3D Systems (TDSC) Q4 2007 Earnings Call March 18, 2008 9:00 AM ET
Abe Reichental – Chief Executive Officer
Damon Gregoire – Chief Financial Officer
Andy Johnston – Assistant General Counsel
Jeff Rosenberg – William Blair & Company
Bill Gibson – Nollenberger Capital Partners
Eric Martinuzzi – Craig-Hallum
Cliff Ransom – Ransom Research, Inc
James Mullins – DL Carlson Group
(Operator Instructions). At this time, I would like to turn the call over to Chanda Hughes with 3D systems. Please go ahead ma’am.
Good morning and welcome to 3D systems conference call. I am Chanda Hughes and with me on the call are Abe Reichental, CEO; Damon Gregoire, CFO; and Andy Johnston, Assistant General Counsel.
The audio webcast portion of this call contains a slide presentation that we will refer to during the call. Those following along on the phone who wish to access the slide portion of the presentation may do so via the web at www.3Dsystems.com/ir.
Participants who would like to ask questions related to matters discussed in the conference call at the end of the session, should call in using the phone numbers provided here on slide 3. The phone numbers are also provided in the press release we issued yesterday. For those who have accessed the streaming of webcast, please be aware that there is a three-second delay and that you will not be able to pose questions via the web.
Before I begin this discussion, I would like to preface our presentation today with a statement regarding forward-looking information. Certain statements made in this presentation that are not statements of historical or current fact are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements may involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance, or achievements of the company to be materially different from historical results or from any future results expressed or implied by such forward-looking statements.
In addition to the statements which explicitly describe such risks and uncertainties, readers are urged to consider statements in the future conditional tenses, or that include the terms “believes,” “belief,” “expects,” “estimates,” “intends,” “anticipates” or “plans” to be uncertain and forward-looking.
Forward-looking statements may include statements as to the company’s beliefs and expectations as to future events and trends affecting its business. Forward-looking statements are based upon management’s current expectations concerning future events and trends and are necessarily subject to uncertainties, many of which are outside the control of the company.
In particular, the factors stated under the headings “Forward-Looking Statements,” “Cautionary Statements and Risk Factors,” and “Risk Factors” that appear in the company’s periodic filing with the Securities and Exchange Commission, as well as other factors, could cause actual results to differ materially from those reflected or predicted in forward-looking statements.
At this I would like to introduce Abe Reichental, President and CEO.
Good morning, everyone and thanks for taking the time to listen to our call this morning. Yesterday, we filed our annual report on Form 10-K with the SEC, and issued a press release with our operating results for the fourth quarter and full year of ’07. We’re pleased to share with you these operating results this morning.
Our revenues for the fourth quarter was a record $44.9 million and while on the face of it, the increase over the fourth quarter of ‘06 was 6%, it should be noted that the ‘06 fourth quarter was heavily influenced by the corrective actions that we took in the latter half of ‘06 to remediate the distractions that we experienced earlier this year.
At the end of ’07 our backlog was $3.1 million primarily from system sales that we expect to complete in 2008 compared with $5 million at the end of ’06. We believe that the December 31, 2007 level backlog is higher than the normal operating trends at all our businesses. As we have told you before, our business is generally not dependent on backlog.
Operating income increased to $1.4 million for the fourth quarter reflecting higher revenue and improvement in our gross profit and operating expenses reversing a $5.3 million operating loss in the fourth quarter of ’06.
However, let me say that while our gross profit margin exhibited some improvements and our operating expenses began to decline and to resume a more normal run rate, I’m disappointed with the slower-than-expected improvement in both categories.
Net income available to common stockholders increased to $1.4 million reversing the $6 million net loss in the ‘06 quarter. And net income per share was $0.06 on a fully diluted basis for the fourth quarter of ’07 reversing a loss of $0.31 per share on a fully diluted basis in the ‘06 quarter.
For the year, revenue increased by 16% over $21.7 million to a new annual record of $156.5 million. This revenue increase included a 25% increase in revenue from systems and other products to $58.2 million and a 19% increase in revenue from materials to $62 million. Gross profit for the year increased by $17.2 million to $63.5 million. Gross profit margin increased by 6.2 percentage points to 41% of the revenue.
