Materialise N.V. (MTLS) Q3 2016 Earnings Report, Transcript and Summary

Welcome to the Q3 2016 Materialise Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference Mr. Harriet Fried of LHA. You may begin.

Thank you for joining us today for Materialise conference call. With us on the call are Fried Vancraen, Founder and Chief Executive Officer, Peter Leys, Executive Chairman and Johan Albrecht, Chief Financial Officer. Today's call and webcast are being accompanied by a slide presentation that reviews Materialise's strategic financial and operational performance for the third quarter of 2016. To access the slides if you have not already done so, please go to the Investor Relations section of the Company's website at www.materialise.com. The earnings press release that was issued earlier this morning can also be found on that page. Before we begin, I would like to remind you that management may make forward-looking statements regarding the Company's plans, expectations and growth prospects among other things. These forward-looking statements are subject to known and unknown uncertainties and risks that could cause actual results to differ materially from the expectations expressed, including competitive dynamics and industry change. Any forward-looking statements including those related to the Company's future results and activities represent management's estimates as of today and should not be relied upon as representing their estimates as of any subsequent day. Management disclaims any duty to update or revise any forward-looking statements to reflect future events or changes in expectations. A more detailed description of the risks and uncertainties and other factors that may impact the Company's future business or financial results can be found in the 20-F for fiscal year ended December 31, 2015 filed with the SEC on April 28, 2016. Finally management will discuss certain non-IFRS measures on today's conference call. A reconciliation table is contained in the earnings release and also at the end of the slide presentation. With that introduction, I'd like to turn the call over to Peter Leys. Go ahead Peter.

Thank you Harriet, and thank you everyone for joining us today on the call. The agenda for our call is on slide 3. I’ll begin as usual with a brief recap of our results for the quarter after which Fried will give you some insight into our exciting partnership with HOYA Vision Care. After that as usual, Johan will go through our numbers in more detail and then I’ll come back on to run you through some of the steps we are taking to position Materialise well for the coming years. When we've completed our prepared remarks, we will be happy to respond to any questions that you may have now. Now, turning to slide 4, you will see the highlights of our third quarter results. Although the market we operate in is still in a state of transition, awaiting a new generation of systems with increased value propositions, we believe Materialise chalked up a good quarter. We had revenue growth of 11%. A figure that does not take into account deferred revenues. Deferred revenue from annual software sales and maintenance contracts rose by EUR2.3 million from last year's periods. Adjusted EBITDA more than doubled compared to Q3 of 2015 as did our adjusted EBITDA margin. And reflecting the benefits of our diversified model, we had revenue increases and positive EBITDA in all three of our business segments. In light of the market conditions, we think this is a good performance from the management teams of each of our segments. And with summary, I would like now to turn the call over to Fried.

