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The ExOne Company (NASDAQ:XONE)

Q2 2013 Results Earnings Call

August 14, 2013 8:30 AM ET

Executives

Deborah Pawlowski - Investor Relations

Kent Rockwell - Chairman and CEO

David Burns - President and COO

John Irvin - Chief Financial Officer

Analysts

B.G. Dickey - Stephens Inc.

Holden Lewis - BB&T

Cindy Shaw - Discern

Hendi Susanto - Gabelli & Company

Operator

Greetings. And welcome to The ExOne Company’s Second Quarter 2013 Financial Results Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Deborah Pawlowski, Investor Relations for ExOne. Thank you, Ms. Pawlowski. You may begin.

Deborah Pawlowski

Thank you, Manny, and good morning, everyone. We certainly appreciate your time today for ExOne second quarter and first half year ended June 30, 2013 conference call. On the call with me are Kent Rockwell, Chairman and Chief Executive Officer; David Burns, President and Chief Operating Officer; and John Irvin, Chief Financial Officer.

We will be reviewing the results of the quarter and six months period that were published in the press release that went out after the market close yesterday. If you do not have that press release it is available on our website at www.exone.com. The slides that will accompany our discussion today are also posted there.

The Safe Harbor statement is noted in full on slide two. As you may be aware, we may make some forward-looking statements during this discussion, as well as during the Q&A. These statements apply to future events and are subject to risks and uncertainties, as well as other factors that -- which could cause actual results to differ materially from what was stated here today.

These risks and uncertainties and other factors are provided in the earnings release, as well as other documents filed by the company with the Securities and Exchange Commission. These documents can be found at the company’s website or at sec.gov.

Kent is going to get this discussion going here today and so with that, I will turn over to Kent.

Kent Rockwell

Thank you, Debbie, and good morning to our investors. Welcome to our conference call here. Today I’m going to make my comments mostly at the end after David and John have reviewed the quarterly performance of the company, but I would like to say at the offset, just from an overview point of view that from a management perspective of this company, we were pleased with the quarterly report and our performance in this quarter.

We basically hit the expectations that we had. We were pretty close to our consensus that the analyst provided on the street and we think that we are in a very positive and growing mode, and that the future for ExOne is still quite positive.

So, with that, I’m going to led David make his comments and I’ll pick it up at the end.

David Burns

Good morning, everyone. This is David Burns, and I’d also like to welcome you to our call. We are gratified by the continuing interest in our company. And I just want to remind folks as we begin talking about our results sort of the core who ExOne is? We are manufacturing technology company and of course, we work in the three-dimensional printing or the ad manufacturing space.

By nature because of the customers that we deal with that being the industrial base around the world. We tend to have our planning and execution and very much of an annual cycle. It’s -- It clearly have seasonality to it. We think in terms of calendar year and that’s the way we see the business developing.

And so as we began thinking about talking this morning, we almost think of this a little bit like a half time report, whereby half way through 2013. So I want to talk about where we think we are relative to that plan we set up for this year.

On slide five, you can see the revenue report for the second quarter and the first half. You can see the spilt between recurring and non-recurring revenue that which we call machines and PSC.

You may recall that we as an objective have said that we would like our business to be about 50-50 between machines and PSC’s, and on a regional basis, we would like our business to rollout about a third, third, third, between Asia, Europe and Americas.

The most appropriate point to look at on the slide is probably the first half, which is the bottom half of the slide. That means we are at $17.2 million revenue, about 60% of that is come from machine business and 40% from the recurring side, and the split you can see are about 49%, 29% and 22%.

Not unusual, the business is lumpy when we get machine sales in the region, one region or the other will spike a little bit, but the business is developing about as we would have hoped.

Moving to slide six, a quick summary of our machine sales in the quarter and the first half. You can see that we’ve exceeded $10 million in revenue in the first half, largely build on the back of sales of our S-Max machines. Our largest print platform the Max platform.

We expected the first half of the year to be strongly focused on the Max platform. We expect the second half of the year have contributions from the other platforms as well the Print and Flex platforms are beginning to build in.

You may recall that we introduced the Flex platform at our Machine Tool Show in September of 2012. And so far we had planned on building and shipping five machines this year with the first shipment being in the third quarter. We are on schedule to make that shipment and we sold three of the five Flex machines that we are building for the year. As I said, the other platform will contribute a little more as year goes on, especially the Print platform begins to build-in in the fourth quarter.

We’ve had good spread around the globe for both customer applications and machine sales, you may have noted in the press release that we sold one machine in a variety -- each of the variety locations in the second quarter. So machine sales is developing exactly as we would expected for the first half.

Slide seven, the recurring revenue side, you can see our growth for the quarter and the half in recurring revenue were about up 20% year-over-year for the first half. In terms of revenue on the recurring side, you may recall the recurring revenue is a composite between our parts manufacturing of the production service centers, our consumables business, as well as our service business and spare parts business.

The first half of 2013, the recurring revenue side had been almost -- has been entirely based on the five production service centers that we had open at the end of last year. We are getting in the sense same-store growth.

