3D Systems' Management Presents at Citi 2013 Global Technology Conference (Transcript)

Sep. 4.13 | About: 3D Systems (DDD)

3D Systems Corp. (NYSE:DDD)

Citi 2013 Global Technology Conference Call

September 4, 2013 3:05 P.M. ET

Executives

Damon Gregoire - Senior VP, Global Operations and CFO

Stacey Witten - Director, Investor Relations

Analysts

Ken Wong - Citi

Rolfe Winkler - Wall Street Journal

Ken Wong - Citi

I’m Ken Wong, the Analyst for -- Citi Analyst for 3D Printing. I’m also the associate on the software team here. I’m happy to have with us today Damon Gregoire who is the Senior VP of Global Operations as well as the CFO of 3D Systems; and also Stacey Witten, Director of Investor Relations at 3D Systems.

So, you guys are new to our conference here, perhaps new to some of the investors in the audience. So, maybe if you could just give us kind of a brief rundown of your business, kind of what you guys do and the markets that you guys cater into.

Damon Gregoire

Sure. First, thanks for having us on the conference. It’s been a great day, good day, one-on-ones and everything we have had. So, 3D Systems is a leader in content-to-print in the additive manufacturing space. We’ve gone through several iterations of being a capital equipments company, then capital equipments and materials, and now total content-to-print. So, we offer software and software services for people to help design and create 3D in 3D.

We sell printers -- 3D printers with seven print engines to help people print in all kinds of different manufacturing and consumer spaces. We have the services that go along with it from services to take care of printers, and to also an on-demand parts business where we produce parts for people that either don’t have printers or need overflow or have technologies they need help with. And finally, we have about 100 different performance materials that go along to run those printers.

We operate in many different segments from aerospace and automotive and transportation, consumer, recreation, healthcare, which is our fastest growing vertical; and among many others including electronics and consumer goods.

Ken Wong - Citi

Great. So perhaps you can help us understand kind of how are customers using your products today, and how do you -- how has that evolved over the last, I mean, you guys have been around for quite a long time, how that evolved over the last 10, 20 years, and kind of how you see that progressing as you guys look ahead?

Damon Gregoire

Yeah. It is the hottest technology that’s been around for 30 years or so is what (inaudible). So, when 3D manufacturing -- 3D additive manufacturing was invented by Chuck Hull, our founder, back in the 80s, the idea was for rapid prototyping, and that’s where this industry sort of got its start and expansion. So, if people needed models and prototypes, they would go to 3D Systems or other additive manufacturing companies to have things done.

We have moved well beyond that, although rapid prototyping is still part of the business. Industrial and manufacturing is the largest part of our business and growing. It’s an area such -- again such as transportation and automotive, but also in healthcare, you know you have companies like hearing aid companies, dental companies that are using our equipment to keep expanding into new areas.

We have now also started last year and moved into the consumer area. So, our price point now range from as low as $1299, and we expect in the next period to be below $1000 and below $500 as we move. So, it's really expanding beyond the expert user into home use and into easier use.

Ken Wong - Citi

So you just touched on kind of at more advanced manufacturing capabilities of the machines. Can you perhaps help us size kind of what that is as a percent of your, I guess, your revenue today, kind of how do you see that progressing over the next two, three years?

Damon Gregoire

Yeah. For everything we do put together, I mean, we expect our revenue this year to be $485 million to $510 million, and the consumer side is still sort of on the small side, it is not reportable or anything yet, we will start reporting in the next quarter on that, but from just the way we look at it, if you look at our printer sales, one out of every two printers we sell goes into a direct or indirect manufacturing environment.

So, about half of our unit placements start to go in there, and obviously as you are talking production printers and things, materials are of much higher use when they are in a production environment than just a rapid prototyping environment.

Ken Wong - Citi

Got you. And I guess on usage, do you feel that your customers are utilizing machines at their full capacity right now? Do you feel that that is something that could pick up overtime?

Damon Gregoire

Yes, it is definitely something that some (inaudible) up than others, and it is picking, you know it is picking up, it will pick up, but people are also learning how to utilize the machines better from the standpoint of, you know you always are going to have some idle time and want some backup for machines, but that’s why we also have our on-demand parts service that we build parts for people, it’s not just prototype parts in some production, but it’s overflow or recovery for printers that have gone down, which allows them to feel much more confident to use their machines more.

