customer names again unfortunately, what I’m seeing is that the e-commerce space in the U.S. is really booming and what I've felt and this is with many, many years of experience and was looking at different markets from my career what I see it, I see it exactly happening here.
When there is a hype around a certain manufacturing technology or around the end market, which is I think what plays a role here, when the players are I would say stronger financially and have more access to marketing tools that could be more costly to others they create a strong waive of demand. That’s what's happening right now.
So, bigger customers again in particular one very large one that’s influencing the market, many other customers that were medium wanting to become much larger accounts because they see the opportunity, more websites springing up and asking for printers who consolidate several websites to provide them services, the market is becoming more competitive between these different players, they now compete more on price and quality than they use to before, these are all signs of a positive market momentum I think and that’s what we are seeing.
So it is yes indeed, it is the -- I did speak about that large customer because it was going to be so meaningful but what has transpired in the last several months, which I’m pleased with is that I see that there is generally a wave going on in the U.S. which is quite significant and that’s what I’ve just been describing.
So, is it fair to say that your portfolio of customers today versus the last time you spoke to us on the first quarter call has improved meaningfully, in your view?
Well, when I call someone a large customer, they don’t usually become large overtime, right so with 72% of the revenues coming from large customer, it is existing customers that became larger right.
Having said that at the same time we're continuously working to add more customers. So I would say the depth of the relationship is something that we’re investing in that’s one thing. The expectations from us are higher for performance of the systems etcetera.
So I would say that the relationships are evolving into a different type of relationship. We started playing a more and more critical role for customers that rely heavily on our equipment and consumables that’s how you should read that.
Okay. I guess I'm going to ask it one more way. Are there any significant relationships that have - significant new relationships since the first quarter call, or is it more depth at existing big customers?
It's more depth at existing customers, but we're continuously progressing with new customer opportunity, some of whom are quite large accounts. So, behind the scenes, I’m reported of course the activities that we're doing to penetrate larger accounts and you should expect that to continue.
So that is not anticipating as of yet in many cases in revenues, but that is something we're very busy doing and is very critical for our future. I draw your attention to that data point that I gave that spoke about average in consumption with these large accounts being five times more than your regular account that’s a big difference. So it’s makes even more meaningful for us if you understand.
Yes, understood. And one last question. I don't know if there's any way you could help us model out through the year any of these line items. Can you give us any sort of a sneak peek at the fourth quarter or revenue growth that you're expecting at this point for the full year, or anything along those lines?
No, I’m not ready to do that, but I’m ready to say that we're expecting a very strong second half of the year. So, it continues to be the case. We see a strong second half of the year. We think that we’re on to a very good ramp up, which is solidifying every day that passes.
We’ve reiterated the fact that the second half of the year should make a big difference to the overall year performance as I said in the previous call. So, that’s how I still feel about that and it should allow us to continue to grow at the rate, that we’ve been wanting to.
Okay. And Gabi, are you sticking with the about 30% growth for the full year?
Yes, I don’t want to comment specifically but since we did talk about this somewhat last quarter I do want to give some kind of directions in order to the fair to all our investors. So we are seeing strong momentum in the second half of the year and it is possible I think that we can hit the long-term CAGR goal this particular year as we have said before, but the ability to hit that number for the full year will be impacted by two things.
One as we saw in the second quarter, the SPSI acquisition created a revenue recognition impact of $2 million in the second quarter and revenue timing issues, this is very important right, toward the end of the fourth quarter could get in the way of achieving the number for the year.
So I would say the following, very good momentum that can solidify what we had spoken about in the past but as stated before two factors one is the one time event related to SPSI was long term is very beneficial for us with the closeness to customers, expansion of market et cetera but that event did take place and then number two revenue timing overall towards the end of the year, whether it allows us to be able to recognize as much revenues as we would like to. These are the things that will faster our ability to be able to hit that.
And you're not commenting on anything specific for the fourth quarter. You're just saying that we have to keep in mind that there is timing issues always. Is that right?
That is correct and again that event that I described relating to SPSI.
Sure. Okay. Thanks very much.
[Operator Instructions] Next we have Bobby Burleson with Canaccord.
Hi, thanks for taking the questions. So, you mentioned that that $2 million impact from SPSI, that was an inventory fill that they do that didn't happen. Just wondering, is there any lingering impact in terms of the sell through to those customers, or is this entirely behind you in terms of how it's impacting your guidance in the second half?