We spend part of 2012 refurbishing and reinvigorating our production service center with our latest technology machine that were faster and had more production capacity, and we are seeing the fruits of that in the first half. We are going to talk a little bit more about the expansion of the production service center network in a moment, but 20% growth is reasonable and we expect the year-over-year growth in the second half, meaning comparing half two of ‘13 to half two of ‘12 to be greater than the 20% that we saw in the first half.

The next slide we titled Second Half Preview, so in the sense, this is the half time report where we think we are as we head into the second half. We’ve given guidance about overall revenue for the year and assuming that we achieve what we see as the necessary growth on the production service center side, we have enough machine capacity to reach the forecast that we created for ourselves for 2013 in terms of total revenue. So we have sufficient machine production capacity in place to meet our plan.

Secondly, for every machine sale that’s required to meet that plan, we do have a customer identified today. We have an active sales process in place for each of those customers. In fact, we have more programs than we would need to flush out the year. But these are million dollar programs, we’re dealing with industrial customers that have fairly long purchase cycles.

And so while we have confidence that we’re going to reach our overall revenue target, there is much to do yet in terms of securing and shipping those orders. But be assured that we have the capacity in place to reach our revenue targets and we have the customer base in place necessary to support our total machine plan for the year.

The one difference that we see relative to where we were some months ago is that we do see a shifting of revenues more heavily towards the fourth quarter. We had originally said that we were going to be a 35% or 40% first half company and are 60% to 65% second half company that is bearing out in fact as the split. But the split between third and fourth quarter we see now weighted more heavily towards the fourth quarter.

And the final thing that I would say has occurred to us over the last few months is that with the rapid development of ExOne and its technologies, we believe that we are really well positioned to help industrial customers transform their businesses.

The part that surprised us a little bit as we’ve got in market penetration around the world is that for many customers. Although they are enthusiastic and very open to the implementation and deployment of our technologies, some of those customers are struggling either with precursor pieces of process necessary to implement our technology or the post process necessary to implement our technology.

And so while we feel we’ve made dramatic progress in terms of our ability to appeal to the industrial base in terms of quality and in terms of the cost per piece that we’re manufacturing, we are finding customers that are struggling a little bit to find ways to implement what we can sell them.

An example would be that you may know that we have very active business in the foundry industry around the world. While many foundries don’t in fact have computer-aided design capabilities on the front end. So while we walk in and we say here is a great digital tool we can use to help improve your business, some of the response is but we don’t even use the computer-aided design to start with. We don’t even have digital designs to begin with.

On the back end, some of the more designs that we’re capable of creating for the foundry industries can make lighter castings, they can make stronger castings. But some foundries we have found don’t even have the capabilities to pour the casting more that we can create.

So in a sense, the pre-print and post-print part of a process needs shoring up. And we as the management team are talking actively about what we need to do about that to make sure that we can as effectively deploy our technologies as we possibly can.

So, moving to the last side, my section slide nine. I just want to review one more time, the sort of, four branches of our operational plan for 2013. When we went out for our recapitalization in early 2013, we regularly talked about these as our four major areas of strategic trust, enlarging our PSC network, expanding our machine manufacturing capacity, increasing the range of material offerings and growing our sales and distribution network.

We had a very effective capital raise. And if you had been watching the series of press releases, you may know some of what I’m about to say here. But let’s touch on each of these four points.

First off, in terms of enlarging our PSC network, we announced a few weeks ago that we are opening our sixth production service center in Auburn, Washinton. You may ask why Auburn and the answer is there is a clustering of foundries up in the northwest, many of them support both the marine industry and the aerospace industry and is the very logical place for us to have a production service center within some miles of our new PSC in Auburn.

There is a customer base that is very, very interested in receiving cores and molds that we put in our machines. And of course as we talked before, trucking distance is important when you’re trying to service customers with 3D printing parts.

We will be announcing shortly a second PSC to be opened here in the United States. We’re in process of negotiating for both the land and building there. And the location will be in the second hub of foundry activities here in the United States.

We have identified in western Japan, a site for our second Japan production service center. By nature when we get outside of the United States, the implementation of production service centers can often take a little bit longer because of either business processes, we need to acclimate ourselves to legal requirements for we are proceeding at pace to open a second Japanese production service center, we expected to be open late first quarter, early second quarter. And we expect to be announcing fourth additional production service center here at least location wise within the next few months.

In terms of expanding our machine manufacturing propensity, we have purchased land in Germany, not too far from our existing setup facilities in Germany. We’ve spoken often about the fact that we’re in five distinctive facilities in Germany today. That was an evolutionary process of acquiring spaces we needed it and we desperately need to get into a single unified space.

So we purchased the land. We have engaged building contractor and we’re in the process of settling the building contract. At this point, we expect to be open in Germany in our new facility in third quarter of 2014. And of course, that is a significant spend for us in terms of the initial raise that we did.

In terms of increasing the range for our material offerings, again you may have seen through the press releases that we are now offering infiltrated iron as a print material. We are offering bonded tungsten. And let me pause there for second, bonded tungsten, I think is exemplar of how and why the deployment of 3D printing can really change the way industrial products are made.