For the year, our operating losses declined by 80% to $5.1 million from $25.7 million in ‘06, while net loss available to common stockholders declined by 78% to $6.7 million from $30.7 million in ’06, primarily reflecting lower income tax provision and the absence of the preferred stock dividends in ’07.
As a result of the positive quarterly trends that we experienced during the year and net income that we reported in the last six months of the year, loss per share in ’07 declined by 81% to $0.33 per share on a fully diluted basis from a $1.77 per share on a fully diluted basis in ’06.
I would like to spend a couple of minutes on material revenue growth. We believe that the continued shift within key components of our annual revenue clearly reflects results from the significant business model changes that we embarked on some 24 months ago. Consistent with our expectations, materials revenue reached a new record of $62 million and represented some 40% of our total revenue. And because we believe that systems placements are a pre-curser for additional materials revenue in future periods, we’re pleased that for the full year ‘07 revenue from systems increased by 25%.
For 2007, our revenue from materials grew by 19% reflecting we believe the positive marketplace reception and traction that our new systems and materials are enjoying and the early traction and underlying momentum from our integrated materials cartridge strategy. We are gratified that for the full year 2007, approximately 45% of our revenue was generated by new products underscoring our significant portfolio transformation and strong emphasis on marketplace leadership through technology.
During the past three years, we have been able to develop and commercialize some 36 new products and at the same time, prune and retire numerous legacy systems and materials. The net result is beginning to emerge more clearly we believe, as our key revenue components shift more decidedly in favor of materials and systems and our service business revenue is stabilizing and its profitability is improving,
Before I turn the presentation over to Damon, I would also like to give you a brief update on Tangible Express. As you may have already heard during the latter part of January of this year, ’08, Tangible Express filed suit in Salt Lake City against 3D Systems claiming more than $4.3 million of damages on various theories. Subsequently, Tangible Express announced that it was closing its doors and no longer providing prototyping or fractional ownership services. Concurrent to that announcement, Tangible Express began offering its equipment for sale and advertising it on the Internet.
On February 29 of this year we issued an 8-K announcing that we purchased certain equipment from Tangible Express for $5.3 million. In connection with that transaction, Tangible Express paid us approximately $638,000 covering the net amount of accounts receivable that it owed us. We also entered into a settlement and release agreement with Tangible Express in which both parties agreed to a general release of all claims against the other.
Let me say that we deeply regret that the innovative fractional ownership business model that Tangible Express pioneered did not gain further traction in the marketplace. And at the same time, we’re pleased that we’re able to arrange a settlement with Tangible Express along commercial lines. During 2007, Tangible Express represented less than 5% of our annual revenue and therefore, we believe that the loss of recurring revenue from this activity will not be detrimental to our future growth plan.
Now for a more detailed look at our 2007 financial performance I will turn the presentation to Damon Gregoire, our Chief Financial Officer. Damon.
Good morning everybody. As you can see on slide 12, revenue from systems and other products increased by $11.7 million or 25% to $58.2 million for 2007 from $46.5 million for 2006, and increased to 37% of consolidated revenue in 2007 from 34% in 2006. This increase was derived primarily from a $10.6 million increase in sales of our newer systems and services; the $4.3 million favorable combined effect of changes in product mix and average selling prices; and a $2 million positive impact from foreign currency translation. This was partially offset by a $5.2 million decline in legacy system sales.
Revenue from materials continued its double-digit rate of growth and increased by $9.9 million or 19% to $62 million for 2007 from $52.1 million for 2006. Materials revenue increased to 40% of consolidated revenue in 2007 from 39% in 2006. Materials revenue volume from our legacy products and new products increased $1.8 million and $5.7 million respectively. Materials revenue was also aided by the $2.3 million positive impact to foreign currency translation and a $200,000 positive impact of the combined effect of price and mix.
Revenue from services was essentially flat for 2007 compared to 2006, and declined to 23% of consolidated revenue in 2007 from 27% in 2006, reflecting the effect of the growth in revenue from systems and materials in 2007.
Declines in volume of legacy services in 2007 almost completely offset the $2.8 million increase in new services and the $1.3 million favorable impact to foreign currency translation on service revenue.