Good morning or good afternoon everyone. In September, we unveiled one of the most significant examples of our backbone strategy. Together with HOYA Vision Care, a division of the global medtech company HOYA Group, a global market leader for the lenses in the eyewear market, we launched Yuniku. Yuniku is the first system that allows opticians to tailor both the lens and the frame to their customer’s individualized visual comfort and aesthetic needs. And that is backed by a sophisticated end-to-end digital supply chain. Yuniku takes full advantage of the benefits of 3D printing and taps at almost every step of the customization, production and logistical work flow into the materialized backbone. What makes Yuniku truly unique is that for the first time ever, both lenses and frames are individualized in a coordinated fashion, in order to fit the customer's facial features as well as his or her functional needs on the visual front. The beneficial effect of this customization on visual experience has been scientifically tested. Wearers of Yuniku glasses get better vision and less fatigue. This promising product matches perfectly with our mission statement to work to achieve a better and healthier world. Importantly, the solution that we have developed together with HOYA not only have the potential over time to significantly enhance the vision experience of millions of people, it also has the potential to revolutionize the dynamics of the supply chain in the eye wear market. Today opticians are confronted with large stocks of frames that depending on fashion and taste may remain largely unsolved. With the Yuniku system, spectacles are produced to order and stocks can be drastically reduced. The Yuniku platform is in line with our strategy, open and it can support multiple designers and eyewear brands. Technologically, Yuniku relies on the materialized technology backbone at almost every step of the work flow. The experienced starts with an accurate 3D scan to capture all relevant facial features of the customer. Yuniku’s scanning device has been engineered by Materialise to meet HOYA’s high accuracy requirements for lens optimization and frame customization. Materialise enables software subsequently reads the scan data and delivers an easy to use interface to the optician, similar to the pannus that surgeons use to plan medical interventions. The optician then introduces his customer’s eye prescription data, relevant information with respect to the customer's lifestyle and the customer’s choice of frame design. Based on this input, our software proposes and visualizes in 3D the optimized customized frame design and lens positioning. The platform allows the optician to propose design adaptations, including color changes and finishing. These are immediately visible on screen for both the optician and its customer. Once the customer agrees to the proposed new glasses, Yuniku automatically links to the technical databases and the order handling systems of both HOYA and Materialise. While HOYA will produce the customized lens, Materialise will produce the individualized frames in compliance with CE standards. In the end, spectacles are certified medical devices. We have set up a dedicated production line in Belgium and are preparing a second line in our new laser sintering plant in Poland. During production, our [indiscernible] software ensures the proper handling of all production data and provides for example unique labels on each printed component. We undertook the soft launch of the Yuniku platform in Europe this quarter. The first products will be delivered towards the spring of next year and we expect the platform to ramp up during 2017. We will showcase at Formnext next week several other examples of the materialized backbone and its components. And at this point, Johan will come on to give you more details on our financial results.

Thank you, Fried. I’ll start with a brief review of our consolidated revenue on slide 6. For clarity, I'd like to remind everyone that when we refer to sales in our presentation this means revenue plus deferred revenues. As Peter mentioned, for the third quarter we generated 11% quarter over quarter increase in revenue with increases in all three of our segments. Materialise software accounted for 27% of our revenue in quarter three, Materialise medical for 33% and Materialise manufacturing for 40%. If you recall, two top goals for Materialise are to grow the contributions that software revenue and end parts revenue make to our total mix. In the third quarter of 2016, total revenue from software products rose by 2 percentage points to 37% and end-parts increased by 1 percentage point to 39% as compared to last year's period. Prototyping accounted for 24% of our total revenue as compared to 27% in the prior-year period. Moving to slide 7, you can see our consolidated adjusted EBITDA numbers for the third quarter. As Peter mentioned earlier, consolidated adjusted EBITDA more than doubled growing from EUR1,175,000 in 2015 period to EUR2,833,000 this quarter. Our adjusted EBITDA margin improved from 4.5% to 9.9 %. These improvements reflect three factors. First, a continued double-digit revenue growth. Second, an improvement in our gross margins by 15%. And third, a modest increase of 5% in operational expenses. Slide 8 summarizes the results of our Materialise software segment. The revenue grew just over 21%, driven by 30% growth in sales generated from OEMs and 15% growth in recurring license revenue. EBITDA grew 30% on the 21% revenue growth. Moving to slide 9, you will see the total revenue in our Materialise medical segment grew 4.5% for the quarter. The 28% increase from direct sales from complex surgery devices more than offset 2% decline in sales from collaborative medical devices and medical software sales. Medical software sales representative 32% of total medical revenues. EBITDA for the medical segment this quarter was EUR754,000 as compared to EUR763,000 in the prior-year period and EBITDA margin remains flat at 8%. Now let's turn to slide 10 for an overview of the quarter three performance of our Materialise manufacturing segment. Their revenue rose close to 11% driven primarily by revenues of end-parts which were up 41% over last year's period. They accounted for 37% of the segments revenue, up from 33% last year. The company’s total number of printers rose slightly this quarter to 148. And since beginning of this year, we have added ten printers. EBITDA almost doubled to EUR1.7 million from EUR800,000 for last year's period including EUR460,000 relating to the updated accounting valuation of resin material stock which reflects the steady improvements we have been making in efficiency. The margin increased to 14.9% this quarter compared to 7.6 % in the 2015. Slide 11 provides the highlights of our income statement for the third quarter. Gross profit increased more than 15% compared to last year's period and gross margin increased to 58.9% from 56.8%. The increase was primary a result of the improvement in the gross margin of our manufacturing segment. In total, R&D, sales and marketing and G&A spending rose by 5% over the prior year period. On a quarter of quarter basis, R&D increased slightly while sales and marketing decreased slightly. Our G&A expenses rose but most of this increase reflected the managerial structure and support we have been implementing within our sales and marketing and R&D groups. As explained in our previous earnings calls, and as we will repeat for the last time in our next quarter's earnings call, a number of employees within these groups have evolved into more managerial or administrative roles and the costs as well as of certain other expenses are not categorized into G&A. Other income net decreased by EUR274,000 to EUR1,369,000. Net other operating income consists primarily of withholding tax exemptions for qualifying researches, developing grounds, partial funding of R&D projects and currency exchange on purchase and sales transactions. The increase was due primarily to the variance in the currency exchange. We posted an operating profit of EUR332,000 compared to an operating loss of EUR834,000 for the same quarter of last year, an improvement of EUR1,160,000. The net financial result was negative EUR124,000 compared to a positive EUR151,000 for the same period last year, reflecting smaller variances in the currency exchange rate, primarily on the portion of the company's IPO proceeds in US dollars. This is reported but mostly unrealized exchange loss. Net loss for the third quarter of 2016 was EUR52,000 compared to a net loss of EUR1.1 million for the same period in the prior year almost exclusively as a result of an increase of almost EUR1.2 million of operating profit. Now please turn to slide 12 for a recap of balance sheet and cash flow highlights. Our balance sheet remains strong with minimal debt accounting for only 18% of total liabilities and equity at quarter end. We ended the quarter with cash and cash equivalents including held to maturity investments of EUR50.5 million compared to EUR50.7 million as of end last year. Total deferred income amounted to EUR18 million compared to EUR16.6 million at year-end 2015. The deferred annual software sales and maintenance contracts rose to EUR14.2 million from EUR11.8 million 12 months ago. Capital expenditures amount to EUR2.3 million compared to EUR2.8 million for the third quarter of 2015 which included printing capacity expansion investments. Cash flow from operations was negative EUR1,466,000 compared to a positive EUR268,000 last year, mainly due to an increase of accounts receivable and a temporary funding of capital expenditures for our new facilities. With that overview, I’ll turn the call back to Peter now.