We have partnered with a customer outside the Cleveland, RP&M. They are very active in radiation shielding which may sound as if it’s, sort of, an itchy thing and it is. But they are one of the United States largest providers of radiation shielding and they discovered that if we print tungsten and they bonded with a certain chemical binders that they can get very, very strong custom-made radiation shields which are necessary in both the defense industry and the medical industry.

And we anticipate that we are going to do much, much more business with RP&M. And again I want to just use this as an exemplar when you sit down and say how would you make this really uniquely shaped things that’s really hard to make any other way, 3D printing you can make it. And when we partner together with the customer and we do material developments, some really good things can happen. So RP&M has bought one of our M-Flex machines and when we’re taking delivery of it year before the year is out.

We’ve also announced two additions to our foundry side, one is using a phenolic binder and ceramic substrate material and the other was using sodium silicate binder. And both of these are advances that allow our foundry offerings to be more environmentally friendly, in many cases to offer parts that are stronger, have higher heat resistance and when we’re in a casting world where we’re trying to get more precise castings new binder and new substrate combinations are very important to us.

And finally, in terms of the growth of our sales and distribution network, we have been growing our core sales group. We now have 14 people that are full time in the sales function around the world. And we’re regularly identifying territories where we need support in adding resources.

At the same time, we have seen the announcement that in partnership with the association for manufacturing technologies, we’re opening sales offices in Shanghai and in Brazil. Those will be ExOne employees at our housed inside our technical centers that the AMT runs. Those people will be directly involved with sales, and at the same time will be interfacing because we anticipate also using distributors in both countries. And we need people that are on the ground in the country, interfacing with the distributors everyday.

So we count our current sales group to be at 16. And if you recall our early discussions, we talked about growing from nine back some months ago and today we’re at 16 with some opportunities to grow yet.

So with all of that, I’d like to turn it over to John Irvin, who’s going to review the much more of financial results from the second quarter. John?

John Irvin

Thank you, David and good morning everyone. Turning to slide 11, I’d like to review our second quarter and the first half of the 2013 financial results. David covered revenue. So I’ll start with the gross profit and the gross margin review. For the second quarter 2013, gross profit was $4.2 million representing a 45.3% gross margin. This compares to last year’s $1.5 million of gross profit or 32.6% of sales.

The improvement in both profit and margin was driven by the increased machine volume as well as the sales mix. Our year-to-date number show us the similar trend with our first half of 2013, recording a $7.0 million gross profit or 40.9% of sales, compared with $2.3 million of gross profit year-to-date in 2012 or 31.6% of sales.

So turn to slide 12 please. And we’ll take a minute to go through our OpEx. Our operating expenses for the second quarter 2013, OpEx expenses were $5.2 million which consisted of $3.9 million of SG&A expenses and $1.3 million of R&D expenses. This compares with operating expenses of $4.6 million in the second quarter 2012 which consisted of $4.3 million of SG&A and $300,000 of R&D.

While the current year’s quarterly SG&A actually went down compared with the prior year’s quarter. Last year’s included a $1.8 million equity-based compensation charge. If you isolate that charge, the other operating SG&A expenses actually went up as expected by $1.4 million, driven by the investments we have been making to grow our business.

These aggressive investments include hiring people both inside and outside sales, people as David had mentioned; other support costs and sales commissions on the higher revenue. Our R&D went up by $1.0 million reflecting the ongoing activities of our ExOne unit, included in those activities associated with our recently announced introductions of iron infiltrated with bronze and bonded tungsten as our two latest and newest 3D printing materials.

In addition, two new binder solutions and other materials that are currently in various stages of development. For the year-to-date 2013 period, OpEx expenses were $9.6 million compared with $6.8 million for the prior period. The increase includes investments to support our growth.

And then finally turn to slide 13. And as usual, let me touch on our balance sheet, at June 30th, we had $64.6 million of cash, compared with $71 million at March 31st, our total outstanding debt was $3.5 million at June 30th compared with $5 million at March 31st. And our stockholders’ equities stood at $84.2 million at the end of the second quarter.

As I previously stated, our plan is to invest approximately $40 million to $50 million during 2013 and ‘14 to expand our global manufacturing capacity, our PSC development and other strategic initiatives. This includes $20 million for the recently announced expansion and consolidation of our German operations.

Turing to slide 15, let me review the guidance for 2013 that we put out in -- qualified in our earnings report last night. We’re currently expecting to achieve 2013 revenue toward the lower end of our guidance range which was $48 million to $52 million.

That expectation is based on the fact that we don’t anticipate any further sales of our micro-machines also known as our laser drilling machines during the remainder of 2013. And the timing of our year end shipments which can be volatile at times. Additionally, we’ve experienced the impact of the weakening yen to the U.S. dollar upon the translation of our Japanese financial statements.

With respect to gross margin, we believe will be at the high end of our guidance range which is 42% to 46% and with our aggressive investments to support the growth, we currently believe that we’ll realize the higher end of our $18 million to $21 million range for operating expenses.

So, with that, let me turn the discussion back to Kent, who will review our long-term targets.

