3D Systems Corporation Q2 2008 Earnings Call Transcript

| About: 3D Systems (DDD)

3D Systems Corporation (TDSC) Q2 2008 Earnings Call August 6, 2008 9:00 AM ET


Chanda Hughes – Coordinator, Investor Relations

Abe N. Reichental – President and Chief Executive Officer

Damon Gregoire – Vice President and Chief Financial Officer

Robert M. Grace, Jr. – Vice President and General Counsel


Eric Martinuzzi – Craig-Hallum

Cliff Ransom – Ransom Research, Inc.

Bill Gibson – Nollenberger Capital

Jay Harris – Goldsmith and Harris

Phil Goldsmith – Goldsmith and Harris


Welcome to the 3D Systems second quarter and first half 2008 earnings results conference call and audio webcast. (Operator Instructions) At this time, I would like to turn the call over to Chanda Hughes with 3D Systems.

Chanda Hughes

With me on the call are Abe Reichental, CEO; Damon Gregoire, CFO; and Bob Grace, 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 this conference call at the end of the session, just call in using the phone numbers provided here on slide three. The phone numbers are also provided in the press release we issued yesterday. For those who access the streaming portion of the webcast, please be aware there is a threesecond delay and that you will not be able to post questions via the web.

Before we begin the 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 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 “believes,” “belief,” “estimates,” “expects,” “intends,” “anticipates,” or “plans” to be uncertain and forward-looking. Forward-looking statements may include comments as to company's beliefs and expectations as to future events and trends affecting this 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 filings with the Securities and Exchange Commission, as well as other factors, could cause actual results the 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 Reichental

As you already know, yesterday we issued our second quarter and first half earnings results for 2008 and also filed our quarterly report on form 10Q with the SEC. I would like to review these operating results with you this morning and give you my perspective on our business and operations.

We reported the following second quarter and yearoveryear results. Revenue for the second quarter increased by $0.2 million to $36.7 million on higher materials and service revenue, but this increase was almost completely offset by a decline in systems sales. Gross profit decreased by 1% to $13.3 million; and while material margins increased, lower margins on systems and services more than offset this increase. The result was a 70-basis-point decrease in gross profit margin to 36.3%. We will discuss the reasons for this decline in a few minutes.

Continuing a sequential trend, operating expenses declined by 12% to $16.1 million; and operating loss declined by 43% to $2.8 million. Net loss declined by 37% to $3.3 million, and net loss per share declined by 44% to $0.15 per share.

For the six months, we reported the following. Revenue decreased by 7%, to $68.4 million from $73.4 million for the 2007 period, including our weak systems revenue in the first quarter. We experienced a 25% decrease in revenue from systems. This more than offset our 3% increase in revenue from materials and 4% increase in revenue from services in the sixmonth period.

Gross profit for the six months of 2008 decreased by 9% to $26.7 million. Gross profit margin decreased to 39% from 40% in the first six months of 2007. Operating expenses declined by 10%; and net loss declined by 17% to $7 million, or $0.31 per share, from $8.4 million, or $0.44 per share in the first six months of 2007.

I would like to take a few minutes and talk about some of the marketplace sectors that we believe shaped our second quarter of this year. Second quarter revenue fell some $4 million short of our midJune expectations. This shortfall was primarily the result of this year's continued uncertain economic environment. With that shortfall, we missed several other key targets that resulted in disappointing results.

On the surface, we returned to modest top line growth in the second quarter during a year that, by all accounts, is a difficult economic period. But the mix of our revenue in the second quarter of 2008 was very different from that in the second quarter of 2007. This reflected, in part, the positive contributions from our integrated materials strategy and initial traction from our recently introduced 3-D Printers as well as the negative impact of abnormally higher sales of used equipment.

We benefited from higher unit volume from the sale of Small-Frame systems and 3-D Printers during the second quarter, but this increase in revenue was not enough to overcome the revenue shortfall from Large-Frame systems and used equipment sales.

Revenue from 3-D Printers was helped by growing demand for our Dental Professional Printers and amounted to 26% of total systems sales. Small-Frame systems and 3-D Printers increased as a percentage of total systems sales, accounting for the remaining 75% of systems revenue, compared to 70% of systems revenue in the second quarter of 2007.

As a general matter, Small-Frame systems and 3-D Printers have lower gross profit margins than Large-Frame systems. Sales of Large-Frame systems declined from the 2007 second period. This reflected a continued uncertain manufacturing environment and lower demand for paid parts from our preferred service providers in the 2008 period.