Well again, what I described in relation to SPSI is normal course of business. Our normal course of business was from one quarter to the next to be in a situation where we have the ability to serve immediate demand and then longer term demand as the quarter progresses, we would always manage that carefully.
As we are working towards closing the deal to stop that process and as Guy had alluded, we basically saw a pretty much zero revenues from a customer that generally has contributed up to 20% of our revenues right. So that has already happened therefore if you look at our year-to-date for H1, it's behind to an extent because of that right, so that is how that should be interpreted and I hope I answered your question.
Can I ask one thing? Go ahead.
Again regarding your remarks about sell through, so prior to June 30 the business we did with SPSI was sell through starting July 1, it's going to be sell through. Q2 we recognize revenue based on net, minus the commission. So obviously comparing apples to apples, Q2 to Q3, our revenue should include the mark up by selling to and that should be a little bit higher.
Okay, great. Thanks. And then was -- did I hear correctly that you had a 35% non-distributor quarter -- or customer in the quarter?
That is correct.
Okay. Is that the merged customer concentration you had before that’s not a distributor?
Sorry could you repeat the question?
Is that the highest degree of customer concentration you've had compared to the past with a non-distributor customer?
Looking maybe either, well at least in size been here. It could be that before then there were worse quarter. So at least this is the period that I've been here and with a single customers, we haven’t had such a big quarter.
But as I said, these things have certain quarters in which they happen more than others. We are in a process of ramping up with a very significant customer. We expect it to continue for several more quarters. But each quarter will be a little bit different is as much as I’m able to say. And I am encouraged by the fact that there are multiple other large accounts albeit smaller than this that are also happening at the same time.
Okay. And you mentioned some of the drivers on the system side for the Q3 guidance or the second half strength including North America, but then also some build out in Europe at customers' facility. Is that a single customer, really, that's driving that uptick in Europe, or is that across multiple customers?
There is a -- what's happening in Europe is that in some cases, first of all there is European large customers that we have as well. So they exist and some of them are ramping up. Others have started to collaborate more than they did in the past with the US-based online retailers and providing them with a solution of printing intra-territory that's what I was alluding to in that comment.
Okay, great. And then I was wondering with this 35% customer or any other large kind of a non-touristy customers that are ramping up how is that translating into the services opportunity and any progress on services gross margins or update on how that's going this year?
Yes, in large account situations we're finding ourselves signing extended warranty agreements that in many cases also include on-site support and much closer turnaround time on spare parts etcetera. So larger accounts do offer an opportunity for expanded services.
As far as how we're progressing, I did say that you know we expect towards the second -- inside the second half excuse me, to start seeing the upgrade revenues that we've been talking about. From a revenue standpoint more from I would say towards the latter part of this year we are signing more service contracts than we did in the past.
But the significant increment that we need to start seeing and I expect us to truly start seeing that before the end of this year is the upgrades that I've been talking about and so that’s still in the works, that’s starting to happen some evaluations are starting as well and so I expect that in Q4 that going to start picking up also.
So it is taking time no question about it but I am -- I do feel very solid about the ability to meet what we’ve been talking about is which we need to get to the breakeven and becoming profitable. The pieces in the puzzle of building themselves as we go step-by-step.
Okay. And is pricing kind of stable? Given that you've got some pretty large orders coming in, is there any negotiating power kind of that's increasing at your customers that could impact margins or ASPs, or are those stable?
I don't want to obviously comment for competitive reasons and also out of discreteness to customers I think that what we have done over the years is we've built a very fair pricing model that takes into consideration the size of customers that we're serving.
And I think that people will find us -- found us to be reasonable in that sense. And so I think it's the strategy we're deploying is a good strategy and I think that the indication is it’s shown in the P&L on the one hand and the gross margins that you’re seeing on the other hand that the customers are satisfied with the prices that they're getting.
You guys have a pretty good view into the Web-to-print kind of growth that's out there, or the online growth that's out there. Is there -- are there competitive pressures, do you think, in your customer base where this is sort of going to become a zero sum game, or are we still early innings where there's plenty of room for this large customer and maybe other guys that are ramping where the pie is growing fast enough for them all to kind of continue to grow?
I think the pie is growing continuously very, very rapidly but I do think that what I've been saying for several quarters that there is a process of I would say consolidation whereby you want to get bigger in printer, bigger and bigger printing shop because not everyone wants to make a capital expenditure.
