3D Systems Corporation Q1 2008 Earnings Call Transcript

| About: 3D Systems (DDD)

3D Systems Corporation (TDSC) Q1 2008 Earnings Call May 9, 2008 9:00 AM ET


Chanda Hughes – Coordinator, Investor Relations

Abe N. Reichental – President and Chief Executive Officer

Damon Gregoire – Chief Financial Officer


Cliff Ransom - Ransom Research

Eric Martinuzzi - Craig-Hallum

Bill Gibson - Nollenberger Capital

Jay Harris - Goldsmith & Harris

Chanda Hughes

Welcome to 3D Systems’ first quarter 2008 earnings results conference call and audio webcast.

I’m Chanda Hughes with 3D Systems, and with me on the call today are Abe Reichental, CEO; Damon Gregoire, CFO; and Bob Grace, General Counsel.

Before we 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 facts 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 statements which explicitly describe such risks and uncertainties, readers are urged to consider statements in the future or conditional tenses or that include the terms, believe, belief, expect, estimates, intends, anticipate or plan 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 heading “Forward-Looking Statements, Cautionary Statements and Risk Factors” that appear in the company’s periodic filings 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 time, I would like to introduce Abe Reichental, President and CEO.

Abe N. Reichental

Yesterday, we issued our first quarter earnings results and filed our quarterly report on a Form 10-Q with the SEC. I would like to review these operating result with you this morning and give you my perspective on our business and operations.

First, we reported the following first quarter ‘08 results as compared to our ‘07 first quarter. In line with this, we reported a 14% revenue decline to $31.8 million primarily as a result of lower large-frame system sales and the uncertain current business climate.

Secondly, a 16% gross profit decline to $13.4 million, primarily due to the lower volume resulting in a 1 percentage point gross profit margin decline to 42%, a 7% operating expense decline to $16.7 million, which resulted in a $0.6 million net loss increase to $3.7 million for the first quarter of ‘08 and $0.01 net loss per share increase to $0.17 for the quarter.

I’m deeply disappointed with the revenue decline that we experienced during the first quarter, a decline that impacted our entire operating results for the quarter. I believe that several independent events coincided during the first quarter to counter the sequential progress that we’ve made in ‘07.

First, let me address our severe revenue decline. Our revenue declined during the first quarter primarily as the result of lower sales of our large-frame Rapid Manufacturing systems, reflecting domestic marketplace softness in demand for prototypes and functional parts produced on these machines. I believe that the soft U.S. demand for end-user parts during the first quarter slowed our ability to close sales for systems destined to parts manufacturers, as they hesitated to invest in significant capacity addition during an uncertain economic period.

Regretfully, due to the relatively lower selling prices, sales from our mid-range prototyping systems and lower-end 3-D printers were not enough to offset the significant revenue gap created by the anemic demand for the large-frame systems.

Furthermore, I believe that, as a result of the highly publicized Tangible Express business failure, our ability to close sales of new systems suffered during the first quarter. Some prospective large-frame buyers paused to evaluate the Tangible Express situation, while others tried to acquire the Tangible Express equipment at deep discounts as a result of Tangible’s announcement during the winter that it was going out of business and putting its entire fleet of 3D Systems’ equipment up for sale.

We ended up purchasing this equipment in its entirety but believe that this event significantly handicapped our sales efforts during the first quarter in the United States. We believe that these two unrelated events taken together caused our domestic U.S. sales to decline to 38% of global sales.

The third factor that affected our business in the first quarter of ‘08 was that starting in early February and for the remainder of the quarter, we received several anonymous letters alleging wrongdoing by the company and certain members of its executive management. The Audit Committee of the Board promptly conducted a comprehensive investigation through independent outside counsel.

That investigation concluded that all of these anonymous allegations were baseless, and that there was no wrongdoing by either the company or its management. While we may never learn the motivation of the nameless author, this investigation consumed considerable resources and time and resulted in significant operational disruptions during the first quarter, including disruptions to our sales process, which in the ordinary course of business tends to intensify during the second half of each quarter. It also added $600,000 of investigative expenses to SG&A in the first quarter.

Also want to bring to your attention that on March 14 of this year DSM Desotech Inc. filed a complaint in an action titled DSM Desotech Inc. vs. 3D Systems Corporation in the United States District Court in Chicago, asserting that we engaged in anticompetitive behavior with respect to resin use in our Viper Pro stereolithography machines. The complaint also asserted that we are infringing on two DSM Desotech patents related to the Zephyr recoater that we have used in all of our stereolithography machines since 1996.