As a result of this lower parts demand and the postponement of certain customer investments, as more companies reevaluate the timing of their new technology investments, Large-Frame systems accounted for only 25% of total systems revenue for the second quarter of 2008.

On the other hand, revenue in the 2008 quarter benefited from higher material sales and the favorable effect of foreign currency translation. However, as I just indicated, this benefit was largely offset by lower unit volume from sales of our Large-Frame systems. It was also largely offset by a higherthannormal incidence of used equipment sales. We believe that this is another symptom of the current economic environment as certain customers tighten their purse strings and settle for lesser equipment at the lower investment levels.

This used equipment sales with lower margins than those the company generally recognizes on new systems sales accounted for 20% of total systems sales for the second quarter. Of the used equipment sales, 33% in units and 40% in revenue involved the resale of systems that we acquired from Tangible Express in the first quarter of 2008.

We do not expect this level of used equipment sales to continue in future periods.

We also recorded $400,000 of additional deferred revenue in the second quarter of 2008 in connection with several extended warranties and discounted service related to certain systems, which we expect to recognize ratably over the contracted warranty and service periods. As a result of these factors, systems revenue decreased by 9% to $11.5 million from $12.7 million in the second quarter of 2007.

The recovery that we experienced in systems and materials sales during the second quarter of 2008 was well below our expectations and was not enough to close the gap from our very anemic first quarter revenue. As a result, revenue for the first six months of 2008 decreased by 7%, to $68.4 million from $73.4 million for the corresponding 2007 period.

This revenue decline reflected the effect of our first quarter revenue shortfall and included, for the sixmonth period, a 25% decrease in systems revenue to further offset our 3% gain in revenue from materials and 4% increase in revenue from services.

Gross profit for the second quarter of 2008 decreased by 1% to $13.3 million. The decline in gross profit margin was primarily due to the changes in revenue mix and lower volume of Large-Frame systems sales mentioned above, which resulted in our inability to fully absorb our overhead, and the high incidence of used equipment sales that resulted in reduced gross profit. Higher sales of used equipment, combined with certain cost of goods sold items, negatively affected our gross profit margin in the second quarter of 2008 by approximately 500 basis points, after reflecting the offsetting favorable effect of foreign currency translation on revenue with the unfavorable effect of foreign currency translation on cost of goods sold for that quarter.

These cost of goods items included amounts associated with our initial planned buildup of VFlash finished goods inventory in anticipation of commercial shipments once we are fully satisfied with it; higher warranty costs; duplicate supply chain costs related to our efforts to discontinue the outsourcing of our domestic logistics activities and to relocate them to our Rock Hill facility, which we target for completion this month; and the unfavorable effect of foreign currency translation on cost of goods sold, which on the net basis reduced our gross profit margin by 60 basis points for the second quarter. Damon will cover both the quarter and the yearend gross profit analysis in more detail.

We're very disappointed that the items discussed above largely negated our gross profit improvement initiatives during the second quarter. We expect to benefit from our previously disclosed gross profit improvement initiatives starting in the fourth quarter of this year. We also expect that our VFlash activity will suppress our gross profit margin by between $0.5 million to $1 million per quarter for the near term as we continue our planned buildup of VFlash inventory and subsequent shipments.

We'll spend a few minutes also talking about the results that we're getting from our integrated materials. Revenue from our engineered materials and composites increased by 9% to $16.2 million from $14.9 million for the second quarter of 2007. This was primarily due to the growing contribution of recurring revenue from our newer integrated systems, notwithstanding a lower demand for parts. In fact, we're very pleased that integrated materials sales increased by 32% sequentially over the first quarter. And for the second quarter of 2008, our integrated materials accounted for 26% of all materials revenue reflecting a 4% sequential improvement over the materials revenue for our entire install base of systems.

We believe that the shift in mix between legacy materials and integrated materials is proof that our integrated materials strategy is working. We also believe that our longerterm integrated materials strategy, which is at the heart of our longerterm target business model, is beginning to gain positive momentum and traction, both in terms of its increased contribution to total revenue and gross profit. Now for more a more detailed look at our second quarter and first half of 2008 financial performance, I will turn the presentation over to Damon Gregoire, our Chief Financial Officer.

