Desktop Metal: Mounting Liquidity Concerns

Desktop Metal's (NYSE:DM) focus on binder jetting could help the company benefit from production scale adoption of additive manufacturing in areas like the automotive industry. Growth has stalled in recent quarters though, and losses are an ongoing issue. Desktop Metal's balance sheet provides it with limited runway, making liquidity an important consideration for investors. This situation has probably contributed to Desktop Metal's desire to merge with Stratasys (SSYS), but Stratasys has been unable to obtain shareholder approval for the deal, despite the enthusiasm of its management team. Against this backdrop, Desktop Metal's valuation looks elevated relative to peers in the additive manufacturing space.

Market

Macro uncertainty has created a weak demand environment, but Desktop Metal has been encouraged by recent customer activity. Based on this, the company believes that it is in the early stages of a recovery and expects an uptick in orders going forward.

This commentary stands in stark contrast to Markforged's (MKFG) recent earnings announcement, where the company suggested that macroeconomic headwinds had accelerated, causing unexpected delays in closing deals. These headwinds are expected to continue into the fourth quarter.

Given ongoing weakness in manufacturing data since Desktop Metal's last earnings call, along with a continued rise in interest rates, there is a high probability of growth coming in below expectations in the second half of 2023.

Desktop Metal

Desktop Metal's DLP and binder jet technology give it exposure to a variety of end markets, with dental being one of the most important. Desktop Metal recently made its Flexcera materials available to other platforms, signing a supply agreement with Carbon3D. Flexcera is a resin used to make dental prosthetics with high strength and lifelike appearance. This move has the potential to expand Desktop Metal's consumable revenue, but the benefit is only likely to be modest.

Desktop Metal also has a growing business with Align Technology. Align Technology sells the Invisalign system of clear aligners and has provided Desktop Labs with intraoral scanners so that it can support general dentist locations.

Within healthcare, Desktop Metal's biofabrication business should be supported by the recent launch of a new Bio Plotter system with Print Roll. Print Roll is a rotating build platform that enables the printing of tubular tissue with multiple materials, combining polymers like PEEK with living cells, hydrogels and oil biomaterials in a single part. This printing technology can be used to manufacture stents or grafts for the body's vascular, digestive, respiratory and reproductive organs.

Desktop Metal has a leading position in binder jetting, having the largest installed base in the industry, and this business had a strong second quarter. Binder jetting offers greater throughput and lower costs than competing technologies, which is leading to market share gains in some applications.

Binder jetting is being used at scale in the automotive industry by OEMs like BMW. Desktop Metal has stated that it now has parts in almost every one of their new vehicles. Binder jet printed castings are also being used by companies in the marine and aerospace industries to consolidate assemblies and improve production economics.

Desktop Metal has suggested that its share of metal printer revenue is approximately 12% and increasing. Based on data from Desktop Metal and Stratasys, this would appear to be counting binder jetting for castings as metal printing. Excluding this application, Desktop Metal's market share is closer to 6%.

Giga casting is one area where binder jet appears to have found product-market fit. Giga casting is a new manufacturing approach where large portions of a car are made as a single component, replacing thousands of welds and hundreds of stamped parts.

Giga castings can:

• Reduce the number of components in a vehicle
• Reduce vehicle weight
• Increase manufacturing speed

Tesla has stated that giga castings have cut their costs by up to 40% and enabled them to produce the Model Y within 10 hours (one third the time of most EV manufacturers).

Giga casting is not without problems though:

• Vehicles using large casts are likely to be more difficult to repair
• It is difficult to maintain tight tolerances with giga casting
• Making a defect free large casting is difficult, which can lead to higher scrap rates
• Fixing design flaws is much easier with a body made up of several small parts rather than a single module

One of the reasons that this approach is only just beginning to gain traction is the cost and risk associated with creating large molds. Machining adjustments to a mold during the design process can cost 100,000 USD and redoing the mold completely can cost 1.5 million USD. Designing a new mold may require half a dozen changes before it performs satisfactorily, making the cost prohibitive. This problem is compounded with a larger mold, as changing the mold is more expensive and problems with the mold are more likely.