Thank you, Johan. Please turn to slide 13 for an overview of the steps we are taking to position Materialise for 2017. I would like to emphasize that we continue to believe very strongly in three different things, prospects for long-term growth, especially given the growing number of high profile, well established companies that are entering our industry, showing that they too understand its potential to transform manufacturing and supply chain dynamics. In anticipation of the full adoption of AM technology for end part manufacturing, we are taking the following steps. Firstly, we are establishing a number of partnerships that should position us very well, as the market further adopts adequate manufacturing for the production of complex and/or customized end products. We discussed during earlier calls, how companies such as HP, J&J/Depuy Synthes and Microsoft are collaborating with us, which we view as an implicit endorsement of our capabilities and industry positioning. During this call, Fried explained how our backbone serves as the basis for our very promising partnership with HOYA Vision Care and we are developing other strategic alliances that we hope to be able to report on in the near future. Secondly, we are expanding our technology platform to better meet the needs of end part manufacturers. During previous calls, we discussed our suite of build processors, our manufacturing control platform, our metal printing competence center in Bremen, our hospital oriented medical software products such as materialized imprint and our X-ray knee guides, where we are continuing to work with the FDA to secure 510(k) approval, which we currently expect in the second half of 2017. At Formnext next week, we intend to announce other new products and solutions that further expand the technological reach and depth of our backbone. Thirdly, we are working to enhance the effectiveness of our internal operations to take advantage of synergies. At Materialise, we believe that operational effectiveness and strategic fit must go hand in hand, as evidenced by our strong performance this quarter on both EBITDA and EBIT. And finally for your information, during the third quarter, we closed on the two financings for the expansion of our facilities in both Belgium and Poland. At this point, I would like to turn to slide 14 and our guidance for the remaining of the year. In 2015, the slowdown in equipment spending did not translate into less robust growth for Materialise, because customers continued to turn to our software solutions to upgrade their existing installed base of printers. This year, as we mentioned in our last call, our business has been somewhat impacted by the transition of our industry. So while we expect a seasonally active fourth quarter for our software unit, we expect revenues for 2016 to be at the lower end of our guidance of between EUR115 million and EUR120 million. We continue to expect consolidated adjusted EBITDA to be between the EUR7 million and EUR9 million that we have originally forecasted. Finally, we now expect the increase of our deferred revenues from annual licenses and maintenance to be in the range of 2 million to 3 million rather than our originally forecasted 3 million to 4 million. Operator, this concludes our prepared remarks. We are now ready to open the call for questions.