Ken Wong - Citi

Yeah. And I guess on the on-demand parts of your business, I get a sense that you guys probably have deployed kind of best practices there. I mean, do you feel that your service bureau customers are kind of at those levels, and kind of what might that gap be in terms of utilizing their equipment to kind of the best of its ability?

Damon Gregoire

Well, for us we have one advantage, our equipment that we put in there were the original equipment manufacturers, so it’s a much lower cost.

Ken Wong - Citi

Okay.

Damon Gregoire

So, we make a point of having excess capacity at certain times in there, because we don’t -- we want to make sure we can service the customers when they need, and it doesn't cost us much to have it, but we are able to utilize our network throughout the country and throughout the world as one of the larger service providers as opposed to some of the smaller ones at certain locations.

So we get -- we know if we get an order for a part, an independent service provider may have to start up a machine to build one part, where we know our location in Seattle is just about to have a machine take off, take it on that (inaudible)platform with the other 20 parts that are there, which makes it much more cost effective for us, but we also want to make sure at all the times we have capacity and we have the newest capacity, so we always are putting our newest technology in the service bureaus also.

Ken Wong - Citi

Yeah. Got you. Okay. So kind of going back a little bit on the industrial market and kind of how big that can get, I think some of the criticism I hear that you guys don’t have as big of a big focus on metals, and you guys do have some metal capabilities and that seems to be what everyone associates with kind of that next leg of growth. Could you help us understand kind of how your customers are using it, kind of how you can -- kind of what your response is to that particular line of criticism?

Damon Gregoire

Yeah. It’s a good question. We've been involved in metals for the last couple of years through a private label agreement that we had, and we did it to put our [tail] (ph) in the water to learn about metals, and we are pretty glad we did, because we probably would have (inaudible) before.

But come about -- just about a month or so ago, we purchased a metals company Phoenix in -- Phoenix Technologies in France, which is a great metals company that we believe, we have already integrated into our sales network and in our operations network.

But the bigger part of this is, metals is good, metals is important, but the plastics in the foundry process is just as important, and you need both of them to operate in the manufacturing environment. And one example I will use is jet engine manufacturers are now looking at metals machines to print certain fluid valves.

Ken Wong - Citi

Yeah.

Damon Gregoire

Right. And that’s the metals machines work, but if you look at turbine blades that go in the jet engines, they’re really moving more towards the foundry process which they use and build out of acrylates or waxes on our other plastics machines that go in there. So, it's not really a process that is applicable or efficient for the metals parts right now, so you need both of those to do this and both of them are huge opportunities.

Ken Wong - Citi

Yeah.

Damon Gregoire

So we are investing in both areas.

Ken Wong - Citi

Got it. And then perhaps you can help us understand the competitive landscape today, I mean, right now it seems like from what I can gather, there are multiple machines from multiple vendors across a variety of customers, kind of how do you see the competitive landscape shaping out over the coming years? Does it get more intense or does is it still remain a fairly kind of benign environment?

Damon Gregoire

Right now and for the foreseeable short-term, I really envision the space as being wide open as far as -- the direct competitors, what we are doing is replacing, displacing, and augmenting traditional manufacturing methods, and we are still nascent in that space.

So, I am not interested in taking a percentage or a couple percentages of market share from my direct competitors than taking it from me, I mean, I am interested and it’s all growing nicely, and I also think it’s important to have more than one competitor grow in this space at this time to get people to really pay attention to the space, trust in the space, that is not just one person that might not be here.

That being said, we are still growing very quickly in the faster side of these. We believe that our business model is set up for us to deal with a competitive environment as we move forward, and it’s beyond just again the direct competitor that’s into our software business, and how we can help design and create and build that goes from design all the way to displacing the traditional manufacturing method. So, that might eat up a little bit, but I think we are well placed to get there.

Ken Wong - Citi

Got it. And I guess, let’s maybe circle over to the consumer side of the market, it’s -- you guys have been pushing your Cube device for just about two years now. Perhaps help us understand kind of how that market has evolved, how you think that that market -- kind of what’s been holding back that market and kind of what gets you over the hurdle in that particular market?

Damon Gregoire

All right. We are excited about the consumer area. (inaudible), I think one of the misconceptions sometimes about 3D Systems is we are talked about as being a consumer company, but our roots are in industrial, and that’s what is driving our profitability at this point and allows us to fund some of the consumer.

