Materialise NV Q2 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the Q2 2023 Materialise Financial Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Harriet Fried of LHA. Please go ahead.

Thank you everyone for joining us today 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 Koen Berges, 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 second quarter of 2023. To access the slides, if you haven’t 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 today can also be found on that page. Before we get started, 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, 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 date. 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 call. A reconciliation table is contained in the earnings release and also at the end of the slide presentation. With that, I’d like to turn the call over to Peter Leys. Go ahead please, Peter.

Thank you, Harriet, and thank you everyone for joining us today. You can find the agenda for our call on Slide 3. As a first item on our agenda, I will summarize the highlights of our financial results for the second quarter of this year, and then I will pass the floor to Fried, who will discuss our investments and a new facility for medical mass customization production in the U.S. After that, Koen will walk you through our second quarter numbers in more detail. As you may recall, I couldn't assume the position of our Chief Financial Officer in May of this year. And we've already experienced that he does bring a lot of valuable experience to the role, and as you will notice, he has gotten off to a very quick start. Finally, I will come back to give you some observations about what we currently believe the rest of the year may bring. And as always, after we have completed our prepared remarks, we will be happy to respond to any questions that you may have. So, let's turn to Slide 4, which summarizes the highlights of our financial results. Our operational performance during the second quarter was very much in line with our very solid performance in the previous quarter. In the second quarter of 2023, we recorded €64.8 million in revenues, representing a growth of almost 12% compared to last year's period. Our adjusted EBITDA for the quarter, which was impacted negatively by the unexpected adverse resolution of an arbitration proceeding for a total amount of €5.2 million, amounted to €4.8 million, which is still a 12% growth compared to last year's period. In the absence of this one-time adverse event, our current EBITDA margin of 7.3% would have been 15.3%. As a result of this unexpected event, our net results turned negative to €0.5 million, or minus €0.01 per share for the period. And with that, I would like to pass the floor to Fried.

Thank you, Peter. Good morning or good afternoon to all of you listening to this call. After the tailwinds that we discussed a quarter ago in our medical business, we faced a serious headwind in Q2 '23 at the EBITDA level. But fundamentally, we confirmed the robustness of our profitable growth in medical devices and software during this quarter. In essence, the medical segment performed at the level of revenue and operational profitability, even stronger in Q2 than in Q1, where we talked about the tailwinds. If we want to ensure profitable growth in the longer term, we need to invest wisely in our medical activities. In the important U.S. market, personalized implants are the major growth driver. Until now, Materialise manufactured titanium cranio-maxillofacial (CMF) implants solely at our 3D printing facility in Belgium. This will change when our new production line becomes operational this summer. The new facility will not only provide capacity for vertical growth, but it will also improve our service offerings strategically in the United States. With the opening of this 3D printing line, Materialise will accelerate the delivery of patient-specific medical implants to patients in the United States. Surgeons are increasingly embracing 3D printing solutions as they recognize the added value these solutions bring to personalized patient care, including more predictable and accurate surgical outcomes and time savings during surgery. The new production line in our printing facility specializes in the 3D printing of personalized titanium CMF implants for the reconstruction of bone segments. CMF implants are used for facial reconstructive surgery, facial asymmetry resolution, correction of facial deformities, as well as general affirmation surgery. With a dedicated 3D printing facility in the U.S., we can respond to surgeons' needs with greater reliability while significantly reducing the delivery time of fully personalized implants to less than a week for U.S. patients. This expansion of capabilities complements Materialise's existing production of 3D printed surgical guides and models that have existed already in the United States. It also expands our collaboration with the healthcare sector and Johnson and Johnson for the delivery of patient-specific instruments and CMF implants. Currently, Materialise produces 280,000 personalized 3D printed tubes and implants per year, of which under 60,000 are for the U.S. market. The advent of technologies such as 3D printing and advanced visualization techniques has transformed personalized patient care. Patient-specific 3D printed medical solutions include surgical guides to enhance accuracy and efficiency and anatomical models for surgical planning. And finally, the reconstructive implants themselves. These solutions are designed with the surgeon's comfort before and during surgery, leading to more predictable and accurate surgical outcomes. As a result, surgeons increasingly adopt 3D printing as part of their medical practices to bring personalized care closer to patients while reducing overall costs for the healthcare system. Materialise has more than three decades of experience in developing FDA-approved medical solutions. We offer a comprehensive range of medical visualization and surgical planning software solutions. 3D printed guides and implants are additional components to our solution that empower researchers, engineers, and clinicians to revolutionize innovation in patient care. Thirty years ago, surgical solutions were highly standardized. Patient-specific solutions were very rare for unfortunate patients that had no alternatives. To the medical device industry, it was highly unprofitable to deliver personalized implant solutions, and as a consequence, it was only done in a compassionate care context. Materialise has pioneered numerous groundbreaking medical 3D planning and printing applications, and we continue to do so with our ever-increasing research and development efforts. We have built a leading position by changing the mindset. Now, patient-specific surgical solutions can be delivered in a cost-effective and economically viable way by the healthcare industry. Custom surgical solutions are still very valuable for unfortunate patients with rare complex situations, often overcoming the limits of current standard treatments. For instance, in 2021, Materialise's innovative 3D planning and printing tools played a pivotal role in the world's first simultaneous double hand and face transplant that was successfully performed at NYU Langone Health in New York City. But today, personalized implant solutions are also important for more patients who suffer from more frequent diseases or accidents. Thanks to mass customization, more people can benefit from the first-time right approach and better-quality solutions in a cost-effective way that enhances the quality of our healthcare systems. In 2017, we introduced one of the first personalized CMF implant portfolios in the United States. This is an opportunity for the healthcare industry and for Materialise in particular. With the opening of our new 3D printing facility in the U.S., we bring personalized care closer to U.S. patients. And at the same time, thanks to our software offerings, we bring the concepts and building blocks of mass customization also closer to the U.S. healthcare industry. The printing facility acts as the regional headquarters for our medical and industrial software solutions in the U.S. Thanks to the expanded facility, we are now able to demonstrate even better than before how all of our tools operate in the patient-specific context for real product development and for real 3D printing production lines, and on top of that, in a certified environment. Let me pass the call to Koen.

