Materialise NV Q2 FY2020 Earnings Call

Good morning ladies and gentlemen, and welcome to the Second Quarter 2020 Materialise Financial Results Conference Call. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Ms. Harriet Fried. Please go ahead.

Good morning. Thank you for joining us for Materialise's quarterly conference call. With us on the call are Fried Vancraen, Founder and Chief Executive Officer of Materialise; 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 performance for the second quarter of 2020. To access the slides, please go to the Investor Relations section of the company's website. The earnings release that was issued earlier today 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 the expectations expressed. 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 company’s most recent Annual Report on Form 20-F filed with the SEC. 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. Peter?

Thank you, Harriet, and thank you everyone for joining us today. You will find an agenda of our call on slide number three. I will begin with a brief recap of our results for the quarter. Then as usual, Fried will give you an overview of some of the new products and projects that we have launched during and in spite of these challenging times. After that, Johan will go through our second quarter numbers in more detail. And finally, I will come back to give you some qualitative insights into what we believe the third quarter of this year may bring. When we have completed our prepared remarks, we will be happy to respond to any questions that you may have. So turning to slide four, you will see the highlights of our second quarter results. In the second quarter of 2020, all of our business units worldwide were significantly impacted by the corona crisis. Our revenue decreased €10.3 million to €38.1 million while adjusted EBITDA declined €1.7 million to €3.4 million. Cash flow from operating activities for the second quarter of 2020 was a strong €7 million compared to €4.7 million for the same period in 2019. At the end of the second quarter of 2020, we have cash and cash equivalents on our balance sheet for a total amount of €125.5 million, with short-term debt as of June 30th of this year of €17.8 million only, and that for a total gross debt of €121.5 million. With those key numbers, I would now like to turn the call over to Fried. Fried?

Good morning and good afternoon everyone. Thank you for joining us today. In the last days of Q2 2020, Materialise celebrated its 30th anniversary in a quarter where we faced the most difficult economic conditions in our history. Even though the celebrations were very sober and mostly consisted of online meetings, we are really proud of our colleagues' achievements in such a difficult quarter both with respect to the output they created and the savings they achieved. As mentioned in our last call on April 30th, despite being largely in lockdown, we delivered multiple COVID-19 initiatives. Starting with preventative devices such as door openers that were printed in several tens of thousands by Materialise, and of which the files were downloaded over 100,000 times from our own service alone by 3D printer users all around the world. Even more importantly, we can claim that the non-invasive passive PEEP masks that our engineering team in medical developed for those who are failing to breathe because of the virus have been saving lives in multiple COVID-19 hotspots around the world. Ranging from Guayaquil in Ecuador, Leuven in Belgium to Chernivtsi in Ukraine, these masks have proven to be very efficient in increasing oxygen saturation levels of critical patients without ventilators that consume a lot of oxygen and by minimizing virus exposure to healthcare workers. Their use is currently increasing particularly as the virus keeps on spreading in countries with less developed healthcare systems. In addition to these exceptional projects in the COVID-19 context, our regular R&D efforts have continued. As we stated in our previous call and as our consistent R&D spending improves, we have released a new version of Mimics Innovation Suite with the version Mimics 23. This version is the first software tool in the world that supports the new DICOM encapsulated STL standards, the international standard for transmitting, storing, printing and displaying medical imaging information that is now extended to 3D models. Mimics 23 contains many features to enhance the integration of 3D printed models in hospital, medical imaging and logistical workflows. It also supports improved scripting, including features that enable easier production of medical models that consist of many separate parts. This particular development was built on an initial request from Mayo Clinic, which we were able to resolve with scripting. After some presentations by Mayo collaborators at conferences, many other hospitals expressed their interest in this functionality. In less than a year, we were able to make it part of the regulatory approved Mimics 23 version. This example illustrates, as we announced a year ago, our scripting offers lean product development opportunities for our medical innovations. For a more complete list of new Mimics 23 features, you can have a look at the Materialise Medical website. With Mimics 23, we also launched in parallel, a beta program for artificial intelligence-based segmentations of heart, knee, and skull, thus ensuring the preparation for our next great release. On top of that, we also launched Mimics Enlight 2.0, which offers a patented and automated planning workflow for transcatheter mitral valve replacement. TMVR, in short, is a procedure that is expected to lead to a multibillion-dollar medical device market as mitral valves from multiple manufacturers have come or are coming out of the regulatory pathway. Our Medical Device activities for elective surgeries in craniomaxillofacial and orthopedic applications came close to a complete stop by the end of April, due to the COVID-19 situation in most U.S. and European hospitals. But they have strongly rebounded in June when elective cases became possible again. While COVID-19 has created a dip in our medical activity in Q2, it has fundamentally increased the interest of hospitals in point-of-care 3D printing. Many hospitals have utilized the 3D printing facilities during the pandemic in order to support their internal supply. Materialise Medical is well positioned to take advantage of this increased interest in the following years. In this context, I also want to draw your attention to the launch of our Mindware program by Materialise Manufacturing and Software in Q2. 3D printing has not only gained a lot of attention in the medical sector but also in many other sectors beyond medical due to the supply chain crisis. We believe that additive manufacturing can be a tool for many companies to help them get out of the crisis situation in the coming quarters or years. However, many companies require not only the software and hardware to make meaningful applications with additive manufacturing in their particular business context, but they also need the mindset and knowledge to use additive manufacturing sustainably. This is where the additive manufacturing intelligence that Materialise has built over 30 years may come to the rescue. Our Mindware consultants and design engineers aim to offer a structured approach to co-create a future out of this crisis with our customers. And let me now pass the call to Johan.