We believe that consumer can take off in the next period if everything worked on we did what we needed to do, sowhat we are excited about it is we pushed our price points down to $1,299. We believe our next version will be under $1,000, next version after that under $500, so pricing has been one of the barriers.

Ken Wong - Citi

Yeah.

Damon Gregoire

For the consumer use, but we also have our CubeX product which start at $2000 and sort of ranges to $4000. And that has a lot more functionality to it, including multicolor, not full color, but multicolor and numbers of different materials that (inaudible) lot in education and everything too.

The biggest barriers to this besides the price coming down are what do I do with it, because you are not having expert users and engineers that want to use this machine, you have children, and you have young adults that need the ecosystem around it, including we have our Cubify site, which not only can you share files and download files to build, but there are easy applications to have fun and to build with.

For instance, if you have one of these and you have a daughter that was having a birthday party, you can go and do an app that did a crown or did jewelry or something that you could total personalize for every child that was at the party without -- and an eight year old can do this. That’s a lot easier than having to go into a CAD package to design these or finding a file just to download and print out the way it is.

Ken Wong - Citi

Yeah.

Damon Gregoire

So the ecosystem I believe is what will help to really drive adoption to the consumer world.

Ken Wong - Citi

Got you. And then, do you feel you guys have kind of the right ecosystem in terms of the asset from the software all the way down to let’s say you’ve got this repository of designs and do you think you are there to where customer -- I mean, consumers can buy Cube and feel fairly comfortable printing something out within the next 10 minutes, 15 minutes?

Damon Gregoire

Yeah. (inaudible) absolutely do that. I mean, it might take a little longer than 10 minutes to print some of the things they want, but within 10 minutes being able to take it out of the box and start to get it set up, and not feel intimidated getting it set up, and just as important with this is, there are certain things people are going to want to build that go beyond the capability of a home printer in a Cube or a CubeX.

But you also have the ability with our Cubify site is to have your files uploaded to our card printing service, and have them printed on higher end technology or full color or something and have that delivered to your house. So it goes -- it goes beyond just what you can print, but you can have things printed in much different details and levels too and have delivered to you.

Ken Wong - Citi

Got it. And on the consumer market, I guess, one of the things that I consistently hear is that it’s going to mirror the 2D printing market where you can have generic consumables come in. I guess, what’s your thought there and why doesn’t that happen in your particular market?

Damon Gregoire

I think you always going to have some people that ask for and push for certain things. But as long as you can build -- in my view, as long as you can build the utility into a printer, the ease of use for you’re not worried what you’re putting through it, how it’s going to work, how it’s going to print. There is a value to that, right.

I mean, it’s sort of get to the point with the 2D printers having to take the syringes and used to fill up those ink cartridges. And it was going to spill and then it never printed right and everything. So there is a value to fidelity that it offers. I sort of put this sort of in line with like an Apple with iTunes, right. I mean, people still use iTunes even though you can go out and get files for free, music and songs, but why do you do it? Because it works well with your iPad or your iPod. It’s going to sound good. It’s legal. It’s going to work right. There is a value to that too.

Ken Wong - Citi

And I guess, on that same -- in that same line of questioning, I guess, as it relates to your more production end machines. How do you protect against your customers using some generic materials and should we be worried that down the line you could have Chinese manufacture of lower materials, can push their way into your consumers?

Damon Gregoire

We found on the industrial side is, although there is always the -- there is a technical ways we stop or don’t have third-party materials going through us including RFID chips and cartridges that are smart cartridges that know when they are empty, avoiding warranties of third-parties are being done. The best way to do this, it mirrors the consumer in some way that you know what you’re getting and how it’s going to work.

But got to offer things that make people want to use this material. So speed is very important on the industrial side. It’s one of the most important things. It’s not just the printer that offers the speed, it’s how the printer and materials interact together. So that’s faster.

You get better recyclability, lower down time, higher yields. If you can offer all of that, the packets that you are talking about the industrial, here is what my machine costs, here is what my material costs, what is my return on investment for the whole package including the time it saves the bill. So you need to offer those advantages with the materials you’re offering than just to say it’s because you are closing your system.

Ken Wong – Citi

Makes a lot of sense. And then on the material, I guess, part of the benefits of this particular model these guys have is that they generate significantly higher gross margins than the systems. Help us understand kind of what that dynamic is, how that helps you guys drive margin expansion going forward?