Thank you, Fried, and good afternoon or good morning to you all. I'll begin with a brief review of our consolidated revenue on Slide 6. Please note that unless stated otherwise, all comparisons in this call are against our results for the second quarter of 2022. Revenue increased by almost 12% to €64.8 million. The growth took place in all three of our business segments. Our software segment grew by 3.6%, our medical segment by 19.6%, and manufacturing revenue increased by 8.5%. The amount of deferred revenues from software, licensing, and maintenance fees on our balance sheet amounted to €41.7 million at the end of June '23, compared to €42.8 million at the end of last year. Over the second quarter of 2023, Materialise's software accounted for 17% of our total revenue. Materialise medical for 38%, and Materialise manufacturing for 45%. Cross-segment revenue from software products represented 29% of our total revenue. Moving on to Slide 7, you will see that our consolidated adjusted EBITDA grew to €4.8 million compared to €4.3 million for the same period last year, representing an increase of more than 12%. This represents an adjusted EBITDA margin of 7.3%. The increase in adjusted EBITDA follows our top-line growth while we continued investing in R&D, which is key to Materialise's further developments. Importantly, as Peter already mentioned, our adjusted EBITDA includes the negative impact resulting from the unexpected adverse resolution of an arbitration proceeding for €5.2 million in May of this year. Excluding this one-time event, the adjusted EBITDA margin for Q2 would have been 15.3%. Slide 8 summarizes the results of our Materialise software segments. Software revenue increased by 3.6% to €11 million, driven by an increase of 7% in our recurring revenue from maintenance contracts and renewals, including our CO-AM subscription fees. Revenue from non-recurring sales, on the other hand, decreased by 2.8%, reflecting our gradual transition to a recurring business model. Adjusted EBITDA for the second quarter increased from €4.8 million last year to almost €2 million this year, representing an improved adjusted EBITDA margin of 17.9%. Moving now to Slide 9, you'll see that our medical business continues to grow at a solid double-digit pace of around 20%, both from software and medical devices solutions. Software revenue grew by 26%, while our medical devices business expanded across most of its business lines by an aggregate of 17%. Because of the unexpected adverse resolution of an arbitration proceeding related to our customized joint business for an amount of €5.2 million this quarter, the adjusted EBITDA of our medical segment decreased to €2.7 million from €4.5 million. This is also reflected in the adjusted EBITDA margin, which dropped to 10.8%. Nevertheless, excluding the negative impact of this one-time event, medical's adjusted EBITDA margin would have grown to 31.6% this quarter. Now let us turn to Slide 10 for an overview of the Q2 performance of our Materialise manufacturing segments. Manufacturing revenue grew 8.5% to €28.8 million, boosted by our core manufacturing business lines in ACTech. Adjusted EBITDA for the quarter ended at €2.7 million compared to €1.6 million for the same period last year, representing an improved adjusted EBITDA margin of 9.4%. This result includes continued investments in our Motion and Eyewear business lines and temporary higher subcontracting expenses while we wait for the start of the new ACTech production facility planned for 2024. Slide 9 provides the highlights of our income statement for the second quarter. Gross profit margin grew to 57.2% compared to 55.2% in Q2 of last year. Despite continued inflationary pressure, cost control helped us bring our operating expenses down by 1.3% compared to the prior year period to an aggregate of €33.2 million. While sales and marketing and general and administrative expenses decreased respectively by 5% and 2%, we increased our R&D expenditures by 6%. Net operating income amounted to a negative €4.5 million and includes the negative impacts of the earlier mentioned unexpected adverse resolution of an arbitration proceeding for €5.2 million. As a result of these elements, the group's operating results were negative by €597,000, compared to a negative operating result of €1,084,000 last year. The net financial income for Q2 was €635,000 and included growing interest income from our cash deposits of around €1.1 million. Net loss for the quarter was at €494,000 or €0.1 per share compared to a net profit of €896,000 last year. Now, please turn to Slide 12 for a recap of the balance sheet and cash flow highlights. At the end of the second quarter of 2023, our balance sheet remains strong. Cash amounted to €136.3 million, while our borrowings position further decreased to €72.4 million, resulting in a net cash position at the end of the second quarter of €63.9 million. Cash flow from operating activities for the second quarter was €775,000. Our operating cash flow consisted of income statement components of €5 million, while our working capital increased by €4.2 million. Capital expenditures for the quarter amounted to €2.1 million and were not externally financed. And with that, I'd like to hand the call back to Peter.

