Materialise N.V. (MTLS) Q2 2017 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the Second Quarter 2017 Materialise Earnings Conference Call. At this time all participants are in a listen-only mode, and later we’ll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to introduce your host for today’s conference, Ms. Harriet Fried of LHA. Ma’am, you may begin.

Thank you everyone for joining us today. On the call from Materialise 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 summarizes Materialise’s strategic, financial and operational performance for the second quarter of 2017. To access the slides, if you have not done so already, please go to the Investor Relations section of the company’s website at www.materialise.com. The earnings press release that was issued this morning can also be found on that page. Before we begin, I’d 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 those expressed in forward-looking statements. These include the company’s future results and activities, management’s estimates as of today, and should not be relied on as representing their estimates 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 the fiscal year ended December 31, 2016 filed with the SEC on May 1, 2017. Finally, management will discuss certain non-IFRS measures on today’s conference call. A reconciliation table is contained in the earnings release and at the end of the slide presentation. And now, I’d like to turn the call over to Peter Leys. Peter?

Thank you Harriet, and thank you everyone for joining us today. The agenda for today’s call is on Slide 3. I will begin with a brief recap of our results for the quarter, after which Fried will give some insights and backgrounds on the current strong growth of our manufacturing segment. After Fried’s comments, Johan will go through our Q2 numbers in more detail, and finally, I’ll come back on to update our plans and guidance for 2017. And when we’ve completed our prepared remarks, as usual, we will be happy to respond to any questions that you may have. So turning to Slide 4, you’ll see the highlights of our second quarter results. Continuing the trends we began in the last quarter of last year and the first quarter of 2017, Materialise delivered yet another set of good results for the period. For the quarter, our revenue grew almost 22% to €33.6 million, not including deferred revenue from annual software sales and maintenance contracts, which rose by another €407,000 from year-end 2016. Each of our three business segments had revenue increases, ranging from almost 10% to roughly 20%, and close to 33%. And all segments generated positive EBITDA. Our EBITDA margin more than doubled, while our consolidated adjusted EBITDA was up 164% compared to the second quarter of 2016. Overall, we continued to see a modest pickup in the demand environment compared to last year, with more and more customers seeking to understand and exploring the potential to embrace additive manufacturing. At this point, I would like to turn the call over to Fried.

Thank you, Peter. Good morning, or good afternoon to everyone. Please turn to Slide 5. Over the last quarters, our manufacturing segment has been doing very well. The segment’s revenue grew more than 25% in the first quarter, and this quarter, we have seen a growth of over 30%. These exceptional growth rates were driven by the strong performance of our end parts production. I would like to take this opportunity to share with you some of my thoughts about what the strong performance of our manufacturing segment tells us about state of the market in general and about the positioning of Materialise in particular. With respect to the market, the growth of our manufacturing activity shows that quite a few players are gradually shifting from internal research and testing of AM technology to the initial production of small batches of parts. It is not unusual that, in this early stage, production is outsourced to highly specialized and experienced companies, such as Materialise. That is a good sign, in particular for companies like ours, but it does not mean that the overall adoption of AM for the production of end parts will happen overnight. Already last year, we anticipated the growth of our manufacturing activities by initiating the construction of new production facilities in Poland and in Belgium. The pictures on Slide 5 give you an idea of our production facilities in Poland, roughly 8,000 square meters, of which 75% is production floor. And of the extension of our Belgium facilities, an extension of roughly 9,000 square meters, of which more than one third are dedicated to production. We will conclude the move to both facilities by the end of Q3, in time for the important fourth quarter. Thanks to fantastic efforts by our team, the disruption of normal operations due to the move is limited. We are significantly investing in the manufacturing segment of our backbone not only in order to meet the growing demand in the market that we currently experience, but also, and foremost, because we are convinced that our involvement in the early stages of the production is crucial to allow us to build a backbone of software and services that the industry will continue to rely on as it grows. Companies that are considering adopting a new production technology such as AM need assistance not only in the short, but also in the long run. And in the front end of our backbone where we perform engineering and printing services, we make our customers rely on our service for the early stage of the adoption of AM in real production. The back end of our backbone includes software, tools and services, which many of our clients will continue to use at a later stage as they feel more comfortable with the technology and are ready to take all or part of the production in house. To the extent that Materialise can help its customers at an early stage, we can solidify our relationships with the customers and be positioned better to serve them in the later stages, when they take technology in-house. This is particularly the case because proximity to the early adopters of the technology for end part production will allow us to better adapt and fine-tune our software backbone to our customers’ needs and expectations. Products like Inspector and MCP, for instance, are first being developed and used internally, and are eventually designed to be used on a much broader scale. For the reasons I’ve just mentioned, the importance of the current [indiscernible] of our manufacturing segment is twofold. First, it obviously represents solid growth of our revenue and customer base; and second, it creates a platform for the future growth of the back-end part of our backbone. We have explained our strategy in many instances in the past, but I absolutely want to repeat it at this stage, a an uneducated glance, at our numbers may create the impression that we are on a path of primarily becoming a manufacturing company. Our end goal is not to become one of the world’s largest additive manufacturing facilities. Our end goal is to continue to build a neutral backbone that includes production, as well as services, and that supports and enables the entire industry. We have done this in the past with our prototyping activity and been successful with this approach. We are now expanding our backbone to satisfy the needs of end part production, and we believe the best way to do that is to gain and gather manufacturing expertise alongside our customers. I would now like to turn the call back to Johan.