Thank you, Fried. I'll begin with a brief review of our consolidated revenue on slide 7. As a reminder, when we refer to sales in our presentation we mean revenues plus deferred revenues. Also, please note that unless otherwise stated, all comparisons in this call are against our results for the second quarter of 2019. As Peter mentioned in his opening remarks, this year's first quarter saw revenue decrease by 21.3%. COVID-19 impacted all segments, although, our software segment still recorded a 2% growth as a result of deferred revenue usage. For the quarter, Materialise Software accounted for 25% of our total revenue, Materialise Medical for 31%, and Materialise Manufacturing for 44%. Cross-segment revenue from software products increased 9 percentage points to 31% of our total revenue due to single-digit growth in both software and medical software business lines. However, revenue from the manufacturing and Medical Device business lines decreased 31% in the aggregate. Moving to slide 8, you'll see our consolidated adjusted EBITDA numbers for the second quarter. Consolidated adjusted EBITDA amounted to €3,382,000 compared to €5,059,000. This €1.7 million decrease should be seen in the context of our revenue quarter decline of €10.3 million. Besides the effect of reduced variable cost of sales, many cost-saving initiatives we implemented had a substantial impact on maintaining our EBITDA margin at 8.9% compared to 10.5% last year. Slide nine summarizes the results of our Materialise software segment. Revenue grew by 2.4%, benefiting from a positive deferred income usage variance effect of €1.8 million compared to last year. Sales decreased by 15%. Non-recurrent sales decreased by 25% and recurrent sales decreased by 5%, both affected by a strong decline of new license sales in both OEM and direct sales. The EBITDA increased by €1.7 million to €3,756,000 and the EBITDA margin rose to 39.4%. In fact, revenue increased by 2% including the effect of the usage of deferred revenue, while savings measures and operating expenses had a positive effect of €1.6 million. Moving now to slide 10, you will see that the total revenue in our Materialise Medical segment decreased by 19.3% for the quarter to €11.7 million. Revenue from Medical Device solutions decreased by 32%, 29% excluding Engimplan. The first two months of the quarter were hit especially hard. In June, however, Medical Device revenue, excluding Engimplan gradually picked up again. Revenue from Medical software sales grew by 7% and accounted for 43% of the segment revenue. Medical software sales were flat this quarter, as sales in June compensated for the 20% decrease of the quarter's first two months. As Fried indicated, the positive trend towards the end of the quarter reflects hospitals gradually beginning elective surgeries again. The EBITDA decreased to €1.1 million. Although the sharp revenue decline of €2.8 million impacted the EBITDA of our medical segment, our cost-saving measures mitigated this impact. Sales and marketing and G&A expenses were 29% lower than in the prior period. In line with our strategy, and as we discussed in more detail earlier, we continued to invest in our R&D programs in medical, where R&D expenses increased by 9%. As a result, the EBITDA margin decreased to just below 10%. Now, let's turn to slide 11 for an overview of the Q2 performance of our Materialise Manufacturing segment. Their revenue was down by almost 32% or €7.8 million. The ACTech business was the most affected by the crisis, but our other traditional business lines also declined, approximately 25%. COVID-19 negatively affected our automotive and aerospace markets, but also impacted our other sectors. Despite mitigating effects of lower variable expenditures and labor cost reduction efforts, gross profit was negatively affected due to the fixed cost of capacity. Savings measures resulted in a decrease of operating expenses of 25%. As a result, EBITDA decreased by €2.2 million to €650,000, while the EBITDA margin decreased to 3.9%. Slide 12 provides the highlights of our income statements for the second quarter. Revenue decreased by €10.3 million or 21.3%. Gross profit decreased by €6.5 million, or 25%. Gross profit was negatively affected by the cost of capacity in our manufacturing and medical device business lines. Consequently, the gross profit margin decreased by 2.4 percentage points to 52.4%. Our revenue fell 21%. Our sales and marketing and G&A spending decreased by 23% and 24% respectively. As a result of specific savings measures, our remuneration costs decreased by €4.6 million, and third-party operating expenses decreased by €2.5 million. As Fried mentioned, we continue to invest in our key development initiatives to position Materialise for future growth. Accordingly, R&D spending only decreased by 1%. Other operating expenses declined by €478,000 to almost €900,000, mainly due to less income from grants and R&D credits. Consequently, the group's operating result was negative €1,827,000 compared to a profit of €36,000 in last year's period. Net financial costs were negative €295,000 compared to a negative €190,000. Income fixed expenses amounted to an income of €191,000 compared to a cost of €61,000 in the second quarter of 2019. The net loss for the second quarter was €1,932,000 compared to a negative €297,000 for the same period in 2019. Now turning to slide 13 for a recap of balance sheet and cash flow highlights. In the second quarter, our balance sheet gained further strength. For the second time this year, our quarter-end net cash position increased by €1.5 million and amounted to €3.9 million on June 31 of this year. Cash amounted to €125.5 million, a decrease of €3.4 million compared to the end of December last year, but over the same period our borrowings position decreased by €6.4 million to €121.5 million. Equity decreased by €9.8 million to €132.8 million as a combined result of the net loss for the first half-year amounting to €4.8 million and the conversion differences on the equity values of affiliated companies amounting to a negative €5.2 million. Of this amount, €3.9 million reflects the effect of the weakened Brazilian real on Engimplan's equity acquisition. Capital expenditures for the quarter amounted to €3.4 million. Cash flow from operating activity for the quarter increased to €7.1 million from €4.8 million. This cash flow amount includes an improvement in working capital of €4.4 million. Total deferred revenue amounted to €33.1 million compared to €32.7 million at the end of 2019. Of the €33.1 million, €28.2 million were related to annual software sales and maintenance contracts versus €27.7 million at the end of last year. Before I turn the call back to Peter, I want to mention, as I did in our last earnings call, that in the context of COVID-19, we took several actions from an operational and financial perspective to guarantee efficient back office and supply chain continuity. Finally, we continue to closely monitor the COVID-19 impact on our businesses in order to plan timely and improving measures to align costs and expenditures, ensuring that our balance sheet remains healthy and strong, and to have a solid platform for future growth after the crisis.