Thank you, Koen. At the beginning of 2023, we said we expected our full year revenues to be between €255 million and €260 million. After our solid results in the first half of the year, we believe we are well on track to post full year revenues close to the high end of the average. When we reported roughly three months ago our first quarter results in April, we increased the expected range of our year-end EBITDA by 10% to an amount between €28 and €33 million. Today, our strong operational results of the first half of the year allow us to maintain our EBITDA guidance despite the €5.2 million adverse arbitration award that we did not expect at the time of our previous call. And with this outlook, I would like to conclude our prepared remarks. So, operator, please go ahead and open the call to any questions.

Thank you. Please go ahead and ask your questions. Our first question comes from Troy Jensen of Lake Street Capital Markets. Please continue.

Hi, Johan. Congrats on nice Q2 results here.

Thank you, Troy.

So first, I guess I want to focus on just some of the profit margin stuff here. I mean, 15.3% adjusted EBITDA is at that near, is that record, recent record levels for profitability for you guys?

Yes. Definitely on the high-end, we had previous quarters that were a little bit better, like the first quarter but, it's definitely among the better performances.

And obviously a lot of strength, and gross margins. So, I guess, question would be on the lines of second half expectations for gross margins, can we stay above this 57% level and then also on EBITDA, adjusted EBITDA? I mean, do you guys think you can run it 15% plus year in the second half?

Well, typically we have some seasonality and the third quarter has been proven consistently a little bit worse in previous years, but yes. Then you also know that the fourth quarter is normally our best quarter. So, over the second half of the year it will be approximately consistent, but with the differentiation between the two quarters.

Great. And congrats guys on this profitability level. I mean, excluding that €0.9 hit, you guys did really well here in Q2, but, other questions I want to hit, I guess on the medical side for you, Fried, CMF, is most of your business titanium and just your thoughts about peak versus titanium in CMF applications?

Well, indeed titanium implants are the major growth driver, although we still have a very considerable part of the cases we support that are done with just the guides and models as well. So, it's not always that the surgeons opt for patient-specific implants and patient-specific guides and patient-specific planning also contribute to still a majority of surgeries where no patient-specific implants are used. Some of those can indeed be with peak implants as well. In our experience, it's still a minority, and we believe that titanium is very competitive.

And even if peak grows, you guys can obviously make peak based CMF parts?

At this moment, we only strongly believe in the added value of titanium.

I see. Okay. All right. That's interesting. I'll switch gears here. I know I'm asking a lot, but, just the 3D software business seems like you guys are doing a great job here and medical and manufacturing 3D was down sequentially. I think deferred revenue dropped a little bit sequentially. So, can you just talk about what's going on competitively and link integration or link 3D integration and just when you think we're going to start to get better growth out of the software business?