Thank you, Fried. I’ll start with a brief review of our consolidated revenue on Slide 6. As I do each quarter, I’d like to remind you that, when we refer to sales in our presentation, we mean revenues plus net deferred revenues. Also, please note, unless otherwise stated, all comparisons in this call are against our results for the second quarter of 2016. As Peter mentioned already in the opening remarks, we realized an increase of almost 22% in revenue in this year’s quarter, with all three of our segments, especially Materialise manufacturing, producing strong growth. For the quarter, Materialise software accounted for 25% of our revenue, Materialise medical for 32%, and Materialise manufacturing for 43%. In the second quarter, across all three of our segments, revenue from software sales and end parts contributed 81% of total revenue. The remaining 19% was generated through the production of prototypes. Moving to Slide 7, you will see our consolidated adjusted EBITDA numbers for the second quarter. As Peter mentioned earlier, consolidated adjusted EBITDA increased by 164%, rising from €1,034,000 to €2,732,000. Our adjusted EBITDA margin grew 440 basis points to 8.1%. These improvements reflect several factors, including our company-wide 22% revenue growth, led by manufacturing’s 32.5% increase, and an increase of only 9% in operational expenses. In the second quarter of this year, we moved most of the 3D printers from our old premises in Poland into the newly-opened production facility, and simultaneously experienced a growth of 50% of our production in Poland as compared to the same period last year. As a result, we experienced some temporary manufacturing inefficiencies, which did impact our gross margin. We expect to complete the start-up process in the third quarter, and look forward to gradually realizing scale effects and efficiency gains again thereafter. Slide 8 summarizes the results of our Materialise software segment, for which revenue grew 19% over the last year’s period. Revenue from recurring sales grew 25%, while OEM sales rose 26%. During the quarter, we began realizing income from our partnership with Siemens, announced in January. Quarter-over-quarter, segment EBITDA rose to 35.5%. Turning to Slide 9, you will see that total revenue in our Materialise medical segment grew almost 10% for the quarter. Revenue from medical software increased 16%, driven by 29% growth in recurrent revenues generated from annual and renewal licenses and maintenance fees. Software revenues represented 36% of the total medical segment. The revenues from medical device solutions rose 7%. Sales from medical collaboration partners rose 9%, while direct sales grew 4%. EBITDA for the medical segment was €758,000 as compared to a breakeven situation in the prior year period. EBITDA margin was up 700 basis points as a result of the higher revenues and only small growth of operational expenses, while the cost of sales margin has improved again to almost last year’s level in the same quarter. Now let’s turn to Slide 10 for an overview of the second quarter performance of the Materialise manufacturing segment. There, as we mentioned, revenue was up almost 33%. The growth was almost fully attributable to the increase in revenue from end part manufacturing. This increase reflects a combination of strong growth in our core business combined with sales of metal and of scanner scales from the HOYA agreement. End parts accounted for 49% of the segment revenue during the first half-year, up from 39% over the same period last year. EBITDA increased from €430,000 to €1,241,000. The margin rose to 8.6% this quarter from 3.9% last year, boosted by the revenue growth combined with the controlled increase of operational expenses, more than offsetting the increased cost of sales from the sub-optimal manufacturing circumstances of moving the printers into the new facilities, as explained before. At quarter-end, the total number of printers Materialise had in production rose to 161, up 11 over the number at year-end 2016. This included two jet fusion printers. But since the 30 of June, four more have been put into production. Slide 11 provides the highlights of our income statement for the second quarter. Gross profits rose 19% compared to last year’s period, while gross margin was 57.7% as compared to 58.9%. Again, this primarily reflects costs associated with the startup of our new production facility in Poland. In total, research and development, sales and marketing, and G&A spending rose by 9% over the prior year period. R&D and sales and marketing each rose moderately, while G&A accounted for the larger proportion of the increase. We posted an operating loss of only €295,000 compared to €1,151,000 for the second quarter 2016, an improvement of more than €850,000. Net financial result was negative €427,000 compared to a positive result of €207,000 for last year’s period, reflecting variances in the currency exchange rate, primarily on the portion of the company’s IPO proceeds held in U.S. dollar. Income tax amounted to €191,000. This compared to an income of €639,000 for last year’s period that reflected a positive movement of our deferred tax liabilities. Net loss for the second quarter of 2017 was €955,000 compared to €436,000 for last year’s period. The small increase in net loss includes, besides the operational and financial variances, the fluctuation of €830,000 in income tax. Now please turn to Slide 12 for a recap of balance sheet and cash flow highlights. Our balance sheet remains strong, with debt accounting for 26% of total liabilities and equity at quarter-end. Capital expenditures amounted to €9.2 million compared to €5.8 million in last year’s period, and includes €5.7 million related to the completion of our new premises in Poland and Belgium, and €2.3 million related to new equipment. Almost all capital expenditures have been financed externally. We ended the quarter with cash and cash equivalents of almost €54 million compared to €55.9 million at the end of last year. Cash flow from operating activities in the first six months 2017 was €5.2 million compared to €5.8 million for the same period in 2016. During the first half-year 2017, the operating activities generated €5.7 million of cash flow, slightly offset by an increase of working capital of €500,000. In the same period last year, the operating activities only generated €2.2 million, while the working capital at that moment -- this improvement accounted for €3.5 million of the cash flow. Total deferred revenue from annual software sales and maintenance contracts amounted to €17.2 million as of June 30th, 2017 compared to €16.8 million at the end of last year. With that overview, I’ll turn the call back to Peter.