On a geographic basis, US and Europe contributed to our higher level of revenue in 2007. Asia-Pacific revenue declined by less than $100,000 compared to 2006 caused primarily by a $1.1million decline in volume and a $0.1 million of unfavorable foreign currency translation that more than offset the $1.1 million favorable combined effect of price and mix in the Asia-Pacific region and reflected a similar trend that we experienced in 2006.
On slide 13, you can see that on the consolidated basis we experienced improvement in our gross profit and gross profit margin in the fourth quarter of 2007. Gross profit for the fourth quarter of 2007 increased by $2 million to $18.1 million from $16.1 million in the fourth quarter of 2006, increasing to 40% of revenue from 38% of revenue for the 2006 quarter.
These improvements primarily were a result of our higher revenue in the period, relatively lower increases in cost of sales, absence in the ’07 period of the business disruptions that reduced ’06 margins, and a higher service revenue and profit margin in that period.
We also experienced strong improvement in our gross profit and gross profit margin for the full year of ’07. On a consolidated basis, our gross profit for 2007 increased by $17.2 million to $63.5 million from $46.3 million for 2006. This gross profit margin increase to 41% of revenue from 34% of revenue for the ’06 period is attributable to our higher revenue, the relatively lower increase in our cost of sales, and the absence in the 2007 periods of the business disruptions, challenges and customer accommodations that adversely affected our profitability in the 2006 periods.
Gross profit from our products and services both contributed to the increase in our gross profit for the ’07 year. Product gross profit for the year increased by $15.2 million or 39% to $54.5 million from $39.3 million for the 2006 period while gross profit for services for the same period increased by 29% to $8.9 million from $7 million for the full year of ’06.
As you can see on slide 15, operating expenses declined by $4.7 million to 37% of revenue in the fourth quarter of ’07 from the fourth quarter of ’06 reflecting lower operating expenses in the absence of restructuring costs that the company incurred in 2006 for its relocation to Rock Hill.
As one of our business objectives, we are working to manage our operating expenses to be in the range of 30% to 35% of revenue as our business grows. However, there can be no assurance that we will achieve this objective. In 2005, our operating expenses declined to approach the top of this range but our SG&A expenses in particular rose disproportionately in 2006 due to the business disruptions and challenges that we’ve experienced in 2006 along with startup of our new ERP system and costs associated with the restatement of our financial statements, the remediation of previously disclosed material weaknesses, and these expenses continued through part of 2007.
We believe that our quarterly operating expenses have begun to resume a more normalized run rate and we expect our SG&A expenses in 2008 to fall in the range of $44 million to $52 million. We understand this is a broad range. Although we experienced a reduction in our SG&A costs in the second half of 2007, we are committed to try to reduce our costs in the range noted above in a responsible manner which will recur over time instead of immediately.
For the full year, operating expenses decreased by almost $3.4 million to $68.6 million compared to the 2006 period. These higher operating expenses were primarily due to higher SG&A expenses that we incurred through the first six months of ’07 for reasons mentioned on slide 15.
R&D costs were higher for the fourth quarter and full year ’07. We had $1.7 million of assets at December 31, 2007 consisting of $600,000 of capitalized software, $400,000 of capitalized equipment, and $700,000 of inventory related to the development of our V-Flash modeler. We continued to work on a variety of new product developments and we expect to incur approximately $13 million to $14 million of research and development expenses for 2008.
We benefited both in the fourth quarter and full year ’07 from the absence of a restructuring cost that we incurred in ’06 periods primarily for our relocation to Rock Hill which reduced our ’07 operating expenses by $1 million in the fourth quarter of ’07 and by $6.6 million for the full year of ’07.
We continued to improve our management of inventories and accounts receivable. Inventories, which amounted to $26.1 million at the end of ’06 declined to $20 million at the end of ’07. Accounts receivable net decreased by $3.4 million to $31.1 million at December ’07 from $34.5 million at December 31, 2006. This decline was primarily attributable to the timing of collections which resulted in a reduction of days sales outstanding to 64 days at the end of ‘07 from 74 days at the end of ’06. We expect to continue to reduce our DSO with the objective of maintaining it at or near our historical range between 59 and 63 days. We expect to reduce our inventories further during ’08 toward a longer-term target of $15 million.