Damon Gregoire

Yes. We’ve expanded our gross profit margin on materials, couple -- one and half years ago. Upper 50s% to about 73% right now on the blended basis and that’s really good return. It’s recurring revenue. And that’s been -- the upwards in margin has been due to a number of different things including manufacturing that we’ve done and then able to have in different locations, remove shipping but also new materials that we’ve put out and the quality that they offer that allows for premium.

That 73% sounds high in some ways but it also offsets some of the R&D that we do spend in materials, the million of dollars that it takes to develop a new material. So that’s what ensures our customers that we’re going to continue to keep the R&D efforts to give them materials that they may want in the future.

Ken Wong – Citi

So I guess maybe just dial back on the margin expansion story, I mean, is it purely a matter of the revenue mix going to more recurring. Is there the opportunity for you guys to expand margins within the materials mix, within the system sales, how should we think about that?

Damon Gregoire

Our margins have been expanding in all of our categories. We have some margin targets that we want to hit on the blended basis that were based on a certain mix. And even with the adverse mix that I say we have where our hardware, our printers have been accelerating at a faster rate, which is a good thing right now. And those are sort of the middle-to-lower margin type of products.

We’ve been able to expand our overall gross profit margin to almost 52% -- 51.8%. Our targets are 56% and then 60%. So even with the adverse mix, we’ve been able to do that because we’ve been able to expand our materials margins. We’ve been able to expand our printer margin from the upper 20s to the lower mid 40s.

Our service margin we broke down into our paid parts business which is now in the sort of the low and mid 40s to our traditional break and fix service margins which are 48% to 50% and rising. So all of our categories are rising. It is really more of a mix issue to get to the overall target that we wanted to.

Ken Wong - Citi

Got you. And maybe we’ll step back a little bit and just kind of talk about some, I guess, some pushbacks that I have been getting in terms of the opportunity here. I guess, one of the things I consistently hear is that you’re never going to be able display traditional overall manufacturing. And like you said you guys are slowly kind of doing that piece by piece but obviously it’s still -- you guys are still, long way to go. Can you help us understand how you guys think about that longer term opportunity? Where do you think you guys can get to in terms of displacement of traditional manufacturing techniques and machines?

Damon Gregoire

I mean, you’re never going to displace it all, you are never going to replace it all. There are certain things that fall right into the, sort of, wheelhouse of this type of technology. And those are things that are organic shapes or one that that you are producing many of them with slight variances to differences like in dental and medical. But then other areas that that required jigging in fixturing in assembly that might have small variations, unintended variations by having manpower do it versus having them printed.

So we intend to keep and we believe will keep moving on in that area, but again its not going to displace everything. But if you look at our used cases now, such as in medical, one of our line technologies printed 17 million aligners last year and there. They printed based on the moles from our technology.

98% in the year, hearing aids, you see worldwide are printed on 3-D systems printers. That was a real push to try to get in to those hearing aid companies about six and seven years ago. The difference is now as we have companies coming to us from the sea levels suite, asking how do I use this type of technology. Help me learn to find this out.

It used to be, you go into an organization, you’d start with an engineer and you have to have him get a champion within the company to want to buy the technology and implement it. Now you have -- the paradigms are turned on the pad right? Where the tops pushing down the side, you figure out the way to use this. So it’s a little bit different, a little bit easier. And another example, I talked about dental is pick up any dental trade magazine now and they talk about digital dentistry and what they are doing for all that and it’s not just that the lab wants to do it because it’s quicker, to get things out. The dentist wants to use digital dentistry for crowns and everything because he can get five or 10 more people a week through his chair and get more money and then us as customers would rather have (inaudible) in the mouth when we’re getting your crown done and then sit there for 10 minutes choking on their group [estimates]. So it is a real pull all the way through.

Ken Wong - Citi

I mean, it does sound like there is very clear cut used cases, for some of these specialized industry such as dental. Do you see your technology expanding well beyond just this very specific nature where perhaps it is a high dollar item with very high level customizability, can this be a more broadly adopted technology maybe not to produce everything, but produce much broader subset of products?

Damon Gregoire

Yes. As we continue to move down the road and people wanting math customization of everything from clothes they wear to jewelry and cars they drive. I sort of envision getting products to a certain point that our maths produced and then customized at the end. Like one instant, maybe you go into the Nike or the Converse store to buy your shoes and you pick out your shoe you want and they have a printer there that then has different designs or things that keep print and push until have as part of the shoe to walk out.