Thank you, Johan. As I indicated earlier, before giving the floor to you for questions, we want to provide some qualitative insights about what we believe the third quarter of 2020 may bring. As you know, certain regions in the world, particularly the Americas, are still in the midst of the first wave of the corona pandemic. In other regions, including certain parts of Asia and Europe, there are threats of a second wave. As a result, there is much economic uncertainty about how long this crisis will effectively last. This uncertainty implies that people do not only freeze budgets for normal course of business investments, but also that they delay investments in innovative supply chain solutions that are necessary to address the new post-corona normal. For Materialise, we currently expect that this prolonged uncertainty will translate into a slower than previously expected pickup of our software and manufacturing sales. In fact, for both units, we anticipate that the third quarter will be more difficult than the second quarter. On the other hand, we currently see that our medical business is rebounding reasonably well as soon as and as long as hospitals and surgeons can reorient some of their attention to the elective surgeries that we support. So based on what we know and see today, we expect a gradual, albeit potentially not sustainable, recovery of our medical business already in the third quarter. Our visibility beyond the third quarter remains fairly limited; so in response to this unclear and uncertain outlook, we intend to continue to manage our cost structure in a balanced way. This means that we will not cut costs as much as possible but as much as necessary. We believe that Materialise remains very well positioned to support many of the digitized, localized, and personalized solutions expected to thrive in the post-corona era. It is therefore crucial that we maintain our software and hardware infrastructure and that we retain the right talent to address market needs as soon as the crisis gives way to the new normal. Thus, while we will continue to monitor our costs, we expect our short-term Q3 EBITDA will be heavily impacted and will indeed be lower than the EBITDA we reported for the second quarter of this year. This concludes our prepared remarks. Operator, you may now open the floor for questions.