We face, for our software, a challenging investment climate at the moment. And as far as we can judge, this is not only for us; it is even beyond the pure additive manufacturing related software industry. Software in general is facing a difficult investment climate at this very moment. But that doesn't mean that we don't have also some internal transitions that are taking place from our previous model where we sold perpetual licenses to annual licenses and subscription models, which is a transition that for medical software has been ongoing already for five years, and that we more recently intensified for the industrial software business. So, that is also impacting our revenue growth because perpetual licenses allow for immediate revenue recognition, while annual licenses are recognized over time in a recurring revenue model. On the other hand, we have that transition from engineering tools with added value to the growth that is also coming from AM, which is a more companywide, or at least AM facility-wide investment that is much more strategic. We want to, but we also experience that those investments are not being made lightly, especially at this moment in the current investment climate, and that is challenging. Of course, we also have to deliver those software and that is also taking longer than delivering an engineering product. So, the combination of all of these factors currently seriously weighs on the growth of the software business.

Got it. Alright, you guys will keep up the good work and get back on track.

Thank you very much, Troy.

Our next question comes from Alex Craeymeersch of Kepler Cheuvreux. Please go ahead.

Hi, good morning. Maybe a first question to the new CFO, Koen. I'm just wondering how you're settling into your position and what are your main priorities at the moment?

Thank you, Alexander. It's been a very interesting journey so far for me. I've had a chance in the last two months to meet a lot of people in the business, both in finance and also outside finance, trying to understand the business that we're in and then all the strengths and weaknesses that can be found there. For me, I think it's been very interesting to learn all of these. For me, the key priorities are to continue delivering purely financially good processes and financial results. That is a process I think that works quite well. I think the challenge for us is, like Fried already indicated, to continue that journey towards even more recurring revenues, especially in our software business, and we're taking further steps also to help support that from a finance point of view.

Yes, thank you. And maybe if I can just elaborate on that recurring revenue side. I saw that the order book deferred revenue has actually decreased versus Q1. Maybe this is normal, but I'm just wondering what the exact reason for that is, if you could explain that please.

It is indeed correct, Alexander, that we saw a temporary decrease in our deferred revenue that we carry on the balance sheet. That is also partly due to timing effects, and we noticed that, for instance, last year we still sold quite a few multi-annual licenses in the second quarter. And of course, the differences from annual licenses mean that they won't come up for renewal one year later. So, that is a trend we are of course monitoring, but that temporarily impacts our deferred revenue in the second quarter indeed.

Thank you for that. And then on manufacturing, very interesting to see the ACTech finally coming up. Just two questions on that. So, one, what would now be the obstacles for you and your clients to make the manufacturing side more attractive? And that your capacity is actually more filled, so also the margins can get a bit higher?

Yes. Particularly in relation to ACTech, we currently face capacity issues. This amount is really higher than what we can deliver. Yes, ACTech is active in the market where cost and delivery times are significant for the kind of industries and automotive industries they are supplying. So, that is why we believe we have serious growth potential on the one hand. Secondly, why it is expensive to subcontract is because we have to ask our subcontractors to deliver very complex and large components on very short notice. And of course, we also ask some premium prices for this. I cannot provide a very clear indication of how much that difference is simply cost, but we are confident that we can increase our EBITDA margin further by a few percentage points if we can produce in-house.

But maybe to ask if, what's the goal there in terms of percentage points or at least EBITDA margins for the future?

Like I said, it is really difficult to give an accurate estimate. So, I prefer not to provide a clear indication at this moment because I simply cannot.

Hey thank you. And maybe as a final question, I mean, now that we're going into the second half, we are already almost at the end of July. What's your visibility typically at the midpoint of the year towards the second half? And how does that visibility lead you to project your guidance at the moment considering that the last guidance was actually a bit conservative given the €5 million impact?

Yes, but luckily it was sufficiently conservative to completely compensate for that quite significant effect that we experienced with the medication outcome. Now there is a difference; I must admit, when you asked me the same question last quarter, I could say that while there were in the market quite some rumors, not just rumors, but companies that announced they were experiencing some downturn in the economic environment, we were very positive and did not see any of it in our quotation levels and in the way the market was demanding services. I must say at this moment that we see a decline in quotation requests. The effect on our output is still limited, but we must admit that the economic climate for us in particular is a bit more negative than it was a quarter ago. So, maybe it has to do with the summer holiday period. But anyhow, it is worse than a quarter ago.

Okay, thank you very much. And again, congratulations on the financial results.

Thank you.

This concludes today's conference call. Thank you for participating, and you may now disconnect.