Rest assured that we intend to vigorously contest all of the claims asserted by DSM Desotech and to reaffirm to our industry friends and customers that we stand behind our products and technology, that we designed the Viper Pro system to benefit our customers in the industry, and that we have our own patents on the Zephyr recoater that predate the patents that DSM claims to have.

We’ll spend a few moments on revenue mix by category and by geographic region. For the first quarter of ‘08 consolidated revenue benefited from the favorable effect of foreign currency translation, which was more than fully offset by the unfavorable combined effect of volume, price, and mix.

In the absence of significant large system sales, revenue from systems and other products decreased by $5.3 million to $7.8 million, from $13.2 million for the first quarter of ‘07. Revenue from materials was also adversely impacted by the absence of large-frame systems sales, which are typically accompanied by significant initial material purchases to charge up new systems and commence production, and the anemic marketplace demand for large parts. As a result, materials revenue decreased by $0.4 million or 3% to $14.9 million for the first quarter of ‘08 from $15.4 million for the ‘07 quarter.

Service revenue increased by $0.6 million to $9 million for the first quarter of ‘08. This increase was primarily the result of $0.5 million of favorable foreign currency translation as changes in sales volume of low and core services largely offset each other.

On a geographic basis, the softness in the domestic market resulted in a steep 26% decline of North American sale to 38% of global sales. Revenue outside of the U.S. remained relatively strong, declining by only 5%.

Now for more detailed look at our first quarter ‘08 financial performance, I will turn the presentation over to Damon Gregoire, our Chief Financial Officer.

Damon Gregoire

As you can see from this slide, which indicates our quarterly sales trend since 2003, systems orders and consolidated sales tend to fluctuate on a quarterly basis as a result of a number of factors, including the types of systems orders by customers, customer acceptance of newly introduced products, the timing of product orders and shipments, global economic conditions, and fluctuations in foreign currency exchange rates.

Our customers generally purchase our systems as capital equipment items, and the purchasing decisions may have long lead times. Due to the relatively high list price of our large-frame systems and the overall low unit volume of system sales in any particular period, the acceleration or delay of orders and shipments of a small number of systems from one period to another can significantly affect revenue reported for our systems sale for the period involved.

Revenue reported for systems sales in any particular period is also affected by revenue recognition rules prescribed by generally accepted accounting principles. However, production and delivery of our systems is generally not characterized by long lead times, and backlog is therefore generally not a material factor in our business. Consistent with the normal operating trends in our business at March 31, 2008, our backlog was approximately $2.3 million compared with the $3.1 million of backlog that we had at December 31, 2007.

Gross profit for the period declined by 16% to $13.4 million primarily as a result of the lower large-frame systems revenue mentioned earlier by Abe that adversely affected our absorption of overhead over the systems category of products by $1.2 million that we believe accounted for approximately 80% of the systems margin decline.

Gross profit was also negatively affected by certain supply chain and third-party logistics inefficiencies, which resulted in higher cost of goods sold, additional freight charges, and by higher warranty costs.

Cost of sales also had an unfavorable foreign currency exchange effect of $1.3 million relating to the deterioration of the U.S. dollar from other currencies. As a result, consolidated gross profit margin decline by 1 full percentage point to 42% compared to the first quarter of 2007, reflecting a 72% drop in systems gross profit margin to 18%, which was partially offset by the progress we have made on materials gross profit, which increase to 65% and improved 27% service gross profit margin for the quarter.

Had it not been for the net effect of foreign currency exchange and $1.2 million of unabsorbed overhead discussed above, our gross margin percentage would have increased, as materials revenue decreased only marginally compared to the decrease in systems revenue.

Seen on Slide 13, operating expenses did continue their downward trend and were $1.3 million lower than in the first quarter of 2007, primarily due to lower selling, general and administrative expenses, which were partially offset by higher research and development expenses.

SG&A expenses declined by $1.8 million to $13.1 million, compared to $14.9 million in the first quarter of ‘07. This decline was primarily due to $1.2 million of lower contract labor and consulting costs, and a $1.5 million decline in severance and stock-based compensation expense.