In comparison, the cost of using sand casting during the design validation process is reportedly only 3% of the cost of using metal prototypes. The design validation cycle using sand casting also only takes to 2-3 months, compared to 6-12 months for metal mold prototypes.

Binder jetting is used to create sand molds for die casting early in the product lifecycle. Combining binder jet printed cores with die casting also allows the creation of higher complexity geometries, like using 3D printed internal cores to create voids in a structure.

The subframes in a car underbody are typically hollow to save weight and improve safety. This is currently achieved by stamping and welding multiple parts together, but Tesla plans on placing solid sand cores within its molds to produce voids.

Tesla utilizes two giga castings in the Model Y, which serve as the front and rear underbody. Compared to the Model 3, these two castings replaced 171 parts, eliminated 1,600 welds, and removed 300 robots from the assembly line. A range of other car manufacturers are now following in Tesla's footsteps, potentially leading to increased demand for binder jetting.

Desktop Metal reportedly has a number of binder jet customers that supply companies like Tesla, Toyota, Volvo and Mercedes Benz. The company does not have a monopoly in this area though, as Tesla is working with multiple additive manufacturing companies.

Financial Analysis

Desktop Metal’s revenue declined 8% YoY to 53.3 million USD in the second quarter of 2023. Part of this decline was attributed to a deemphasis of lower margin product lines. Growth was led by metal binder jetting solutions, consumables, services and subscriptions.

Desktop Metal is currently guiding to 210-260 million USD revenue in 2023, suggesting roughly 30% YoY growth in the second half of the year. Demand reportedly improved across the second quarter, supporting an expectation of improved performance going forward.

Desktop Metal's gross profit margins expanded 2.3% YoY in the second quarter, due in large part to Desktop Metal’s efforts to reduce fixed costs through the closure of six production sites. Several initiatives under the second tranche of Desktop Metal's 50 million USD cost reduction plan have recently been completed. These cost savings are weighted more towards the fixed cost base in COGS and are only expected to be fully reflected in third quarter results.

Non-GAAP operating expenses were 34.7 million USD in the second quarter of 2023, a 17.4 million USD reduction since the start of Desktop Metal's cost reduction efforts in the first quarter of 2022. As a result, Desktop Metal’s operating losses are declining, and the company expects to reach adjusted EBITDA breakeven by the end of 2023.

Job openings at Desktop Metal have declined significantly over the past 12 months, which should be supportive of improved profitability if Desktop Metal can generate topline growth. The rapid drop in job openings over the past two months could indicate demand weakness though.

While Desktop Metal expects to achieve adjusted EBITDA breakeven by the end of the year, cash flow trails adjusted EBITDA. At adjusted EBITDA breakeven, Desktop Metal has suggested that cash burn will be under 10 million USD a quarter. Monetization of inventory is expected to reduce cash burn in the second half of 2023, which should help with liquidity problems. There is also the 32 million USD termination fee that Desktop Metal should be in line to receive after Stratasys shareholders rejected the merger agreement.

Desktop Metal’s management team has suggested that is hoping to become cash flow positive with around 100 million USD cash still on the balance sheet. This seems like an overly optimistic projection to me though, particularly if growth ends up being weaker than anticipated.

Valuation

Desktop Metal's stock has faced serious headwinds since Stratasys shareholders rejected the merger. The failure of this deal to gain approval has both removed support for Desktop Metal's stock and increased investor focus on the company's path to profitability.

Desktop Metal's valuation remains high relative to peers, leaving the stock vulnerable to further declines if the company's financial performance disappoints. This risk is highlighted by Markforged's 30+ percent stock decline in the past few days, after the company preannounced earnings that were materially lower than expectations.