Or the automotive companies wanting to participate in the aftermarket, automotive industry where you go in and you get your Ford, but then you can have your initials put on the steering wheel and emblems put on the outside of the car, so having to go to the aftermarket person to do that. There is definitely differently things and there is so many things we haven’t even thought of yet right now.

Ken Wong - Citi

And then circling back on the consumer market, you guys -- you just indicated earlier that you guys have somewhat funded that with your more profitable industrial part of the business. I mean, is the consumer market a profitable venture, if not now, is it down the line?

Damon Gregoire

Definitely, will be and it is, I mean, but it’s not driving like our growth profitability wise. We funded it starting a couple of years ago, pre revenue and starting with revenue. But if we’re looking at this right now, I mean, our margins on our consumer printers are about our corporate average they are in 40s. Our margins on the materials are in the 70s for that too. So it is definitely driving gross profit margin and operating margin maybe not to a levels of some of the other areas but and the small numbers really just didn’t impact that’s the thing. You take a lot of units of 1299 to match $500,000 industrial unit.

Ken Wong - Citi

Got it. The last -- I would say last -- 18 months or so, you guys have been investing pretty heavily in your on-demand services business. What’s the motivating factor here? What’s the benefit to the company in terms of having your own internal service bureau?

Damon Gregoire

There is a lot of benefits. One is we understand even more so what customers are asking for in parts and materials and finishes. We’re able to use our expertise in the service bureaus to test new product. We’re able to be profitable and expand business obviously because we’re able to run this segment as a larger business as opposed to a smaller one that’s very concentrated cost. But even in a more importantly than that is when we started in the service bureau business on-demand parts business in 2009, we firmly believe that it would be added to the business, that people that end up buying parts come back and buy printers and people that buy printers come back and buy more parts.

And that’s really what happened. So, this is our best channel to the markets to sell printers, because you are independent third party service provider is definitely afraid of you selling a printer to the customer. But we have really found that the more people use this technology even in-house the more they continue to come and outsource because they get addicted to it and the value of that. So it’s done that also and you can tell because our printer revenue is increasing fast, but our parts revenue increasing fast too. So you think if it wasn’t that case one would suffer and that is not what’s happening.

Ken Wong - Citi

And you mentioned your partners, I guess how do they feel about you guys expanding your services business so quickly in the last 12 months, I mean, should they view as a competitive threat?

Damon Gregoire

Some definitely do. I mean, I am not going to lie. So everybody loved it, right. Some people didn’t some people did because we do run partners still. We have preferred service partners that we have programs with. But one of the things that we have been able to do now is when you have a number of small independent service providers, this space got commoditized too quickly.

So we have been in the process of decommoditizing this space. We have got branding our parts built on the newest technology built with this material. So people are now asking for those. And, the value chain and the value in the parts has been rising and that has helped some of the third parties now. So they are seeing some of that, they have been able to be a little more profitable at times too, although we are the big player in this space there for that now.

Ken Wong - Citi

Got you. And then with all your accessions into this particular space I think one of the things you guys pointed out or at least industrialists have called out that your AR has been – counter deals have been rising and your DSOs have been going up as well. Can you help us understand the dynamic here, kind of what happened, -- kind of why is it causing that particular trend and how we should we think about DSOs going forward?

Damon Gregoire

We have had an increase, I think in the end of the year of the first quarter DSO with 72 days and last quarter was 84 days. Some of it was acquisition related but the majority really was the timing of some sales, a large acceleration of sales in the last month of the quarter due to the expanding demand and also new product introductions which we believe will start to flush out over the next period.

The other part is we moved our sales intentionally and kept moving towards our reseller network more so than just direct sales which those resellers are given terms usually 30 to 45 days so that sort of falls into that. We expect our DSOs to start to come back and normalize a little bit over the next couple of periods to about 75 days and that’s what we are expected to be. And that was the biggest drivers to that.

Ken Wong - Citi

Got you. And then kind of back little bit on M&A, you guys have, I guess, have bought a pretty good number of companies in the last few years, mostly kind of more byte size, how should we think about your philosophy around kind of the build or buy arguments and what should we think about you guys targeting in terms of filling gaps in your portfolio?