Damon Gregoire

The first thing I'd like to point out this morning is that our recurring revenue continues to move in the direction of our longerterm operating model, with 69% of our total revenue in the second quarter coming from materials and services. Of that, materials accounted for 44%. The graph on slide 11 also shows that our geographical mix of revenue remained fairly consistent in the second quarters of 2008 and 2007. Gross profit for the second quarter of 2008 decreased by 1% to $13.3 million. Gross profit margin decreased by 70 basis points to 36% for the second quarter of 2008.

The decline in our gross profit margin in the second quarter was primarily due to changes in our revenue mix and our lower volume of systems sales, which resulted in our inability to fully absorb overhead, and the high incidence of used equipment sales. Other items affecting gross profit margin in the second quarter were higher materials revenue with higher gross profit, 60-basis-point adverse impact of foreign exchange on cost of goods sold that Abe mentioned earlier, along with a 30basispoint adverse effect due to duplicate supply chain costs related to moving logistics activities inhouse, and a 110basispoint impact of costs associated with inventory of VFlash machines and finishers, as well as higher warranty costs that also adversely effected gross profit margin by 80 basis points.

The combined impact of these items, including the high incidence of used equipment, negatively affected our gross profit margin by approximately 500 basis points. For the first six months, gross profit decreased by 9% to $26.7 million. Gross profit margins decreased to 39% for the first six months of 2008, from 40% in the first six months of 2007.

The decline in gross profit margin for the first six months of 2008 was primarily due to the factors just discussed that affected the second quarter, along with a significant decline in volume of Large-Frame systems sales that we experienced in the first quarter. Cost of sales increased by $400,000 in the second quarter of 2008 and decreased by $2.3 million in the first six months of 2008, compared to the respective 2007 periods. These changes were generally in line with our changes in revenue in each period.

Operating expenses continued their downward trend in the second quarter of 2008, declining by 12% to $16.1 million from $18.4 million in the second quarter of 2007. This decrease primarily reflected lower selling, general, and administrative expenses, as research and development expenses were essentially flat compared to the second quarter of 2007, notwithstanding our continued new product development activities.

The decline in SG&A costs reflected reductions in 2008 of contract labor, consultants, and accounting fees due to our improved internal control and financial reporting structure. R&D expenses increased to $3.6 million in the second quarter from $3.5 million in the second quarter of 2007.

For the first six months of 2008, operating expenses declined by 10%, compared to the first six months of 2007. The $4.1 million decrease in SG&A for the first six months of 2008 included the $2.3 million decrease in the second quarter we just discussed on the previous slide and the $1.8 million reduction in the first quarter of 2008. This reflects the continuation of a trend that established itself in late 2007.

The 2008 sixmonth period also included $600,000 of expenses that the company incurred in connection with a previously disclosed audit committee investigation in the first quarter of 2008. Legal expenses for the first sixmonth period, while they were below the level for the first six months of 2007, are expected to be higher than the company's targeted legal expenses for the full year of 2008, primarily as a result of expenses associated with its previously disclosed pending litigation.

We are not at all satisfied with our slowerthanexpected progress on carrying out SG&A cost reductions. As a result of the continued uncertain economic environment, we have decided to undertake additional cost reduction programs, including curtailment of certain planned discretionary expenses for the balance of 2008, which are intended to speed up our progress. While we believe that our quarterly SG&A expenses have begun to resume a more normalized run rate, we are not yet achieving our stated targets.

Reflecting on our actual midyear SG&A performance in factoring in our planned marketing activities for the remainder of this year and the uncertainty of our legal expenses arising from litigation for the second half of this year, we expect SG&A expenses for the second half of 2008 to fall in the range of $24 million to $26 million.

For the first six months of 2008, R&D expenses increased by 8% to $7.2 million from $6.6 million in the first six months of 2007. R&D costs in the first six months of 2008 included costs associated with the VFlash Desktop Modeler, as well as other new product development activities. We're continuing the development of additional new products and, accordingly, we expect to incur from $7 million to $8 million of R&D expenses in the second half of 2008.

Although, sequentially, our DSO dropped from 73 to 70 days, we are working to continue to reduce it back to historic levels. Accounts receivable net decreased to $28.5 million in June 2008, compared to $31.1 million at the end of 2007. The changes reflect our 2008 quarterly revenue level as well as an increase in days sales outstanding from December 31, 2007.