We ended the fourth quarter of ’07 with $29.7 million of unrestricted cash compared to $14.3 million of unrestricted cash at the end of ’06. This increase resulted from $14.7 million of cash provided by financing activities, $2.6 million of cash provided by operating activities, and the favorable $300,000 effect of exchange rate changes on cash that were partially offset by $2.2 million of cash used in investing activities. Cash provided by financing activities included the $20.4 million of net proceeds from a private placement of common stock in June ’07, and net proceeds from stock option exercises and equity compensation which were partially reduced by a repayment of $8.2 million of bank borrowing in July ’07.
During 2007, we reduced our indebtedness by $24 million. This resulted from a conversion of the remainder of our 6% convertible subordinated debentures into common stock and our voluntary prepayment of our Silicon Valley Bank revolving credit facility that we chose to let expire on October 1. On a goingforward basis, we elected not to renew the revolver with SVB, expecting that we may able to negotiate more favorable terms in the future as credit conditions and our performance improve. In the meantime, with our strength and cash position and operating performance, we do not believe that we will have a need to make bank borrowings in 2008.
For the year ending December 31, 2007, we generated $2.6 million of cash from operating activities. Net cash provided by operating activities was $10.2 million in the second half of ’07, reversing a $7.6 million cash used in operating activities through the first half of ’07.
The principal changes in non-cash items that favorably affected operating cash flow included $6.9 million of depreciation in amortization expense and $2.7 million of stock-based compensation expense.
Net cash provided by financing activity increased to $14.7 million in ’07 from $10 million in ’06. This ’07 increase resulted primarily from $20.4 million of net proceeds from our private placement of common stock in June, partially offset by the $8.2 million repayment of our revolver.
Our total outstanding debt and capitalized lease obligation decreased to $12.2 million from $36.1 million at December 31, 2006 primarily due to the conversion of all our outstanding 6% convertible subordinated debentures into common stock during ’07, our voluntary repayment of all outstanding borrowings under the Silicon Valley Bank facility, and scheduled payments of principal on our outstanding industrial development bond that covered the Grand Junction facility. We’re still planning to sell the Grand Junction facility and then the remainder was on the capital lease of our Rock Hill facility.
That concludes my comments. Abe.
Thanks Damon. Before we begin the question-and-answer session, I would like to spend a few minutes to review with you recent developments in business and how we see them contributing to our growth and profitability.
First with regard to the state of the business, we believe that having completed our vigorous transformation that took us about six quarters we are emerging as a stronger, more stable, sustainable, scalable business. We believe that the residual effects from the significant business setbacks and disruptions that we experienced in the course of implementing our strategic initiatives in 2006 are now completely behind us.
Annual sales level for our systems and materials suggest that the demand for our new product is strong. As a matter of fact, in the course of ’07 we enjoyed the repeat sales of Viper Pro and Sinterstation Pro systems to early adopters which we believe indicates marketplace confidence in them and a preference for them.
With that said, we believe that our growing install base coupled with the integration of our new systems with proprietary materials cartridges should improve over time the profitability of our business and revenue for materials continue to outpace the growth in systems. As such, the stability of our revenue base should improve as considerable sales raises the percentage of the product mix relative to systems.
At the end of ’07 we have successfully remediated all of our previously disclosed 2006 material weaknesses and significant deficiencies except for two remaining items related to inventory. We urge you to carefully read item 9(a) in our recently filed annual report on Form 10-K for additional details on our remaining weaknesses. We plan to vigorously remediate these remaining financial control weaknesses and achieve state of the art financial control procedures and processes.
We’re gratified with the progress we’re making with reductions in inventory and days sales outstanding and believe that our stronger balance sheet enhances our financial strength and flexibility. We continue to transform our company in the way we do business to achieve a strong record of sustained growth and profitability for several opportunities and initiatives that we have initiated over the past few months.