Damon Gregoire

It is only about 37 since 2009. Some of those have been R&D acquisition and some have been revenue acquisitions. We definitely look and evaluate make versus buy every time, it would be, and living sort of in these exponential times you have to think about how quickly the make is to, right and how quickly you wanted their. But we are very -- we have been very good and diligent about what our purchase prices have been here too. So, it has been -- it’s been very accretive towards these acquisitions, but some of them, some of the things we’ve walked away from because it has been too expensive or what we could with ourselves.

Others like, to start the whole consumer part was -- October 2009, we bought a company called Bits From Bytes which is the whole -- which is driving our consumer kind of level that technology we buy. We bought that for less than $10 million versus the sales that just happened with Makerbot at $400 million. So, I think our timing was right on that is what I am saying and the buy versus make was a very good decision on that one and we are starting to get to where it is reportable income to us, kind of thing for that too.

So, we definitely looking where our gaps our. We have said - in the parts business it’s more geographical at this point, into Europe we said a couple of month ago that we would like to continue expand into the U.K., Germany, but then into China and Brazil we have already expanded into the UK a month -- a couple of weeks ago.

So we thought those others, we would like to expand into and then we would continue to invest in some of the software side, and then the medical side. You know one of the companies we invested in about a year and half ago was Bespoke Innovations and those -- that makes hands and wrist braces but we own the whole company, we own the scanning system. We own the whole value chain for these and those are being commercialized this half of this year. So, some of those, we wouldn’t be able to get to by starting from ourselves.

Ken Wong - Citi

Got it. I will pause you for a sec. I have got plenty other questions, but just wanted to see if anyone out in the audience wanted to (inaudible) something up here -- up here in the front. Bring the microphone around.

Question-and-Answer Session

Unidentified Analyst

I went to the 3D Printing (inaudible), my question is looks like the high-end you can protect yourself pretty well because there are lots of patterns and (inaudible) but the low end tried to sell the broader markets look like there is a lot of competition besides to augmenting other boost sale for $500. And my question is I think the space is commoditized very fast as you said but when you try to reverse that trend, but it seems to me that it’s against the natural force, it’s the price -- simply the fact that the price can go down, it’s a natural force which means it’s the technology already there and the competition already got the technology, how you protect yourself from that, at the low end?

Damon Gregoire

Well, that’s a really good question too but we have also said we -- we are lowering our prices to get down to those, but not at the expense of our gross profit margin. But the bigger difference is we are using our industrial expertise and everything to help build a better printer on the bottoms side and does more especially with the firmware and the software.

And on the flip side too, we actually used the customer user experience on the low end to help to make our user experience higher on the high end, but the biggest part of this still gets around the ecosystem, right. And how do you use that, I mean, I can give you the best printer in the world with materials for free but what are you going to do with that unless you are an engineer and a designer versus a very good eco system right.

I mean, and you need to be able to get file, share file, design files, but also again we believe that the apps that we have to help people design without even thinking about its all point click, drag and drop is a huge part of that too and that’s hard to build overtime. I mean, to start from, I mean a lot of these, the low -- low ends are starting from the machine but not having the other part of it and it takes some investment to get there too.

Ken Wong - Citi

Other one in the back there? Maybe just let me add on that, I’m just wondering if a lot of these lower end machines are coming from low cost regions like China, I mean have you guys considered to have outsource of production out to one of those areas or…

Damon Gregoire

We obviously and people talk about that, we have looked at that from -- before and what it is. But we firmly believe that this type of industry and everything is re-localizing manufacturing in the United States.

Ken Wong - Citi

Yes.

Damon Gregoire

And we are able to do this again, we are -- we are at $1299 and we are still in the 40s for margin as we go to a thousand and $500 we still think our gross profit margin stays the same and we would like to keep some of the jobs here in the U.S.

Ken Wong - Citi

Got it.

Rolfe Winkler - Wall Street Journal

Hi. Rolfe Winkler from the Wall Street Journal. I wanted to ask you about -- can ask you about ARDs and how you said that part of it is due to resellers becoming a bigger part of our business. You had some correspondence with the SEC earlier this year in which they asked you for more details on this being a component of your business and you guys said that sales through resellers is not material, less than 2%, could you help…

Damon Gregoire

No. What we have said was that was a different question. The 2% was -- that wasn’t sales to resellers, that was..

Rolfe Winkler - Wall Street Journal

Inventory maybe?

Damon Gregoire

It was there in -- yes, there is…

Ken Wong - Citi

Inventory levels.