The days inventory on hand sequential decrease to 102 days was due primarily to increased revenue for the second quarter of 2008. As of June 30, 2008, inventory increased to $26.1 million compared to $20 million at the end of 2007. This increase included the remaining $1.2 million from the first quarter purchase of Tangible Express and in the first six months’ materials and systems inventory purchases that we undertook to support future growth.

Specifically, the inventory increase in the second quarter was driven by $3.7 million of purchases of direct metal systems; 3-D Printers, including VFlash systems; and certain key components to support future production of 3-D Printers. Excluding Tangible Express equipment that we sold to customers or decided to retain for our own use, these inventory investments aggregated to $6 million for the first six months of 2008. Except for the second quarter inventory investments noted above, inventory would have declined by approximately $2 million from March 31, 2008, to June 30, 2008.

In view of the shortterm inventory investments in support of our expanding 3-D printing and direct metal systems portfolio, we have to take a backwards step against our previously stated inventory reduction goals. Based on our current go-to-market strategy, we still expect inventories to decline to $20 million to $22 million by the end of 2008.

We continue to focus on improving our working capital management in order to pursue our nearterm growth opportunities vigorously. For the first six months ending June 30, 2008, cash declined to $19.1 million from $29.7 million at December 31, 2007. Approximately $7.8 million of this decrease was attributable to the first quarter of 2008. The remaining $2.8 million decrease in cash arose in the second quarter of 2008. This $10.6 million decrease resulted primarily from $8.4 million of cash used in operating activities and $3.5 million of cash used in investing activities in the first month of 2008.

These uses of cash were partially offset by cash derived from financing activities and the effect of changes in foreign exchange rates. The net use of cash in the first six months of 2008 included the inventory investment discussed on the previous slide.

Abe Reichental

Before we begin the questionandanswer 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 future growth and profitability.

I know that the magnitude of the shortfall in our core business will likely raise questions about the strength of our business model. In line with that, let me say that, despite the significant setback that we suffered during the first half of this year, I remain confident in our overall direction. Notwithstanding the uncertain current manufacturing climate, our sales recovered somewhat in the second quarter of 2008. We believe that we are well positioned to gain additional lost ground in the coming quarters.

Our growing install base, coupled with the integration of our new systems with proprietary materials cartridges, should improve the profitability of our business as revenue from materials continues to outpace the growth in systems. As a result, the stability of our revenue base should improve as consumables sales rise as percentage of the product mix relative to systems. We believe that with the absence of abnormally high used equipment sales that we experienced in the second quarter, gross profit margins should also improve.

Let me also spend a few moments updating you on the progress that we're making with our VFlash system. With the previously reported electrical noise problems related to our VFlash Desktop Modeler and the resulting delays in our planned commercial shipments, which we announced in connection with our May 9 first quarter earnings call and subsequently at the Rapid investor show a few weeks later, we neither made any commercial shipments of our VFlash Modeler during the second quarter nor recognized any revenue from our VFlash Desktop Modeler in the second quarter or first six months of 2008.

This morning, we're happy and pleased to share with you that we commenced selected shipments of VFlash Desktop Modelers in early July, after successfully resolving the electrical noise problems that previously halted this phase. Consistent with our previously announced plans, we anticipate the continued managed phased rollout through the end of 2008.

We believe that our internal delays are not indicative of any marketplace demand for this product; and due to the relative low price per unit and managed rollout plan, we do not anticipate the VFlash Desktop Modeler to be a material revenue contributor during 2008. As I mentioned earlier, we also expect that, as we continue our planned build-up of VFlash finished goods inventory and subsequent shipments, this activity will suppress our gross profit margin by between $0.5 million to $1 million per quarter for the near term.

I also wanted to talk about some of the upsides that we believe we have in our business plan. Even during a very challenging first half, 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 product in order to achieve our strategic objectives.

After a decade and a half without any SLA resin sales in Japan, we opened the Japanese marketplace to our key Accura materials, expanding our portfolio of proven, dependable Accura materials in Japan.

We also launched two new professional highdefinition 3-D printers, the ProJet HD 3000 3-D Production System and the ProJet DP 3000 3-D Production System to a favorable marketplace reception. We have launched two direct metal laser sintering systems, the Sinterstation Pro DM100 and DM250 SLM systems, and begun taking orders for these systems.

And we're actively pursuing digital dentistry opportunities with 3M, Sirona, SensAble, and other market participants. We expect incremental revenue from these new products to help mitigate first half revenue shortfall during the coming quarters.