Kent Rockwell

I would like to refer back first to David’s graph about the first half. When you think about our business, you must remember that we are essentially a global company. And then our revenues are in the first half were 49% out of Asia and then the balance being split between the U.S., the Americas and Europe. And so we are subject to the [relevancies] of the global economy and I want to just -- address that for just a minute.

In Asia, we see a fairly a positive market when we consider China and the opportunities that we envision there. As David said, we have opened an office in Shanghai now. And David will be fortunate enough to be going back to China for two weeks here in the next week or so to pursue some additional activities there.

In Japan, we did have the impact of the devaluation. And that -- had that not occurred, we would have actually exceeded the consensus in the quarter. And so those are the kind of things that we have to -- we're unanticipated. The machine that was sold there actually was priced back and -- before we had started the underwriting. So we couldn’t change price at that point.

But the Japanese market, it’s been essentially a little flat for us in the PSC level because we change that machines there. And it’s -- there has been a little disruption in our operations during that period of time. They do have a brand new S-Max that assists them in important service. They got a brand new S-Print and we had very positive results for their customers, using our new phenolic binder there.

And so the demand for that and the output in Japan should certainly increase in the PSC site. And I believe that the opportunities for additional sales in the Japanese market are positive as well and we’re also working in other Asian location for machine sales at this time.

If you read the [AEP] report this morning, according to [AEP] Euro zone has going through the longest term recession and is officially ended today, I can say that from our perspective, there is some truth to that. We’ve seen the euro zone very flat for us in the last six months where that was essentially in the year’s best or strongest market. The machines sales in Europe this period has been very slow and our PSC business actually backed off a little bit there as Europe simply constraint their capital spending across the board.

We are seeing increase there now. The activity is up modestly and we are looking for increased activity in the second half. In the Americas, we have improving demand. We are selling machines in the U.S. now and I think that the PSC business which was a little slow and we are learning something about the cyclicality of that between the first and second quarters. But we are experiencing in this quarter increased activity at the PSC’s lower levels and we anticipate seeing that continue through the balance of the year.

Canada has been good market for us and very consistent somewhere to the U.S. We have a lot of opportunity but we’re not generating revenues. We came back from South America and couple of shows down there. We intend to invest in South America later this year. And the demand for our product and service is extremely positive. So it’s just a question of getting in there and setting it up right.

It takes a little time, going into Brazil or any other South American countries to get your positioning right. But we’re very enthusiastic that it will be a growing opportunity for us. So, global demand overall for 3D printing, I think is extremely positive, extremely growing.

We’re seeing much more customer acceptances in -- certainly in the domestic market here. And we got a lot more customer activity as David said, we have a name n very single machines that we can ship. So it becomes not an issue for us of trying to generate more demand at this point. It’s really -- I can’t really execute on the demand that we have to get us to this next level of performance.

So execution is the key for us. When we think about execution, it’s not just about delivery. It’s about executing on getting the right people in place and we’ve increased our employment from when we started the underwriting, we are at about 136 people, we’re now up I think maybe 155 with including terms. We’re now up to 202.

So we’ve increased over 30% in -- and anytime you do that there is a training period. When we’re trying to train service personnel, marketing personnel, you almost can’t expect to see anything from them for the first four to six months because the technology that they’re learning is something that’s new and their ability to get in and translate it into the market place simply takes time. It’s not an immediate reaction. Having said that, we’re enthusiastic and we’re very comparable with what we have accomplished.

Looking beyond the second half, obviously the market is looking for ExOne to continue to grow in a rather positive manner for quite a considerable period of time and we are working hard to get our sales, over the longer term, certainly north of $100 million in the revenues and positive performance of the profitability.

And in doing that, I think all the things that we’re focused on are driving us to be able to say that we’re very much on target with what we said to our investors in our original underwriting.

Our materials development is moving quiet positively, David mention, where we are, some of the other materials that we have coming online are very, very much in demand by the customers that we’re working with in close collaborations. More than that, there are some materials that are little subsets that we believe we will participate those markets in a proprietary manner and that we will expand our opportunities in some of this new materials similar to the bounded tungsten that we are working in now

Obviously, we have to enhance our machine technology, we are still very comfortable about our competitive position. We think it’s quiet strong. We think we are improving it. We are working on some more environmentally expected machines, with new binders and that’s all moving quite well. We are looking at to adding to our machine portfolio for addressing the new materials markets with another machine which will be here shortly.

The customer collaboration has increased tremendously from February. We now have a lot more market liability and the customers that are coming to us or continuing to be major names or major industrial opportunities globally.

And one thing I think that’s little different from, in our perspective from the peers that we seen to be measured against quite often in the polymer sector is that, our growth in the industrial sector is more a function of design innovation and the customers take long time to get from design innovation into employing 3D printing in there day-to-day activities.

And so the process of development is a little longer but the market is no less rewarded in margins and the size of the market are simply larger then what anybody can really measure at this point, and so we still see the opportunity for this company to get to a very substantial position.

One of the things that we’ve notice as we develop in the last six months is that it’s not just about machines and we knew that all along, but the opportunities in the pre-print design phase and the post-print processing is very, very important to our overall strategic growth and 3D printing is a systems of the process, it’s not just simple machine.