Your first question comes from Jason Celino at KeyBanc. Please go ahead.

Good to hear from everybody.

Hey, Jason.

Based on your qualitative commentary, it sounds like you expect Q3 to be even more impacted. Are you suggesting that Q2 is not the trough in growth in trends we're seeing?

Yes, we clearly indicated that the industrial sectors are still suffering very heavily at this moment, especially in Europe under the economic consequences of the corona crisis. During Q2, we had a few elements that worked in our favor. For instance, we had some work in process to finish that we could invoice during Q2. Our pipeline is now emptier than it was at the beginning of April. Another beneficial effect that we experienced, as we mentioned in our presentation, is the effect of the deferred software sales that we benefited from in the second quarter, which will be less pronounced in the third quarter. We anticipate that we might see a better September month, but especially in Europe, we see that a lot of companies are maximizing their holiday period at this moment and that there is really very little business.

Okay. Thank you. And more of a broader question. I know things are quite impacted right now, but we've been hearing a lot of traditional companies in automotive, aerospace, and other industries accelerate digital initiatives. How do you think Materialise plays into that type of trend?

As we expressed, we really see some opportunities for Materialise in this context. Although at this moment, people are setting up their plans, and these plans are not yet converted into investments. Given the difficult economic situation, they are being cautious with their budgets. However, we expect that this situation may alter as we slowly climb out of the crisis.

Great. Thank you. Appreciate the questions.

Thank you, Jason.

Your next question comes from the line of Gregory Ramirez from Bryan Garnier. Your line is open.

Hi. Yes, good afternoon, and thank you for taking our questions. My first question is about the medical division. You mentioned that elective surgeries are recovering gradually. Should we assume that the medical device business is starting to grow again in June and July? If current conditions persist, when do you anticipate growth will return to double-digit or mid-teens levels as it was before the crisis? My second question concerns cost management. You've done well in that area. Have you altered your approach to managing costs? In April, you implemented some salary adjustments. Are those still in effect? Are you planning to restructure the business given the current market circumstances? Are the production teams still working in shifts? Could you provide more details on that? Thank you.

Gregory, thank you for those questions. On medical, as Johan and Fried both indicated during the prepared remarks, while the business came to a halt in April, we saw a good rebound already in June. We currently have good hopes that this rebound will continue throughout the coming months and hopefully the next quarters. However, it's extremely difficult to say this with a high degree of confidence because nobody knows how situations will evolve. Hospitals and surgeons do not know to what extent they will effectively be able to free up hospital beds for those elective surgeries, and they always need to be prepared to switch back to a crisis mode for COVID-19 patients. In theory, if the crisis were to subside sustainably, we could probably be more confident that Q4 will again be a strong quarter for medical, particularly elective surgeries. But on a global level, especially for Europe and the U.S., predicting this is quite challenging. We really need to monitor the health situation month by month as the status in hospitals directly impacts our medical business rebound. So while we maintain more confidence in the medical business than in the other two businesses, industrial and software industries may be slower to pick up investment rates and innovation programs.

If I may then answer the second part of your question on the cost side. As we indicated, with support from our people, we have managed drastic cost-cutting, including on remuneration during Q2. Given that medical is close to operating at 100% currently, we will definitely not be able to maintain the same cost reductions during Q3. Additionally, in multiple countries, government support programs are either running out or being weakened. Therefore, it will be more challenging in Q3 to maintain the same cost levels. However, we believe that with the current level of orders, we will be able to work on a full force in medical, even though it may be more challenging for our industrial and software activities.

Thank you very much.

Thank you, Gregory.

I am showing no further questions at this time. I would now like to turn the conference back to Mr. Peter Leys. Please, go ahead.

Thank you, operator. And thank you all for joining us today. In closing, I'd like to emphasize, with a high degree of pride, that the morale here at Materialise remains really strong. Our people are committed, extremely engaged and inspired because they understand and see the longer-term potential of the solutions that we offer to the market and that we are developing for the near future. We may not have any trips or conferences scheduled at the moment to bring us physically closer to you. However, as we said last time, we are only a phone, Skype, Zoom, or Teams call away. So if you have any questions, please feel free to reach out. Thank you again for joining us, and enjoy the rest of the day. Goodbye.

Goodbye.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.