Damon Gregoire

Is there difference.

Rolfe Winkler - Wall Street Journal

Yes.

Damon Gregoire

Sale -- our sales to resellers are very high, but we don’t sell -- that had to do with stocking of inventory to resellers and we don’t stock in inventory to resellers. Most of the time they are buying to ship to customers or it’s very normal for us to ship on a resellers to perhaps like to end customer. But we have been moving for the last couple of years to selling more through reseller network than we have it, it has been the same.

Rolfe Winkler - Wall Street Journal

There is some concern about that that maybe there is a lot of printers getting into the channel…

Damon Gregoire

That’s been the question that…

Rolfe Winkler - Wall Street Journal

(Inaudible)

Damon Gregoire

That is, that is…

Rolfe Winkler - Wall Street Journal

You still buying demo units and that whether or not they are going to be able to sell those units.

Damon Gregoire

That question was specifically around them having inventory not demo units.

Rolfe Winkler - Wall Street Journal

But as far as demo units, is the build up of demo units and does that have anything to do with the increase in receivables?

Damon Gregoire

Not more than any thing else, I mean, demo unit is a regular thing that all of our resellers have done for the past 10 years, where they buy and sell them or they turn them over after a period of time. So that wasn’t…

Rolfe Winkler - Wall Street Journal

So you do have a new distributor though -- distributor relationship with Synnex for instance and they are expanding their reseller network a lot more quickly recently. Correct?

Damon Gregoire

No. I mean, Synnex, those one like Synnex, Hawkwood, Staples that really didn’t impact the first half of the year at all.

Rolfe Winkler - Wall Street Journal

Okay.

Ken Wong - Citi

Okay. Any others? Well I think you guys just recently reported Q2 results you guys gave fiscal year guide which I think has not gotten some push back in terms of how do you guys get to the $5, $15 earnings guidance you guys put out there. It does suggest that you guys have to really accelerate your margin expansion in the next two quarters and perhaps kind of just walk us through the puts and takes there and how we get comfortable with your back half guidance?

Damon Gregoire

I mean, the couple of the big areas on the pay parts business we believe, we are able to continue to expand the margin there and the materials which we talked about what materials gross profit margin is we believe that our materials growth rate expands in the second half of the year.

Ken Wong - Citi

Yes.

Damon Gregoire

Excuse me, and then our software business continues to expand in the second half of the year which is even higher margin for the materials at this point. So, margin expansion is the biggest part of that.

Ken Wong - Citi

Got it.

Damon Gregoire

Then you have talked about the OpEx to the R&D sort of remaining that 6% to 7% of revenue. But then the SG&A number to come down as a percentage of revenue remain flatter or even come down in total at some -- to get down to those numbers.

Ken Wong - Citi

And I guess from the SG&A side I assume that’s kind of mostly sales but at the same time you guys are -- you guys are trying to accelerate the topline, so I guess kind of how do you -- how does that number kind of trend lower, kind of what’s…

Damon Gregoire

Well there is some, it has been some -- some concentration of spending that was in the first half of the year for certain marketing events and everything that had happened there -- that we have control over. But the other part is we were just talking about the reseller network and more sales going to the reseller channel, that being the case.

The reseller, compensation so to speak is captured in the revenue line because you are discounting it there as opposed to paying commissions to all of your sales people that stands up in the SG&A line. So the SG&A line doesn’t go up nearly what the revenue line would go up with the new models, I mean moving into model that we are.

Ken Wong - Citi

Got you. I will kind of pull the audience one more time, see if there is any other questions, okay. I think we might be done, our last minute. So I guess I will toss out one last question. So as I guess as we kind of look out specific to kind of the consumer opportunity, you guys have talked about getting $500 machines out there, I mean do you feel that I mean last I heard there is roughly comes to 35,000 to 45,000 machines sold in 2012 on the low end personal side. I mean do you think the $500 price point is sufficient to really accelerate that number to double. Is that something that gets what, what percentage of households do you think start to look at that device at that price point?

Damon Gregoire

I mean, I can’t talk the exact numbers or that but I think it does accelerate it drastically. But not only for households but for schools, in education, also it becomes as you know much more of an easy discretionary spend at $1299.

Ken Wong - Citi

Got it. I think with that I will wrap it up. Thank you, guys.

Damon Gregoire

Thanks.

Ken Wong - Citi

Thanks for coming. Thank you guys for showing up.

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