Thank you, Johan. Please turn to Slide 13. We are reaffirming our fiscal 2017 guidance, which calls for consolidated revenue between €128 million and €134 million, adjusted EBITDA between €10.5 million and €13.5 million, and an increase of deferred revenue from annual licenses and maintenance by an amount between €4 million and €5 million compared to 2016. Based on our strong performance in the first half of 2017, we currently expect that revenue and adjusted EBITDA will be closer to the high end of the ranges. While we had initially anticipated a much stronger performance in the second half of 2017 as compared to the first half of the year, we now expect that the better performance of the second half of the year, as compared to the first two quarters, will be less outspoken. Each of our segments actually has performed very well in the first half of 2017, and did even better than we had anticipated. We are obviously very much encouraged by these results, but prefer to build some caution into our outlook for the rest of the year for a number of reasons. Firstly, while the market for 3D printing is performing better this year than it did last year, we believe that, as Fried explained earlier, the majority of the players that are considering the technology, particularly for the production of end parts, are still in a fairly early stage of the adoption cycle. In other words, we will not be able to simply ride the waves of a strong market growth in the near future. Our sales teams will have to fight for every inch of growth, just like they have done in the recent past. Second, as Johan mentioned, we are in the process of moving parts of our production to our new facilities in Belgium and Poland. While our teams are working hard and smart to minimize the impact of the move, we believe it is prudent to factor in some temporary down side consequences of the move on both our top line and our cost of sales in the second half of the year. In summary, we are very pleased with our results in the first half of 2017. We are confident and positive with respect to our outlook for the rest of the year, but we see no reasons to become overly optimistic on the short term. This concludes our prepared remarks. Operator, we are now ready to open the call to questions.

[Operator Instructions] We have a question from the line of Troy Jensen of Piper Jaffray. Your line is open.

I’ve got a few questions here. I guess I want to start with software. I was wondering if you guys could provide what the OEM partnership contribution is within that segment, and maybe how that’s ramped over the past couple quarters?

The OEM sales rose 26% compared to last year. And the OEM portion is approximately 30%.

30% of software?

Yes.

Can you talk just quickly, since Siemens is ramping, I’m assuming that’s hitting that line. Can you talk about the HP partnership and what else could kind of be driving this segment for you guys?

Well, the Siemens partnership recorded its first revenues, but this is a new one. Its impact on the overall number is still very limited. It just refers to the successes that have been registered. The existing partnerships that we have around our build process is mainly with many of the metal printed manufacturers remain the bulk of these kind of revenues. Now, you also asked with respect to HP.

They’re also -- that is, there’s not much of the good growth of our OEM sales that is attributable to the collaboration with HP. So in other words, the Siemens contract and the HP collaboration haven’t contributed significantly to the current good performance of our OEM sales.

[Indiscernible] HP just launched kind of mid-Q2, so you’ve only got kind of a half a quarter impact. Do you think either one of these could start to be material for you guys?

Well, that is what we are hoping for. Both companies have large market shares, and have the potential to attract a new generation of customers, and to, as I think we all hope, that they have impact on the entire sector, we hope that this definitely comes for in the Materialise software, as well.