On the front end you have a lot of design optimization technology that we’re looking at because its’ something that helps customers fine better and more efficient uses for our machines and so we’re studying pre-printing a little bit more and in post-print processing we are doing the same thing because there are new processors for achieving full density in certain parts as we look what our customers requirements are.

So, I think that from our perspective running this business, where we are very well founded and where we thought we should be, where we want to -- what we want to accomplish in this time period and in looking at the long-term objectives of the investors to make this and into a major long-term investment. I think we’re very well-positioned and moving in the right direction.

And with that, I’ll be glad to turn Debbie and take questions.

Deborah Pawlowski

All right. Manny, we are ready for the Q&A.

Question and answer session

Operator

(Operator Instructions) Our first question is from B.G. Dickey of Stephens Inc. Please go ahead.

B.G. Dickey - Stephens Inc.

Yeah. Good morning, everyone.

Kent Rockwell

Good morning

B.G. Dickey - Stephens Inc.

My first question is just on your updated revenue guidance for ’13. A couple things there. First, can you guys quantify the FX headwind impact that you had in the quarter in dollar terms? And then also can you give me a little bit more color on the portion of the revenue is being push out, what’s changed in the market relatively to your prior guidance, that’s causing this to be -- your expectation for this have to be pushed out and how concern which should be about this delay?

Kent Rockwell

David will take that question.

David Burns

Thank you. Good morning. The first half of it is about FX and so let me briefly describe the way we sell in Japan. Our Japanese customers depend on yen-based pricing. So we quote in yen. And in the sense we transact in our company to eventually sale to our customers in yen. So the weakening of the yen in our estimation, remember now we set up our plan based on a yen translation rate at the beginning of the year that was, yeah, maybe, it was bout 10% to 15% shift since then.

So, in the first half we believe that the effect is been more than $1 million of revenue that we would have recognized at the old FX rate and we estimate the second half could usually be this in the same ballpark.

So, all in it looks like it’s probably causing us a couple million dollars worth of FX translations. Your second question was about, I think you are looking for color and you said in the shifting and delay?

B.G. Dickey - Stephens Inc.

Correct. My concern there would be just be that you are obviously expecting a portion, you commented in your prepared remarks that you got some sales that you now expect to be more heavily weighted towards the fourth quarter and then just given the fact that you are now at the lower end of your prior range on the topline, just trying to get some color on, what’s driving that, that push-out or that delay or companies pulling back on their spending or delaying, just kind of some color there would be helpful?

David Burns

Sure, absolutely. While one point I want to make sure we emphasize is that in our original plan for the year we had anticipated two incremental laser drilling machines, micro machines to be sold this year. There are exactly a million dollars a piece. And those two sales are simply not going to happen this year.

We don’t anticipate product lines going away, but we understand where we are -- what that program development. So those two machines are out, there is $2 million there, and there is couple of million in FX translations. So, when we look at the downward pressure on our guidance, those are the two of the biggest drivers.

I understand your question. And when you set up for the year, you begin to say to yourself how many machines you are going to build, when do I expect them to book them, which programs I am working on and when do I expect them to come to roost. And then you can kind of guess that most of that booking activities is going to take place within some period of the year and I have always said it’s April through August, September.

All I can say at this point is that when we set up the year, we had anticipated a couple of more machines being in the third quarter. It’s not clear to me now that those programs are going to book out in the third quarter. Overall, it is not a question of delays or customer reticence or reluctance. It’s a question of simply the timing of the execution of securing the order, realizing there were a $1.5 million shipment that perhaps is traveling six weeks on the ocean, then it’s everything from forwarders to banks, to Letters of Credits, there is whole chain of things we have to execute.

So, from my perspective, I don’t feel there is any weakening at all in the machine business. This is about prognosticating the timing of when events are going to break. And we still can prognosticate it clearly. So, all in all, I think that’s what we are trying to tell folks as we still believe demand is robust. We are going to do the business, we tell we’re going to do. Exactly, when it breaks, we’re not sure.

But the two things we are sure of is the two laser machines are out which is $2 million of revenue. And we are sure that translation of the yen dollar has cost us a couple of million dollars in revenue.

Kent Rockwell

David, you might also mention the fact that we have one machine in Russia that has deferred. It is not that we lost the sale, but we do know that there was one sale that was -- we thought was imminent and they simply -- the customer lost the money and they are postponing it into the -- into the next year.

Kent Rockwell

Correct. Yeah. I mean this program in -- for Russian for the aerospace industry, it was partially funded by government funding in Russia. We went through a tendering process. We won the tender. We negotiated the contract and then the customer was unable to secure the financing they needed this year. So the contract in place and we believe we will execute it next year at this point.

John Irvin

B.G., this is John. Let me just kind of wrap that answer up with an accounting explanation on the timing issue. These are very complex machines that we sell that have very different layers of acceptance from a revenue recognition. And so at this point, we know that some of these are moving because of acceptance procedures and the timing of how we are going to able to recognize the revenue from the third and fourth quarters.

So I think David -- David gave a great business explanation of what’s happening with some of the shift of the revenue. It has nothing to do with the demand of our business. The demand for the machine is strong. The market is strong. It’s simply our ability to get the revenue recognized in the certain period.