[Operator Instructions] And our first question comes from the line of Troy Jensen with Piper Jaffray. Your line is now open.

Hey. Congrats on a nice quarter, guys and thanks for taking my question here. So quickly I just like to dive a little bit in the medical business and that is an area that one of your competitors [indiscernible] talks a lot about. So I’m curious to know if there is any increased competition from your perspective. And if you can just spend a little bit more time in this X-ray product here. And we know this is an important launch for you guys. If it does come out in the second half of ‘17, should we think of this as an ‘18 revenue opportunity?

Maybe to answer your specific question on X-ray first, Troy, and then I'll pass the floor to Fried to discuss about the competitive environment in medical more in general. We're basically fine tuning our X-ray knee guides solution as a result of some iterations with the FDA. We do not expect that this will have significant impact on the expense sides. I mean the bulk of the investments really have been done there. Clearly, we are continuing discussions with the potential partners and we believe that as our 510(k) approval will become closer to reality, somewhere mid-2017 that we should have a better view on how these collaborations would look like and what the impact would be on revenue. Clearly, the ramping up of that product will be more likely for - end of 2017 and more likely 2018. Question will be how specifically will we then be able to negotiate specific agreements with several partners. And it's a bit too early to anticipate on how the compensation structure will look like there. I hope troy that answers your question.

Very helpful, Peter. Thank you.

I’ll just pass the floor to Fried to answer the first part of your question.

Well it’s clear that in the medical 3D printing arena, we are currently in a phase that while the revenue streams are still quite limited, because in the end, we are dealing with products that are not even launched or just being launched and we have a lot of potential, but at this moment, a relatively little, yeah, revenue streams that is important to have the right partnerships. And there I think Materialise is very well positioned. And we are expanding the amount of partnerships. We have made a few announcement, but there are more in the pipeline that will enable to take advantage of the growth of 3D printing and medical industry in the future. I think this is the situation in which we are today. We are one of the few companies that can really provide full service to larger players in the industry. So there's a lot of potential there.

All right. Understood. And another one for me, just within your OEM category, I'm curious to know if Concept Laser and Arcam are partners of yours. And if so, if you had any conversations with GE about their intentions in this space?

They both are partners of ours. It's - I mean we are in constant contact both with our partners as well as with the potentially future owner of these companies, not only in view of their potential future ownership, but also for other reasons we are collaborating with GE. And discussions on how we go forward on the software fronts, obviously are part of the overall discussions that we have with these various parties.

Perfect. Understood. And then just last question for me and I'll leave the floor. Can you just give us a sense in for the timing for some of these new generation 3D printers that you guys are partnered with?

Well, I think one of the - yeah, the biggest part is there is HP. And, yeah, we are definitely moving forward. But I leave it to HP to make the announcement here.

And our next question comes from the line of Weston Twigg with Pacific Crest Securities. Your line is now open.

Hi. Thanks. Just a couple of relatively quick questions. First on the medical results, which were a little soft year-over-year, can you explain why the sales from the collaborative medical devices was down and maybe what we should expect moving forward?