This decrease was partially offset by $0.5 million of unfavorable foreign exchange effect, and a $0.5 million increase in bad debt expense, as well as $600,000 of expenses that the company incurred in connection with the Audit Committee investigation mentioned by Abe earlier this morning. Additionally, the company also incurred $700,000 of legal and accounting expenses during the quarter, as a result of its work to resolve various legal and compliance matters.

Notwithstanding these additional SG&A expenses that retarded our pace of reducing SG&A expense in the first quarter of ‘08, we believe that our quarterly SG&A expenses have begun to resume a more normalized run rate. Accordingly, we continue to expect that our SG&A expenses for the full year ‘08 will fall into the range of $44 to $52 million.

Research and development expenses increased by 17% to $3.6 million in the first quarter of 2008 from $3.1 million in the first quarter of 2007. R&D costs in the first quarter of 2008 included costs associated with the launch of our V-Flash Desktop Modeler. We’re continuing to work on this as well as other selected new product developments, and we expect to incur from $13 to $14 million in research and development expenses for the full year of 2008.

Apart from the high costs associated with the launch of our V-Flash Desktop Modeler and the abnormally high investigative costs and legal expenses we are incurring in the short term, we expect that our quarterly operating expenses are resuming a more normalize run rate.

We are disappointed with the temporary backsliding in our DSO to 73 days and believe that we will quickly be able to restore it back to normalcy. Our current high level of inventory on hand of 121 days is partially attributable to the Tangible Express purchase mentioned earlier, which we believe will benefit the company over the next period.

Notwithstanding the temporary inventory swell, which was largely a result of the Tangible Express equipment, we believe that our current business, we should be able to reduce our ongoing inventory level to approximately $15 million and are confident that as we make further improvements in our working capital management, we can expect to lower our accounts receivable days outstanding and return to our historic levels of performance in inventory.

We ended the quarter with $21.9 million of unrestricted cash. The decline of $7.8 million at March 31, 2008, from $29.7 million at December 31, 2007, resulted primarily from $7.1 million of cash used in operating activities, which included the $5.3 million purchase of Tangible Express equipment and $2.1 million of cash used in investing activity, which was partially offset by $0.9 million of cash provided by financing activities and by a favorable $0.5 million effect of exchange rate changes on cash.

That concludes my comments.

Abe N. Reichental

Before we begin the question and answer session, I would like to spend a few minutes reviewing with you recent developments in our business and how we see them contributing to our growth and profitability. Let me also mention that in the interim, nasdaq.com was able to post our slides. So for those of you on the webcast, you can now follow along. I am starting on Slide 17 now, which is titled “State of the Business”.

I understand that the magnitude of the shortfall in our core business will likely raise questions and create some skepticism about the strength of our business model. In light of that, let me say that despite the significant setback that we suffered during the first quarter of this year, I remain confident in our overall direction and expect to regain lost ground in the coming quarters as the result of the positive traction that we are getting from our new products.

I’m gratified that during April we were able to close several large-frame systems sales that were previously deferred. I expect that notwithstanding the uncertain current economic climate and its associated uncertainties relating to capital spending patterns, we should be able to continue to benefit from our new products and initiatives.

Our growing install base, coupled with the integration of our new systems with proprietary material cartridges should improve the profitability of our business. And revenue for materials continues to outpace the growth in systems. As result, this stability of our revenue base should improve as consumables sales rise as a percentage of product mix relative to systems.

Finally, I believe that our substantially reduced indebtedness and ongoing improvements in working capital management provides us with the flexibility to pursue our near term growth opportunities vigorously.

Moving on to Slide 18, I wanted to share with you some of our recent product announcements. Even during a very challenging quarter, we were able to make progress in many areas as we continue to invest in new products and capabilities and to expand the geographic reach of our products in order to achieve our strategic objectives.

Since the beginning of the year, we’ve begun selective shipments of the V-Flash Desktop Modeler, our affordable new 3-D system. We also entered the Japanese marketplace for the first time to our key Accura materials, expanding our portfolio of proven, dependable Accura Materials in Japan. We launched the ProJet HD 3000 3-D Production System, the new high professional high-definition 3-D printer that quickly produces high-definition parts and patterns at high throughput, maximizing entire build.