Then shifting to the healthcare business, that’s actually had nice recovery here. I think what you guys need to highlight here is just customer concentration within this segment. If you go back, Biomet Zimmer used to be a huge percentage of your healthcare business, and I think the underlying business has grown rapidly, but we couldn’t see that because Biomet Zimmer was diluting down. So I guess I’d be curious to know how big is Biomet Zimmer now in your healthcare business versus where it was a year or two ago.

Well, as you know, you may remember, Troy, we were at -- two years ago with the situation that Biomet Zimmer represented more than 70% of the overall medical segment business. Today this has dropped below 50% of the OEM sales. And that means ...

Something less than 40% of the total sales in the medical segment.

Yes, so from 7-0 to 4-0, and that means that other partnerships, like the DePuy Synthes partnership, and other partnerships that we have in place are really starting to account for more than 50% of our partnership sales within the medical segment.

I just want to slightly adjust, the 40% I mentioned is 40% of the medical sales, excluding software, so it’s ...

Devices.

The gross margins did down-tick sequentially, and to me it’s obviously coming from the manufacturing strength. Just curious, is it just a blend issue that kind of drove gross margins down, or it has to do a lot with this capacity expansion that’s not getting fully absorbed yet?

Yes, it’s a combination of the two. Troy, you pointed out well. The blend issue obviously plays a role. As manufacturing has been growing significantly over the last few quarters, blend has shifted a bit more in the direction of manufacturing, which obviously is less beneficial for our gross margin. And secondly, within manufacturing, as we pointed out earlier, yes, we are in the midst of moving to new facilities in two jurisdictions. And temporarily, that has a not-good impact on the gross margins. But we believe that is temporary, and that is something that we should be able to address in the quarters to come as the move will have been absorbed by the respective teams.

Especially as it coincided also with a quarter in which we had a very high growth, and even focus more into Poland, where we had an increase if you compare it to last year’s period of more than 50% of increase in activity. So the combination of both has led to this temporary sub-optimal situation of production efficiency.

[Operator Instructions]. And our next question comes from the line of Julian Mitchell of Credit Suisse. Your line is open.

This is actually Jason Makishi on for Julian. Just really quickly, one of the reasons that you called out sort of a -- wanted to keep a lid on expectations for the full fiscal year was that the majority of the players in the technology, particularly on the end part side, are still in the early stages. I guess if you could provide any visibility as to when -- is this like a 12 to 18 month time horizon that they transition into a less preliminary part of this cycle -- and then maybe attribute growth acceleration that you could see when they do transition out of these early stages? That’d be great if you could just give a little bit more color on that.

Well, actually, it’s hard to give an absolute answer to this as the product development cycles in different industries can be very different. For instance, for aerospace industry, they have been working already quite a while on several products, and it really takes them years to get new materials approved, and then, once a material and a process are approved, to start defining components. So we see the first components now appearing on the market, but their real ramp-up is still a factor of a few years, I would say. And actually, in medical, we are confronted to a large extent with a bit similar situation, well, it was already taking a serious amount of time to get, for instance, our surgical guides, which are medical instruments, approved at FDA. For 3D printed implants, it’s even longer time periods. And you talk about several years to get those kinds of approvals. Now, there are industry segments where the adoption can go faster. For instance, an often underestimated segment for additive manufacturing is components for industrial machines. And there we see that the time to market can be quicker, and that, within one year for some of those companies, you see that they are starting with more and more series of parts that go into the industrial machines. Unfortunately, here we talk about relatively smaller companies and relatively smaller series than when we talk about aerospace or medical.

As a quick follow-up question, where would you see a lot of -- if there were to be a moderation in growth particularly in the manufacturing segment, where you guys have sort of reported very strong numbers thus far in the half, what would be sort of the most likely factors contributing to a moderation sequentially maybe into Q3, if not all the way throughout the year?

Well, in Q3, we have the particular effect that, while we started our move, which has to happen gradually because we cannot shut down our operations completely, that the bulk of our move is actually happening in the third quarter. So we have there a capacity issue, let’s say, to make sure that we service our customers with the right speed and the right quality. That is on short notice why we have to be careful. But on the somewhat longer-term, it’s especially the market trend, as Peter was explaining, and as we discussed before.

Thank you. And at this time, I’m showing no further questions. I’d like to turn the conference back over to Mr. Peter Leys for any closing remarks.

Okay. Thank you Operator, and thank you all for attending our call, and probably interrupting some of your holidays for the sake of our call. We are currently planning to attend an investor conference in New York in early September, and hope to meet some of you at that time. Thank you all for your interest, and we look forward to continuing the dialogue with you. Good-bye.

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may now disconnect. Everybody have a great day.