Let me spend a few minutes giving you a V-Flash update. We believe that the film-transfer imaging technology that we developed from the ground up during the past three years for use in our fast and affordable V-Flash desktop modeler may be one of our most significant new product developments. We believe that over time, V-Flash has enormous potential to enhance and accelerate our recurring business model substantially. That is why, notwithstanding the fact that we unveiled the system at our inaugural world conference this past September and immediately commenced with reseller training, we subsequently decided to delay our planned year-end system placement by a few months in order to resolve certain performance issues that surfaced during this period and to take advantage of additional opportunities to simplify and enhance the system.
We did so because we want to make sure that V-Flash and subsequent systems launched off of our film transfer imaging technology platform are squarely in the upside column and do not get into the market before their time.
As we have said all along in previous public disclosures on this topic, we have been cautious and deliberate in the way that we have been approaching and conducting the introduction of this system into the marketplace. I’m pleased to share with you this morning that in line with that, we have resolved the causes for our previously announced rollout delays and have commenced over the past few weeks with selected shipments to hearing aid customers. Also consistent with our expectations, our initial hearing aid customers have favorably received the product.
Late last week, we informed our trained resellers that we plan to commence selective generalpurpose reseller shipments before the end of March of this year and we plan to continue our deliberate, cautious managed phased rollout approach for the middle of ’08. As we have said on several occasions previously, due to the relatively low price per unit and our carefully managed rollout plans, we do not anticipate V-Flash to be a material revenue contributor during 2008, but it may slow down our anticipated gross profit margin improvement for several quarters until such time as the recurring revenue form V-Flash material reaches a critical mass.
Let me move on to another new and exciting product that we launched recently. In January of this year, we announced the launch of the high-definition, high-end 3D printer as the ProJet HD3000. This is our next-generation multijet modeling system that we leveraged all of our extensive multijet modeling technology platform. This new product is slated it to be a successor to our InVision system. It packs powerful features and benefits that we believe are ideally suited for the professional design and professional manufacturing environment.
Specifically with this machine, we believe that we’re bringing to the marketplace unique performance differentiators like improved productivity, better accuracy, enhanced quality and greater flexibility in everyday usage. We believe that part its unique capability is its ability to make direct castable products in the sense that it can make not only parts and models, but it can also make sacrificial patterns for use directly in the investment casting process.
Another of the unique features of this system is its ability to nest or stack parts on top of one another in the Z axis direction. This is a unique capability. It is not available in any other 3D printer of its kind. It is particularly relevant and significant to users who want to run unattended operations overnight and over a weekend and it is ideal for customers like jewelers and dental labs that actually make oneforone sacrificial patterns that go into their precious metal casting operation. The more patterns they can stack onto one single batch, the more productivity they get out of the machine. This, we believe, is a unique capability that will serve our intended customer base quite nicely.
Additionally, we’re introducing with this machine enhanced accuracy. Enhanced accuracy not just because the machine is capable of making very delicate and very fine details, but also because of the unique melt-away support system that we have that does not in any way harm the surfaces of the parts.
And finally, we’re introducing this system with enhanced, bestinclass feature detail capability. There were many additive manufacturing products out there in this class but I do not know very many of these can deliver the kind of featured detail that our new ProJet HD3000 is capable of. We believe that the availability of this system and its more recently introduced companion the ProJet Dental Professional 3000 System has the potential to be important contributors to our revenue growth in ’08.
Let’s move on to slide 23 and talk about a new direct metal capability that the company announced on February 4th of this year when we announced that we entered into a private label arrangement with MCP Tooling Technologies and would, with immediate effect, bring to the market two new systems, the Sinterstation Pro DM100 and the Sinterstation Pro DM 250 SLN Systems, direct metal manufacturing systems that build fully dense parts for end products, prototypes, and tools. These systems reliably build highly complex metal parts with high resolution. With this alliance, we are expanding the reach of our manufacturing solutions and entering new market applications. We expect this tuck-in activity to be accretive to our longer-term target operating model and to have the potential to be another important contributor to our revenue growth starting with the second quarter of this year.
In line with these systems, we created some new DuraForm Metal material for the Sinterstation Pro laser melting systems consisting of six mainstream metals including aluminum for aerospace and automotive, a titanium material for medical and dental applications, a cobalt-chrome material for dental, stainless steel material for general-purpose parts, and tool steel for tooling applications.