Kent Rockwell

I would verify -- I just want to say what John said is absolutely correct. We have -- there is no suggestion at all that demand is faltering. It’s really down to the execution on a very complex contract. That sometimes are six to eight months and particularly when you are dealing with this much foreign activity as we are, you would have issues about when -- when funding occurs because there is a lot of government funding associated with some of these machines.

So -- and some of the governments simply are putting things on hold. You can see that even in the United States. So, demand is overall -- still actually is robust and growing. So, we don’t have any concerns about the lack of demand. It’s all tactical stuff that has to do with other macroeconomic considerations in the marketplace.

B.G. Dickey - Stephens Inc.

Okay. Great. I really appreciate the detail and the color there. Very helpful. Then my second question is just on, your appetite for M&A, you are obviously aware your competitors are pretty active in this arena, just curious to your color or commentary on that. Is it something that you are looking at or are you really just focused on growing organically for the time being?

David Burns

Our growth to this point, of course, has been totally organic. But as I mentioned in my overview about ‘13 and beyond, we have to start to consider looking just beyond the internal opportunities because we are now starting to see opportunities will really augment our growth. And we have that responsibility to shareholder to always be looking outside as well as inside.

What you are -- just trying to get your feet on your ground, my focus has always been -- stay very narrowly focused until you got into critical maths. We are at critical maths in our own minds, right here. I am comfortable with what we have achieved and where we are going. So we can start now to move to look at filling in some of the opportunities that might really augment our growth and sustain our market position as we further penetrate the 3D market.

B.G. Dickey - Stephens Inc.

Okay. Perfect. That’s very helpful. I’ll pass it on. Thank you.

Operator

Thank you. The next question is from Holden Lewis of BB&T. Please go ahead.

Holden Lewis - BB&T

Thank you. Good morning.

David Burns

Good morning, Holden.

Holden Lewis - BB&T

I guess reference the mix playing a role in the gross margin getting to where it did in the quarter and obviously you sold -- all the units you sold were the big ticket matches. You sort of educated that the mix will incorporate more prints and flexes as we go into the back half. What does that do to the gross margin? Did those machines get the same gross margin because they are lower ticket, maybe the gross margin is somewhat lower -- how should I think about the machine blend and the gross margin effect?

David Burns

Good morning, Holden. This is Dave. I think that in general the machines that carry a lower pricing while we are going to have a very consistent view of margins and we talk about them being north of 50% consistently on a machine product line and they will be. The opportunity for an individual program perhaps to spike in terms of margin because you sold one machine that’s got a lot of options on it or for other reason, get loaded up, are simply less so.

So I think that we’ve been very fortunate in a lot of the S-Max programs we have gotten really in the sense premium margins as we gone along as we begin to create a greater breath of machine sales. I think the margins are going to narrow in a range. I don’t think they are going to drop significantly, but probably not going to have as frequent spike because we had again an individual program that stood out in a relatively low revenue quarter. Does that kind of makes sense?

Holden Lewis - BB&T

Yeah. In fact, right now your machine mix has been good as they can be from the margin standpoint. And you may not see the same degree of favorable mix going forward. I think it is what I’m hearing?

David Burns

Because we blended down a bit because of much more consistent margins in the lower priced machines.

Holden Lewis - BB&T Capital Markets

Right. Now -- now the other sort of moving piece there, is always simply the volume and leverage. When you think about sort of the Q2 at the 45.3%, great mix, but lower volumes than you expect to have over the next two quarters. When we think about the mix, you are going to have in the back half, what raise more? Do you get a margin uptick because the volume outstrips the mix effect or do you get a margin downtick because the mix effect outstrips the volume here?

David Burns

Well, the one thing that we do know is that as we get utilizations up our -- our unabsorbed manufacturing overheads drop which drive margins up. So by nature, a larger revenue base is going to give greater support to higher margins. All in, we think that margins are going to continue to be where they are or tick up rather than down as volumes grow.

Holden Lewis - BB&T Capital Markets

Got it. Okay. Great. And then just secondly, can you talk about the materials -- the two materials that you rolled out, how can we think about that impacting the model. When would you expect to see a meaningful, number of sort of iron applications and tungsten applications and therefore see that, I guess driving into the PSC business and drove us into really consumable business?

David Burns

Well, we internally have anticipated the rollout of all of our materials in the way we have modeled out ‘12 --‘13, ‘14 and ‘15. So, our sense of the volumes we’re going to reach are not necessarily influenced by the fact that we suddenly made an announcement about our material.

I would say it is all built into our sense of growing, 40% to 50% a year. That said, iron presents an opportunity to -- to be able to print a very low-cost alternative for the industrial marketplace. So while our stainless products have gotten good acceptance, stainless by nature is pretty expensive to print and to process. Iron is far less expensive. There is a lot of shops when you walk around, you see iron parts every where.

Really, iron does for us, it is almost directly interchangeable with casting applications. So, people who cast iron can now print iron and so we are walking in and people begin to say hey, I could do this or that, which is great from our perspective. And again, I think, the importance of tungsten for us is simply to give a great example of how this collaboration can work to pry out a niche that we think are going to have big impact on.