And we launched a second ProJet, the DP 3000 Dental Professional System, a dental lab system which accurately, consistently, and economically manufactures precision wax-ups for dental professionals. And we also launched two new Sinterstation Pro DM100 and DM250 SLM Systems.

These are the two direct metal laser sintering systems based on the MCP Tooling Technology machine that quickly builds fully dense metal parts for a wide range of metal materials for functional parts, tooling, and prototypes. As I mentioned previously, we expect both the ProJet systems and our new fully dense direct metal systems to become significant contributors to our revenue in the coming quarters.

With regards to V-Flash, I wanted to give you a quick update and some reiteration of what I’ve said previously. During the first quarter we commenced selected shipments of our V-Flash Desktop Modeler to hearing aid and general purpose resellers and customers. In the course of doing that we also encountered several technical difficulties that have slowed this phase down, and we anticipate resuming hearing aid shipments in June and general purpose unit shipments in July.

We anticipate continued managed, phased rollout of our V-Flash Modeler for the third quarter of this year. As we have said on several previous occasions, due to the relative low price per unit and our carefully managed rollout plan, we do not anticipate V-Flash to be a significant revenue contributor during ‘08, but it may slow down our anticipated gross profit margin improvements until such time as recurring revenue from V-Flash materials reaches a critical mass.

We believe that over time, V-Flash has enormous potential to enhance and accelerate our recurring business model substantially. As we have said all along in previous public disclosures on this topic, we have been cautious and deliberate in the way we have been approaching and conducting the introduction of this system into the marketplace.

Moving on to Slide 20 “Gross Profit Improvement Plan”, I’m very disappointed that we lost ground during the first quarter against our previously stated gross profit margin target. As evidenced by our materials gross profit margin, which increased to 65%, and the improved services gross profit margin, which increased to 27%, we have been taking deliberate actions designed to return and to exceed our historical gross profit margin levels.

However, the contribution from these operational improvement was not enough to overcome the adverse impact of unabsorbed overhead from lower systems sales and unfavorable foreign exchange effects on our cost of sales.

As Damon said previously, had it not been for the net effect of foreign currency exchange and the $1.2 million of unabsorbed overhead that Damon mentioned earlier, our gross profit margin percentage would have increased as materials revenue decreased only marginally compared to the decrease in systems revenue.

Having said that, we are in the midst of working on several additional gross profit improvement plan objectives that I would like to comment on briefly this morning. First, due to inefficient third-party logistics and the warehousing performance over the past three years, we decided to move this activity into our Rock Hill facility. We’re working to complete that move by August of this year.

Second, to resolve the outstanding material weaknesses that we have reported relating to inventory management, we plan to integrate added ERP functionality and as I just indicated move inventory management activities in-house as well.

Third, to eliminate an inefficient system for handling returned parts that has inflated inventory and cost of goods, we have begun to streamline the process and move our returned parts activities in-house. And fourth, to remedy premature failures of warranty parts supplied to us by third parties, we have begun a series of quality improvement initiatives with our suppliers.

Finally, to mitigate further adverse foreign exchange impact on our cost of sales and to enhance our disaster recovery plans, we’re in final stages of bringing online in Rock Hill a chemical blending facility that in many respects will duplicate our facility in Marly, Switzerland.

I also wanted to spend a few minutes talking about our target operating model and in fact introduce to you this morning a revised target operating model. We have updated our long-term target operating model, and our new revised model is depicted on Slide 21, for those of you following with me on the webcast. This revised target operating model projects our forward-looking expectations for our business as it reaches revenues in the range of $170 to $200 million.

Let me first say that we fully recognize that we did not achieve all of the objectives of the original model that we built based on $150 million revenue assumptions. But we nevertheless used it as a basis for measuring our progress in meeting our strategic objectives in areas such as consolidated revenue growth, which exceeded the $150 million mark at the end of ‘07; revenue contribution from materials sales, which doubled over the measurement period; and revenue from new products, which reached over 50% of total revenue during the December ‘07 quarter.

The revised target operating model we’re sharing with you this morning seeks to more accurately reflect and also give way to the business model as it operates today, and to also factor the short-term gross profit margin drag that we expect to incur in future periods as a result of our planned V-Flash commercialization.

Specifically, the model contemplates that we will continue to emphasize the growth of consumables relative to systems and that as we do that, our gross profits should be in the range of 46% to 55%. This would reflect the revised systems mix towards systems with mid and low range pricing and realization of our previously mentioned profit improvement plan.