We expect to sell these new systems into the general purpose mechanical parts manufacturing applications, as well as aerospace, wind tunnel, and end use parts. We also expect that these systems will have a significant role in extending our dental solutions portfolio and footprint. Finally, we expect that these systems will be used for conformal cooling of injection molding parts.
I would like to spend a few minutes talking about our activities within the digital dentistry arena, starting with a little update on our projects with the 3M. As you know we’re gratified that our Viper-Pro system was selected as the manufacturing platform of choice for a 3M venture dental study model leveraging their new Lava Chair Side Oral Scanner. And we believe that 3M anticipates rolling out their solution during the second half of this year.
During the mid-winter Lab Day in Chicago, which is a significant dental industry event that took place several weeks ago, 3M ESPE shared this intent to further expand the Lava platform to provide multiple materials and indications for lab and dentist customers, including wax and resin patterns, laser sintered metal, and other custom implant solutions.
To meet this goal, we understand that 3M plans to selectively open the Lava Scan ST Design System so it can work as a front end to other production systems. In line with that, we expect to benefit from this initiative by selling our ProJet VP Systems into the Lava Network as required.
Moving ahead to slide 25, we are also excited about our partnership with Sirona Dental Systems. As you may have already heard or read, Sirona recently announced that it began to offer anatomic wax patterns to it’s lab end users through its infiniDent service using our InVision and ProJet dental professional 3D modelers. Sirona advertises the infiniDent inCoris wax patterns as the most accurate, consistent, and economical way to fabricate wax patterns and we are grateful to play a small part in their success.
At the recent mid-winter Lab Day event in Chicago, we also unveiled our new direct metal dental solutions. Our digital metal manufacturing solutions uses all cobalt chrome alloys, stainless, and titanium. It has precise material quantity control which equals no waste for these precious metals and our system provides high precision for digital technology resulting in less finishing than with cast products.
Reflecting on the progress we have made to date against our long-term objectives, including the fact that our first condition for success, revenue greater than $150 million annually has been met, and with the significant infrastructure we have put in place for growth and scalability, we believe that our long-term operating model which is displayed on slide 28 is achievable over time.
Finally, as demonstrated by our progress to date, we believe that we are continuing to turn the company around and place it on a solid, longer term sustained profitable growth path for meeting our customers’ needs, leading in innovation through technology, improving financial strength and flexibility, developing new products and categories, growing globally, creating new marketplaces for rapid manufacturing and 3D modeling solutions, and providing measurable value for our customers and stockholders.
We will now open the call to questions. We kindly request that you ask one question at a time and then return to the queue, thus allowing others to participate in the Q&A session.
Thank you Ms. Hughes. (Operator Instructions). Our first question will come from Jeff Rosenberg from William Blair & Company.
Jeff Rosenberg - William Blair & Company
You mentioned in your prepared remarks that the gross margins, while they improved, they disappoint you. In Damon’s prepared remarks there was more of a year-over-year comparison. Can you talk a little bit about what was the cause of the shortfall in gross margin?
Let me first say I am disappointed because we indicated in the past and have expectations over time that we will not only return to our historical gross profit margins but that we will surpass them. And the areas that are still weighing on our gross profit margins you know, have to be with the residuals from transfer between suppliers which were costly in the ’07 period and some of our residual inventory and price management issues that were still working to overcome
While we made progress in the fourth quarter and for the full year, I’m not satisfied with the rate of progress and I continue to believe, the company continues to believe, that once we get past some of these residuals from the shift in manufacturing suppliers and once we more conclusively resolve some of our inventory and price-related legacy issues we should be able to speed up the progress that we’re making.
I also would indicate, Jeff, and I think Damon was more specific about this, that when you look at things like price and the impact from mix within price those were favorable impacts for us. So we don’t think that we have any selling price issues or average selling price issues that are impacting this. We believe that this is squarely on the sourcing and supply-chain side of the area, which is we believe a challenge that is more easy to fix.
Thank you, and we’ll take the next question from Bill Gibson from Nollenberger Capital Partners.
Bill Gibson – Nollenberger Capital Partners
Good morning Abe. I want to zero in a little bit on materials which certainly seeing an improvement but it seemed to back off in the second half. Is that just playing out on a short-term basis or what’s going on there? Speaking as a percent of revenue.