And while it may not be many tens or millions of dollars, it is our -- it certainly a million plus dollar niche that we’ve got a lot of flexibility and control over this point. And you are going to hear a lot more materials like that as we are able to reveal customer collaborations, we have done and material development we have done. You are going to hear more materials are come out in kind of that specialized way as well.

Holden Lewis - BB&T Capital Markets

Okay. And then, just breakeven, in past quarters, you talked about what the consumable piece was? Can you talk about what sort of the consumable dollars were this quarter versus same quarter last year?

David Burns

Well, we know our consumable business overall year-over-year was up 20 plus percent for the quarter. I know that. I got to scramble here to pull a numbers out or maybe we could pick it up on your call.

Holden Lewis - BB&T Capital Markets

Okay. Thank you.

David Burns

Thanks.

Kent Rockwell

Well, I’d like to add one last one, you said, talking about the margin on lower machines, the lower priced machines is that, one of the things we always look at is what is the ROI in the eyes of the customer for these machines? And the ROI of the small machines is actually potentially even higher than it is on the S-Max. So there is no reason to expect that we should have to look at pricing erosion or margin erosion as a result of selling these lower machines. The customer is going to get a very good return on investment.

Holden Lewis - BB&T Capital Markets

Okay. Thank you.

Operator

Thank you. The next question is from Cindy Shaw of Discern. Please go ahead.

Cindy Shaw - Discern

Thank you very much. I wanted to go back to the discussion about and it sounds not so much order slipping into the first quarter of next year, but maybe the shift and get the full sign-off and acceptance. Is that having any change on your view to calendar ’14? Should we think about that as bumping up first quarter revenue next year and bumping up your view for next year’s revenue?

John Irvin

Yeah.

Kent Rockwell

Go ahead.

John Irvin

I’ll take it. Hi Cindy, it’s John.

Cindy Shaw - Discern

Hi.

John Irvin

In revenue recognition, all right. I think I’m talking about just before, if we can’t recognize something in the third quarter, it’s likely that it’s going to get recognized in the fourth quarter. If we can’t recognize it in the fourth quarter, we’re likely to recognize it in the first quarter.

So when it slip because of revenue recognition and its acceptance procedures that are required in the revenue recognition process, it’s normally quarter-to-quarter and so fourth quarter shift is going to be -- is going to be mean first quarter of ’14.

So it -- I don’t think I can recall one shift that’s been a six-month or a nine-month or a 12-month shift. So this is -- these are timing shifts and again, it has really nothing to do with customer demand. It has to do with our pretty complicated acceptance procedures for us.

Cindy Shaw - Discern

Okay. So it sounds like that could really bump up first quarter next year revenue without having any negative effect on, in other words, it’s not going to take away and push everything out, it sounds like, is that fair?

John Irvin

That’s right. That is fair and logical, yeah.

Cindy Shaw - Discern

Okay. And then another housekeeping question. I know the tax rate has been a real wide range for this calendar year. Now you’ve got more visibility into the year, can you comment on the tax rate for the full year or the second half?

John Irvin

Yeah. This is John. Here is the tax, the tax issue is, we still have a very anomalous effective tax rate and it’s driven by -- driven primarily by the fact that we are taxable in Germany. We’re not taxable in Japan and we’re not taxable in the U.S. We’ve engaged outside tax accounts on the last three months and have spent a lot of time with them to develop effective tax strategies that we’re left with burden in the future. But you can expect this year it continue to be anomalous.

And I think people will try to say, well, it’s going to be 40% or 50% or 60%. It could be a 100% effective tax rate this year with just a $1 million of pre-tax income and a $1 million of taxes obviously that’s a 100% tax rate.

So but here is what I think will happen in the future. As we get profitable in the U.S. As we get effective tax strategies in place. We will get a normalized tax rate sometime in the future, hopefully, we’ll get closer to a normalized tax rate in ’14.

Cindy Shaw - Discern

Okay. So no real change to this year’s outlook for the tax rate still at pretty wide range we’ve been looking at maybe even little higher it sounds like? And…

Deborah Pawlowski

Cindy, I’m sorry. We’ve got a few more, I’m sorry, but we’ve got a few more in queue. Could I ask you to get back in line, so we can get to everybody else too?

Cindy Shaw - Discern

Okay. Can I ask one more quick question?

Deborah Pawlowski

All right. One more quick. Well, actually your questions are quick, I got to get these guys to answer shorter.

Cindy Shaw - Discern

Okay. If the PSC in the second quarter, the growth rate of PSC revenue has slowed, but it sounds like you’re expecting it to pick up in the second half and if you could comment, was that capacity limitations, you mentioned the machine shipped out, what, and you talked about seasonality? So if you could just give us color on what happened and why it’s going to pick back up?

David Burns

Well, Cindy, the most significant single thing that happened in second quarter was we lost about a half of a quarter’s production in Japan as we reorganized the swap the machine out and moved the new machine in. So nothing other than that, it certainly wasn’t market driven, it was more of our internal execution.