Second, that materials will contribute between 42% and 45% of total revenue and that new products will amount to more than half of all revenue. Third, that we will continue to emphasize efficiency in operations and cost control, with the objective that SG&A will decline as a percentage of revenue to a range of 23% to 25% as the company realizes savings from its move to Rock Hill and leverage from further top line growth.

Four, that we continue our technological leadership and our new product development efforts and that as our revenue grows, research and development will decline as a percentage of revenue from 9% to 8%, as the company continues to spend between $13 and $14 million annually on research and development.

Five, that we will continue to expect that we will become profitable on a sustained basis, with operating income in the range of 15% to 20% of revenue and resulting net after-tax income in the range of 10% to 15% of revenue. And finally, that we expect the company’s business to remain a low consumer of capital expenditures, with capital expenditures to remain in the range of 2% of revenue. And as a result we expect our depreciation and amortization to be approximately 4% of revenue.

In closing, let me say that notwithstanding the speed bumps that we encountered in the course of the first quarter, we believe that we’re continuing to turn the company around and place it on a solid, longer-term sustained profitable growth path, through continuing to meet our customers’ needs, leading in innovations through technology, improving our financial strength and flexibility, continuing to develop a steady stream of new products, growing globally, and pursuing our growth initiatives in rapid manufacturing and 3-D modeling, understanding that it only matters as long as we provide measurable value to our customers and stockholders.

Chanda Hughes

We will now open the call to questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Cliff Ransom - Ransom Research.

Cliff Ransom - Ransom Research

Is this is a second delay in V-Flash? Did you not pre-report these problems because you thought you might get large systems sales toward the end of the first quarter?

Abe N. Reichental

The V-Flash delay is, yes, a second delay as a result of expanding the field activities and discovering primarily some electrical noises in the system that we wanted to remedy before we further expand our exposure. This is not related to system performance in the sense of how it would perform in terms of building parts. It had to do with some electronic noise that we wanted to remedy immediately before too many systems got into the marketplace.

Cliff Ransom - Ransom Research

Has that now been remedied?

Abe N. Reichental

It has been remedied, it’s now being worked into the all the systems that have been online and as I said we would be commencing shipments, first for hearing aid customers and then for general public.

Secondly, with regards to large-frame systems and why we have not reported this earlier, you absolutely right that, notwithstanding our best attempt to retrain and recondition the marketplace to conduct buying activities uniformly throughout the quarter, the bulk of our activities tend to happen in the second half of the quarter, and more significantly in the third month of the quarter.

And given the size and magnitude of some of these sales, it is not clear to the company until the last bit of the quarter exactly where we stand in terms of revenue, and therefore we were in no position to alert the market any earlier.


Your next question comes from Eric Martinuzzi - Craig-Hallum.

Eric Martinuzzi - Craig-Hallum

I noticed that one of the supplemental cash flow statement disclosures talks about a $3.6 million transfer of equipment from inventory to property and equipment net. What is that equipment going to be used for?

Damon Gregoire

Part of that equipment is being used in our Rapid Manufacturing Center and at 3D University here in Rock Hill, that has training courses for various people along with the university. And at times we move equipment in and out of there, so we will have sold some of that equipment over the past periods, and it’s just a matter of replacing it. Most of it was what was there previously.

Abe N. Reichental

Eric, let me add that we have certain commitments to our own RMC to make sure that we have x number of machines always deployed in a variety of Rapid Manufacturing activities to support our sales activities but also to support some of our customers. We have some commitments to 3D University, in terms of having equipment on site there to facilitate training.

We also have some demo equipment that we put in some of our satellite offices, primarily in Germany, Japan, and the UK. That equipment is on a rotational business. It periodically gets sold and refreshed from time to time to make sure that we in our showrooms and at the University have the latest equipment. That’s why you’ll see those movements between inventory and assets.


Your next question comes from Bill Gibson - Nollenberger Capital.

Bill Gibson - Nollenberger Capital

Abe, I want to go in a little more on the big system sales. You mentioned booking a few in April. If those had fallen in March, would you have felt good about the quarter and hit your numbers there, because I also sense a bigger concern that it may be an economic slowdown impacting you as well that’s longer-lasting.