Bill, as a percent of total revenue when you look at 40% of $156.5 million we think that was a respectable improvement and certainly, since we embarked on this journey at the end of ’03 we more than doubled our material revenue and at the same time obviously, grew overall revenue. We believe, Bill, that in the foreseeable future obviously as we place more systems the number of systems that we place now that more of the systems have integrated material cartridges within them, it becomes a precursor to future revenue sales but the selling prices of systems obviously are significantly higher on a per-unit price than the recurring revenue that comes with them. So if we sell a large frame machine in the range of say $400,000 to $600,000 that has an immediate substantial impact on total revenue and the recurrent revenue for that machine is going come in smaller increments.
We also believe that when we install large and small machines there is a lag time from the time that we sell it and ship it until the customer begins to put it on stream and run it 100% so that we can fully benefit from the recurring revenue stream. We believe that the trend that we’re seeing is consistent with our expectations. We also believe that we still, to a large extent have a very large legacy install base that is less predictable because these are all open systems and are susceptible to foreign materials and so forth. As that changes as the mix within the install base changes it towards a more closed system we have some expectations and beliefs that as that tide turns a little bit more we will see greater impact in our material revenue.
Our next question will come from Eric Martinuzzi from Craig-Hallum.
Eric Martinuzzi - Craig-Hallum
My question also has to deal with the gross margins. I know when we first started talking about a long-term target model was in 2004 and at that time, the expectation was for 50% to 55% on the gross profit. In the four years since we’ve first started talking about it, it’s really, and I’m going to throw out 2006, since we all know what happened in 2006 but it’s been between 40% and 45%. I’m curious, what is it that drives it to 55%? Because we just finished a quarter where it was 40% as well as the year. I typically think that Q4 is really a peak earnings quarter for you guys, and I didn’t see the flow through that that I was hoping for. What takes it from 40% to 55%? That’s a huge jump and I don’t see it, especially with doing things like reselling other people’s products on the metal side, you know a direct metal product, that is going to get you a reseller margin that would push it down.
I think, Eric it’s a good question and it’s a fair question. We have said all along that there are two fundamental conditions to achieving the 50% to 55% long-term target. The first is revenue in excess of $150 million, which for the first time as of the end of ’07 we passed through, we achieved. The second is more than half of the revenue coming from materials revenue. We have been working over the past period that you mentioned very hard and very deliberately to retire a bunch of legacy systems to introduce new systems and to significantly increase and grow our materials revenue business.
The way for us and the reason that we believe that we have credible expectations to achieve this kind of a higher gross profit margin stems from our belief that this is going to become, over time, a business that will have significant recurring revenues from materials in it. The second condition is that about half of the revenue or more will be generated from materials.
In the same period in question that you mentioned Eric, we doubled our materials revenue and we’re just in the last year, year and a half of the period that you mentioned. we just succeeded in launching a new generation of systems that reflected the strategy that we talked about in the previous period or periods of material cartridges.
With regards to direct metal systems and the fact that that would be a distributed product, that is all true but again for us, the emphasis over time even from the direct metal systems is going to be on materials. The exciting part for us, Eric, about systems like this, unlike other direct metal systems on the market today is that it has a very broad, tested, and proven portfolio of materials that as you’ve seen from the webcast are well-known, tested, proven, fully dense materials that we believe when we sell will be accretive to our long-term business model.
Our next question will come from Cliff Ransom with Ransom Research, Inc.
Cliff Ransom – Ransom Research Inc
Good morning. On V-Flash, Abe can you give a sense in the delays of where they came? Was it technology? Was it shifts in the voice of the customer? Did it relate to the Cannon contract manufacturing or to fundamental changes in your long-term market expectations?
Well it came primarily from areas that we discovered during the shakedown, and customer exposure, and internal exposure in terms of customer-related wants and complexity or simplicity of the system we felt that we could benefit from taking a pause and making some changes that could, we felt, significantly simplify and enhance the performance, quality and reliability of the machine and so we decided to take advantage of that.
It’s not really coming so much with any supply-chain kind of activities or contract manufacturing activities. Of course when you make a change it impacts your supply chain but the changes that we attempted to implement has to do more with our desire to simplify the system and enhance its performance. As we said previously, you know we felt strongly that a few-months delay is not significant or material to future results but that if we don’t do it right, it will be very significant and material to future results.