Yeah. Wes, thank you for that question. I mean when we talk about the collaborated sales, I mean we have this development whereby the new partners that are actually opting for our backbone are actually compensating for the decline of revenues that we have been experiencing from Zimmer Biomet. And if you look at our last quarters, there have been quarters where our new partners have been able to more than offset the lesser revenues from the Zimmer Biomet and this quarter is a quarter where our new partners have not been able to entirely offset, but I can add to that the prospects that we have with some of these partners and I think I can particularly refer to J&J/Depuy Synthes are such that we are very optimistic about the continued success and growth of our collaborated partner program.

Okay. Very helpful. And then the other one was just on operating expenses, looks like they were down pretty substantially quarter-over-quarter, want to know why that is specifically and if this is a level that we should expect moving forward in terms of operating expenses?

Well, I must say that the operating expenses are in line with what we've seen in the past, in the quarters before as well, they’re in line with the lower increase of operational expenses compared to increase of revenues. Cost of capital under control. We also have kind of a seasonality effect. But besides that, in the summer months, besides that, I must say also that our way of working is enabling us that if we don't grow or haven’t by 20% in general over the company that our cost structure is such as well that we can keep costs under control with a lower growth than we have in the past years.

[Operator Instructions] And our next question comes from the line of Ben Hearnsberger with Stephens. Your line is now open.

Good morning, guys. Thanks for taking my question. This is actually Hugh on for Ben. I want to start with a little higher level question. I’m curious to know what you’re saying in the printer industry and how this impacts software outlooks for next year, fiscal year ‘17.

Yeah. I think the number of research reports and the number of some of the other stock listed companies in the 3D printing field indicate that, at this moment, the growth is still extremely limited in printer sales, especially on the non-metal side. In metals, the situation is just like it was last year. In our opinion, still a little bit different. There is a faster route there. We truly believe that this is going to change, because we clearly see the uptake of manufacturing and manufacturing will require more and more printers in the future. This goes hand in hand with some of the changes in requirements, because the requirements for manufacturing are different than in the prototyping business and that's why like Peter indicated during the presentation, we are adapting our development and we are preparing ourselves in order to take as well advantage of the big road in manufacturing as we have done in the past in the prototyping business.

And Hugh, if you look at our numbers, even though as Fried rightfully indicated, growth is still rather slow. We did have a strong growth in our software sales and one of the reasons is, as you know, over the last quarters, we have expanded our portfolio of software solutions, gearing them at end part manufacturing. One of the reasons for the strong growth of our software sales in spite of the continued soft growth of printer sales is the success of some of the new products that we have added to the suite and I think in particular of our manufacturing control platform, which is one of the products that really accounts for the stronger growth of our software segment and I really all invite you to attend or at least review the press releases that will be issued in the framework of Formnext, because there you will see that we further add new solutions and new products to our software suite to our backbone. That should also help us to continue to see a healthy growth in our software segment.

That’s really helpful, guys. And then just the last question for me, look at the manufacturing segment, we saw that spike in the adjusted EBITDA margins. Can we expect them to stay at this level? Can we look at this as a run rate?

It's always better to, I mean, to look at more than just the most recent quarter to come up with a run rate. I think that is just safe and so it has also been explained. I mean, we continuously work on our gross margin. I mean the folks there at our production do an excellent job. And as is explained also in the press release, one of the reasons for the very strong result is that as a result of the efficient use of our material in general and of our resin in particular, we have been able to reevaluate some of the resin inventories that we have and that is a one-off. It's explained in the press release. So that is to a low extent, but still that partially also explains the very, very strong EBITDA margin that we posted in manufacturing this quarter. So actually what I'm saying is it is our ambition to stay that high, but if you want to be somewhat prudent, please consider that as a very strong quarter from an EBITDA margin perspective.

And I’m showing no further questions at this time. I would now like to turn the call back over Mr. Peter Leys for closing remarks.

Thank you, operator and thank you, everyone for joining today's call. We're looking forward to seeing some of you at Formnext next week. If you'd like to make a date to stop by our booth, then please contact LHA, our investor relations firm and they will be happy to show you around or to schedule a meeting with one of our key managers who will be present at the booth next week. Thank you again and talk to you at the latest within three months or so. Good bye.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.