Abe N. Reichental

No, I don’t think that if we had gotten all these systems booked in I would have felt good about the first quarter. I am a little bit concerned, and my concern is more related to the consumption of parts in the market and primarily larger-size parts, which is where our equipment tends to be differentiated and what drives principally our material sales.

And we have done enough channel checks and also observed from other players in the industry that the first quarter exhibited a slowdown in demand for parts and large parts. Many of our large Rapid Manufacturing systems are sold to preferred service providers that are in the business of making and selling parts.

They’re also sold to some very large OEMs that have, if you will, their own in-house service bureaus for the benefit of their corporations. And in economic periods like the first quarter that had slower demand if not anemic demand for such parts, we see that impacted in the reluctance, hesitation or concern on the parts of these people to add capacity during an uncertain time.

So I would not have been happy had we had the sales in April fall in the first quarter. I am a little bit concerned: I continue to be concerned. On the other hand, I’m somewhat gratified that we did get some of those sales because what it tells me is that there may be some relaxation about the future of the economy here in the United States and that some companies that hesitated, particularly in segments that are reluctant to purchase during recessionary times, like automotive.

When we saw some automotive purchases come through in April it gave us some confidence that maybe the uncertain economy is not going to be long-lived.


Your next question comes from Jay Harris - Goldsmith & Harris.

Jay Harris - Goldsmith & Harris

Abe, what caused the decline in revenues from the first quarter of ‘07 to the first quarter of ‘08 in Asia Pacific and Europe?

Abe N. Reichental

In Asia Pacific and Europe, it was just a mix. We just sold fewer systems. But we did not see the same distribution as we saw it here in the United States. Let me say generally that our mid-range and low-range systems performed quite well in relative terms. It was really the large-frames that was very noticeable and specifically in the United States. In Europe and in Asia Pacific I would chalk that to just a slow start to the year.


Your next question is a follow-up from Cliff Ransom - Ransom Research.

Cliff Ransom - Ransom Research

When you were talking about the gross profit improvement plan in Slide 20 and talking about inefficient third-party logistics, was it UPS you were using for that after you fired them?

Abe N. Reichental

We came to the realization after many, many attempts of trying to evolve and realize potential operational efficiencies in all of the cost reductions that we were hoping to get as a result of outsourcing. We’ve realized that not only that we’re not getting the expected operational cost reductions but that the inability to tightly manage inventory, the need to periodically write off inventory that wasn’t located properly.

The swell in the system on recurring materials that come back for warranty and repair and are not handled properly, and as a result the company has to purchase additional inventory while it is in the system more than negated and erased any potential saving which theoretically the company should have realized. We think that it cost significantly several percentage points in deterioration in gross profit margin.

And as you can see just from the results of the first quarter, even without fully implementing the entire gross profit improvement plan, we have made significant progress on service gross profit, which probably went up by almost 10 percentage points from the first quarter of ‘07, if my memory serves me correctly. And also on materials, which I think our gross profit margin improved by some 3 percentage points from the first quarter of ‘07.

And my point here is that by moving and gaining control of our inventory and gaining control of our return warranty power and gaining control also over resins which currently we’re manufacturing in Switzerland and at the moment are very exposed in terms of foreign currency, gives us a much more decisive path to not only achieve our historical gross profit margins, which notwithstanding even the dismal results of the first quarter, were within a sniffle but really getting closer to our long-term target.


Your next question is a follow-up from Bill Gibson - Nollenberger Capital.

Bill Gibson - Nollenberger Capital

You mentioned in your gross margin improvement plan that, eliminate the premature failure of warranty parts, and warranty expense was up in the quarter. Abe, are we having problems with the outsource manufacturers, or what’s going on there?

Abe N. Reichental

The problem here is not with the outsource manufacturers that assemble the machine in its entirety. We have some specific components that are failing prematurely in certain product categories. These are expensive components in the category of lasers and certain pumps and motors that are not really the responsibility or the design of the assembler of the equipment. But rather it comes from other third-party suppliers.

When we have premature failures, if a component like this, Bill, is designed to run, let’s say 50,000 hours, and it only runs 10,000 hours and it’s still under warranty, it’s very costly to the company because we have to replace it. It’s even more costly because we have to send out a sales service technician to do it. It increases our inventory, and that in combination with not having an efficient return materials system using our third-party logistics partner, further exacerbate our warranty costs.