I think what happens and it's very much like the business model in my previous industry with foundries, we have a given capacity and you want to try to utilize it to the best of your ability. You try to add more and more customers, but when those customers start showing up obviously price sensitivity comes to the table.
If they can get different bids from different suppliers, it’s turnaround time, it’s quality and so it’s not easy to compete in that market but so many people see it as such a lucrative opportunity that many of them want to come in.
So I don’t that anytime soon as this is going to slow down. I see it increasing continuously but I think that that entry barrier for new players will become more difficult because you are going to need to be more and more professional. To me this is a classic market evolution process.
Moving on from Stifel we’ll hear from Patrick Newton.
Yes. Thank you, Gabi and Guy. Just jumping right into the services, you'd touched on this already, but on the upgrade side. But is this all about shifting Storm II to the Storm Hexa, or are there other products that we need to watch as far as having kind of an upgrade cycle?
No, there is going to be more. I said - I think in one of our conference calls that this is a strategy that we’re going to be deploying across many platforms. You should expect us to start offering upgrades on other platforms as well mostly in the industrial space but it’s not just the Storm, the Storm Hexa it’s also other platforms and those are going to be rolling out in the second half of the year.
So I am actually pretty excited about that and I think the customers are going to be because as I said before these upgrades are focused on productivity. Things such as re-circulating head that allow them to consumer less ink because ink waste goes down in many cases it’s throughput, color gamut, better performance because of climate control systems and the systems themselves, bulk ink containers that allow them to work uninterruptedly for longer periods of time et cetera, et cetera.
So I think these are various different components and you are going to see us starting to talk about upgrades not just for the Storm but for other platforms also.
And I guess I should have clarified. In order to achieve your break-even target, is that all just based on this current upgrade cycle?
It’s not all based on it because at the same time service revenues from contracts and time and material is also growing but if I ask myself what’s the next big chunk increment that I am relying on, that’s the one that be worth quite a bit of many on a quarterly basis and that will make I would say a step function in reaching that target that we’ve set for ourselves. So, it is meaningful but it’s not the only things that growing.
Great. And then, thanks for the details on the SPSI, I guess, revenue impact due to inventory restocking. But I'm curious, as a second derivative, are you seeing any change to the relationship with Hirsch given the acquisition, or are the distribution channels geographically segregated enough that there is no, I guess, business disruption?
No, I think as I said earlier on in answer to one of the questions, we value the relation with Hirsch quite a bit. The owners of this business, they are solid people, solid industry people, great customer relationship. They do a good job representing our brand. This relationship is important for us. The region that they represent is an important region for us. They’ve seen how seriously we take that not just by word of mount or by actual practice the changes that we’ve made in the regions that I reported in the past management in the different regions is going to make that relationship even deeper.
And I think if I can use this platform basically though our distributors that are listening maybe to this call, we value these relationships quite a bit. What we did with SPSI is a great indication of that because we did not just say one day like many vendors, hey, we’re going to go direct see you, we respect these people too much for that and therefore we created a platform for them to enjoy the benefit and the merits of all the hard work that they did for us to move forward and we’re going to continue to play fair in the market and that I think is the way that our distributors are probably judging this particular event that took place.
Great. And then just last one for me was a clarification. I thought in answer to an earlier question you'd said that the large DTG supplier that's ramping in the second half -- I think in a previous call you'd said it was focused on the Avalanche product family. And I thought in answer to a question you had said there could be some Vulcan layered in to that account as well. Just wanted to see if I heard that correctly.
No, I didn’t say that not at all. I did say that large customers but not that specific one large customers' are looking and actually some of them are already engaged in these evaluations that we’ve been talking about a deploying Vulcan as well. And what’s interesting is obviously on the same floor having an Avalanche and a Vulcan they will both be utilized in different manners because we’ve realized and learned how it’s best operated in the last six months so they can take advantage of those technologies, those customers that have decided to do so.
Great. Thank you for taking my questions. Good luck.
All right. With nothing further from the audience at this time I would like to turn the floor back to Gabi Seligsohn for any additional or closing remarks.
Well, I would like to thank everyone for participating in today's call. We have a very interesting second half ahead of us and look forward to seeing you guys out there. As we’ve reported in the press release we’re going to be presenting at the Canaccord Conference next week. For those of you that are attending them, we’d happy to see you. Thank you and have a great day.
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