Kent Rockwell

Yeah.

Cindy Shaw - Discern

Right.

Kent Rockwell

Europe was slow but it’s coming back.

Cindy Shaw - Discern

Okay. Great. Thank you. I’ll get back in the queue.

Operator

Thank you. The next question is from [Parag Sankaran] of Canaccord. Please go ahead.

Unidentified Analyst

Hi. Thanks for taking the question. I just had a follow-on question on the PSCs. You talked about some seasonality that you’re seeing -- starting to see in the U.S. and you expect Europe to pick up. In terms of the newer PSCs, if you could talk about the time line that you expect them and what revenues, do you expect them to be similar seasonality or they kind of offset based on the geography that they are in?

David Burns

This is Dave. No. I think that seasonality that we see tends to be economically driven and not necessarily individually regionally driven. We expect to be printing parts here in the third quarter in Washington and delivering parts, so we’ll begin to get marginal contribution to revenues certainly in the fourth quarter and ramping up, and we’ve said, generally that we expect 12 to 18 months to get to a ramp reaching upwards toward breakeven. And I think that ramp is going to apply in Auburn, Washington as well. I don’t know of anything that would change that.

Unidentified Analyst

Okay. And the other question on the margin, as these PSCs ramp up and get beyond breakeven as the newer machines get installed, would you see a margin benefit in terms of how it flows through the model?

David Burns

Well, again, it’s the same thing that we’ve been saying all along, when we get to full -- when we get to breakeven in a PSC, the marginal -- margins are about 80%. So once we get above that breakeven point, we expect margins to kick up significantly in the PSCs.

Unidentified Analyst

Okay. Great. Thanks a lot.

Operator

Thank you. The next question is from Hendi Susanto of Gabelli & Company. Please go ahead.

Hendi Susanto - Gabelli & Company

Good morning, Kent, David and John, and thank you for taking my questions. Related to the previous questions, may I know how many machines and what machine capacity will be in the new PSC in Auburn, Washington, Western Japan, and expanded capacity in Germany?

David Burns

Hi Hendi. This is Dave. In Washington we’ve installed one of our larger print platforms initially. We think that’s sufficient for the initial period. In Japan, we would anticipate installing initially one of the largest print platforms and likely a print size print platform that decision has not been made, but I think that’s way it’s forming up.

In Germany, the capacity expansion is not yet on the PSC side. The capacity expansion is specifically to give us much more consolidated facility and control over our build process. So we don’t anticipate the PSC capacity in Germany changing, most of the floor space is devoted to machine building.

Hendi Susanto - Gabelli & Company

Okay. And then my follow-up, as we see PSC revenue growing its portion, would you be able to share gross margin rank and the insight into where gross margin of printed products, materials and binders, relative to machine and then in the corporate gross margins?

Kent Rockwell

Yeah.

John Irvin

(Inaudible) question.

David Burns

No. I don’t think I totally understood the question.

Hendi Susanto - Gabelli & Company

Yeah. I think basically I would like to know like the gross margin rank of let say where gross margins of materials and binders relative to machines and corporate gross margins.

John Irvin

Yeah. I think, this is John. I think there is a lot of complexity to that answer. So I’m not going to rank them, but I’ll give you a couple ways to guide you to some of the answer. The bigger machines, the more optionality, the higher the margins. The smaller the part the smaller the product being printed potentially the lower margin.

And some of our larger programs that we’re seeing at our production service centers carry very high margins. But it’s just too complex to be able to rank our different margins with the different lines of business.

Hendi Susanto - Gabelli & Company

And how about the materials and binders?

David Burns

I don’t think we’ll breakdown margins but…

John Irvin

Yeah.

David Burns

Hendi, I don’t think from the modeling perspective we have broken out margin separately within the recurring revenue stream and I don’t think at this point we’re likely to start that.

Hendi Susanto - Gabelli & Company

Okay.

David Burns

By the way jumping back to that, your question was about revenue and it was just over 10% was consumable revenue for the second quarter of total revenue.

Hendi Susanto - Gabelli & Company

Thank you.

David Burns

Yeah.

Deborah Pawlowski

All right. This is Debbie. I’m sorry. There are some people that are still in queue but we have run out of time. So if you do have other questions, please feel free to give us a call and we can certainly get your questions answered. But Kent, would you like to say goodbye?

Kent Rockwell

All right. Again, I’ll [capitalize] our perspective of the quarter was frankly that we achieved what we had anticipated from our management perspective and that the qualifying of our looking-forward, I don’t think that there is anything that’s out of context from what we’ve said in the past. The demand for our product and our services is excellent. I think we’re penetrating it. We’re just recognizing that right now all of this growth takes some tactical initiatives and it’s really about just the tactical initiatives of being able to get it done and we’re learning from that and growing with that.

So I’m quite enthusiastic that we’re trending in the right direction and doing all the right things. And it’s hard to measure a business that has the opportunity that we have and with the kind of growth that we’re experiencing right now just with people in 90-day segment. Going forward we’re trying to do what we’re supposed to do and providing that information. And so we’ll continue on with the following quarter, everything looks good from our perspective. Okay.

Operator

Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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