Now, if you look at what most of this is captured in our field service gross profit margin, and as you can see, we’ve already improved that by 10 percentage points. I’m just telling you that’s not enough. There is much more juice to be squeezed here and we’re actually now stepping up in our effort to work directly with some of our third-party suppliers to bring this to favorable resolution quickly.


Your next question is a follow-up from Jay Harris - Goldsmith & Harris.

Jay Harris - Goldsmith & Harris

Abe, what were your objectives for the March quarter?

Abe N. Reichental

Jay, I can’t begin to give you an answer on that. Suffice it to say they were much higher than what we achieved. That’s why I’m deeply, deeply disappointed. But without beginning to give general guidance here on revenues, I’m really not at liberty to share with you what were my expectations except to say that we were very far from achieving what we wanted to achieve. This was a real disappointment.


Your next question is a follow-up from Cliff Ransom - Ransom Research Inc.

Cliff Ransom - Ransom Research

Abe, I accept that you have a philosophical stance on forward guidance and we’re not going to get it. Do you have hard numbers internally that you don’t choose to share with your shareholders about what you think the second and third quarters, fourth quarters, will look like?

Abe N. Reichental

We have, Cliff, hard numbers for every reporting period. We have a budget. We break the budget into monthly and quarterly expectations. We drive the whole business in accordance with this annual profit plan that starts with revenues and goes all the way to the bottom line. We are compensating our entire team in accordance with achievement of those objectives. So the answer is yes to all of it.


Your next question is a follow-up from Jay Harris - Goldsmith & Harris.

Jay Harris - Goldsmith & Harris

Abe, I wish you would arrange for a forum that’s more effective than a one-hour conference call to pursue the subjects raised by the press release.

Abe N. Reichental

Jay, we are going to be at the RAPID Show, the week after next. We plan to give a very expansive overview of where we are in the business, not just myself but many of our senior members of the management team are going to be on hand to participate and answer questions.

Our entire portfolio of equipment including all of our large-frame systems are going to be on display. And we would make ourselves fully and completely available to answer any and all questions. If you made time between then and you wish to talk with us one on one in a conference call, we would be more than happy to accommodate you, starting after the end of this conference call.


Your next question is a follow-up from Cliff Ransom - Ransom Research.

Cliff Ransom - Ransom Research

Abe, what have you changed in your quarterly, monthly, annual profit plan budgeting, based on your experience in the first quarter?

Abe N. Reichental

Well, we made several changes in our sales plan for the year. We’ve made some changes in how we are trying to accelerate and pull in some of the longer-term prospects. We have not at this point in time given up on making up what we lost in the first quarter during the remainder of the year.

I tried to indicate that in the press release, and in my prepared comments today, that we have some expectations and beliefs that we could gain some of the lost ground in the coming periods. So, while we have adjusted some of our go-to-market strategies, at this point in time we haven’t given up yet on making up the difference.


Your last question is a follow-up from Eric Martinuzzi - Craig-Hallum.

Eric Martinuzzi - Craig-Hallum

Abe, given the revenue shortfall, is there a restructuring plan that you’ll be implementing?

Abe N. Reichental

No. It took us, Eric, a long time to build the right team here. I came in to the company at the tail end of a massive restructuring plan, which in my view decimated the organization and resulted in a long-term devastating effect on our ability to develop and sell and succeed. It was very expensive to rebuild what was lost in the 2002 to the 2003 period.

That does not mean, Eric that we’re not looking very carefully at every discretionary expense. It does not mean that we’re not looking very aggressively at other areas where we could reduce our expenditures or increase our profitability by reducing our cost of sales. But I honestly don’t believe that a restructuring of people is what’s called for.

When you look at revenue per head in this company, with our 360-some odd employees, we are I think very efficient in terms of our productivity. Most of our employees are highly trained specialists, and my sense is that that would be very short-term thinking on the part of the management to contemplate these kinds of restructuring, which may look good on the P&L for a few quarters but will be much more expensive to remedy as we regain the loss ground and continue to execute on our business model.


We have no other questions at this time.

Chanda Hughes

We will now close the call. Thank you for joining us today and for your continued support of 3D Systems. We will have the webcast slides posted on our website at www.3dsystems.com/ir. A recording will be available two hours after completion of the call. To access the recording, please dial 1-888-203-1112. A replay of the webcast will be available after the call on 3D Systems’ website.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!