So in keeping with that deliberate approach, even though it was a humbling experience to say “Sorry, we have to delay” that was the right decision to make. We made it. We’re now cautiously and deliberately moving forward you know, as we advertised previously and we will continue to move in this cautious pace, probably well into the middle of this year to make sure that V-Flash is firmly and squarely in the upside column where it belongs. There is no change in that philosophy and so far so good.
Our next question will come from James Mullins with DL Carlson Group.
James Mullins – DL Carlson Group
It’s just been answered.
Thank you. Our next question will come from Pat O’Neil.
Good morning. I have a question about your settlement with Tangible Express. It seemed highly unusual that you would take back $5 million worth of equipment if in reality there was a sales contract for that equipment. Even if they were going into bankruptcy. Can you explain what kind of contract you had with Tangible Express and whether the $5 million write-off was reflected in 2007 operating results or whether that’ll be carried forward into 2008?
Well let me first correct two things. This is not a take back. This is a purchase of equipment. The sales contract that we had with Tangible Express were ordinary sales contracts. This equipment was paid for in full in the period that it was purchased with the exception of the remaining receivable on the more recently purchased system that was paid in part and subsequently settled as part of this transaction. This is a purchase of used equipment for the purpose of reselling it. It will be principally an inventory-related activity as we do from time to time by proactively purchasing any piece of used equipment that is available on the market.
We know from experience that our used equipment has a fairly high value in the marketplace. We have, in every reporting period since time immemorial, have used equipment sales activity and we believe that since this equipment was already available for sale on the market that if we didn’t have the ability to purchase it and resell it it would be sold in the marketplace anyway and it could potentially displace and replace some of our potential sales. Used equipment with the 3D Systems brand name on it fetches a fairly decent price. It’s a highly lucrative and profitable activity to participate in and any opportunity that we have in the ordinary course of business we take advantage of to purchase any piece of used equipment and resell it as a used or reconditioned it and sell it with an extended warranty.
Thank you, and our last question comes from Cliff Ransom with Ransom Research Incorporated.
Cliff Ransom - Ransom Research Inc
Abe, I’m not trying to beat a dead horse here but I’m trying to get a sense on V-Flash because it’s so important; not many of us expected a big impact in ’08 but we expect a big impact in 2009-2010 if this is a successful product. What gives you the confidence that the twomonth delay was the right number?
Well the delay that we had in the past is a delay that we took to correct issues and to take advantage of opportunities that surfaced in this timeframe. As I said earlier today Cliff, we believe that at this point in time, those issues were addressed and resolved and so we are moving forward. The confidence that I get is based on the daily and weekly updates that our good team of people gives me based on the progress that they make.
I continued to practice this through the middle of ’08 as a very cautious, managed phase rollout with the understanding that if we need to take our foot off the accelerator a little bit to take advantage of additional opportunities, we will. Whether this begins to ramp up fully in the next few periods or not, I don’t think will over time alter the significance of this technology to us and it’s potential impact on our future recurring revenue model which we expect as we continue to refine it will be significant.
I also mentioned in my prepared remarks this morning, Cliff that V-Flash is not going to be the only product launched off this platform. We expect additional products to be launched off this platform over time. And again, the cautious and deliberate early delay here I think is indicative of how seriously we take this opportunity and the cautious nature in which we want to ensure that when we finally begin to place it in the market en masse that it’s every bit as successful as we expect it to be. Because we continue to believe and we continue to expect that once we get it to the marketplace, it will have a significant impact on our recurring revenue business model.
Ms. Hughes there appear to be no further questions in the queue at this time. I will turn the conference back over to you for any additional or closing remarks ma’am.
Thank you for joining us today and for your continued support of 3D Systems. A recording of this webcast will be available two hours after completion of the call. To access the recording, dial 1-888-203-1112 and enter the confirmation code 4467834. A replay of this webcast will be available approximately 90 minutes after the call on 3D Systems investor relations website www.3dsystems.com/ir.
Thank you ladies and gentlemen. That does conclude today’s conference call. We do appreciate your attendance and have a wonderful day.
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