Also, I want to spend a few more minutes regarding additional SG&A reduction initiatives, particularly in view of what we believe is still our high operating costs and in view of the continued uncertain economic environment. Along with that, we're working on additional SG&A reduction initiatives.

Specifically, we expect to curtail special accounting costs and the use of the remaining contractors and consultants that we have been using; taking advantage of available South Carolina job development incentives, starting third quarter; normalize our annual audit and tax review costs; have an absence of expensive recruitment and relocation costs; and most importantly, deliver operating cost savings from our Rock Hill consolidation.

We also expect that selling expenses would rise consistent with rising revenue. However, in view of some of the shortterm operating realities we face, we expect SG&A expenses to continue to decline at the slower rate than previously anticipated, specifically due to the anticipated marketing and legal expenses we have identified. As evidenced by our material gross profit margin, which increased to 61%, we have been taking deliberate actions designed to return and exceed our historical gross profit margin levels.

However, the contribution from these operational improvements was not yet enough to overcome the adverse impact of unabsorbed overhead from lower systems sales and unfavorable foreign exchange effect on our cost of sales. We believe that the items we identified earlier largely negated our gross profit improvement initiatives during the second quarter. We expect to benefit from our previously disclosed gross profit improvements initiatives starting in the fourth quarter of this year.

With slide 24, I would like to provide you with an update on several additional gross profit improvements plan objectives that we shared with you at our last investor meeting in Florida. First, due to inefficient third party logistics and warehousing performance over the past two years, we decided to move this activity into our Rock Hill facility. We're working to complete that move by the end of this month, and we expect our P&L to benefit from this activity in the latter part of the third quarter.

Second, to resolve the outstanding material weaknesses that we have reported relating to inventory management, we have integrated end of the year ERP functionality and, as I just indicated, move inventory management activities in-house.

Third, to eliminate an inefficient system for handling returned parts that had inflated inventory and cost of goods, we have moved our entire returned parts activity in-house.

Fourth, to remedy premature failures of warranty parts supplied by third parties, we're working diligently to improve all identified third-party supply parts quality.

We believe that successful completion of these abovementioned initiatives will result in improvements to our service margin. Finally, to mitigate further adverse foreign exchange impacts on our custom sales and to enhance our disaster recovery plans, we started out a chemical blending facility in Rock Hill that is now fully operational and duplicates largely our facility in Marly, Switzerland. We expect our operational results to begin to benefit from this action beginning in the current quarter.

Regretfully, our third-party logistics partner's strategy did not deliver expected results. This partnership caused us significant profit leakage that we plan to resolve by completing the move of this activity in-house at the end of this month.

Before closing our presentation, I do want to spend a few minutes discussing our longerterm target operating model that we shared with you recently at the Rapid show investor day. As you can clearly see from the historical data on slide 25, revenue growth and gross profit have had greatest hiccups, particularly in the last couple of years. Revenue has remained lumpy as a result of our historical heavy reliance on Large-Frame systems sales and lack of integrated materials strategy.

Today, the mix of what we sell has shifted significantly towards our operating target, with materials representing over 40% of revenue and Small-Frame systems and 3-D Printers becoming a more significant part of our system sales. While we have not completely reduced our top-line dependence on the sale of profitable Large-Frame systems, we believe that we are getting closer to our desired revenue mix.

As for gross profit, we have reviewed with you this morning several items that offer us the opportunity to improve our gross profit by an additional 500 basis points. In addition, a review of our 2008 results shows that product pricing and our cost of goods actually improved slightly over the past six months. Bearing that in mind, we believe that with all the gross profit improvement initiatives that we either have in place or are working on, we should expect improved performance in the coming periods that could place us nearer the lower range of our longterm target operating model.

With regards to SG&A, while our progress has been slower than expected, as Damon mentioned earlier, we have been making steady sequential progress. We ended the first half of 2008 with SG&A at 37% of revenue. While this is some 12 percentage points shy of our target, in absolute dollars spent, we believe that the $1.5 million quarterly gap to the target is manageable. We expect to close it over time, recognizing and accurately reflecting our anticipated marketing expenses and litigation reality.

All told, while this has taken a great deal longer than anticipated to achieve, and while we have experienced more than the anticipated speed bumps along the way, we believe that our integrated materials strategy is beginning to bear fruit. We further believe that continued integrated materials revenue growth, coupled with the decline of SG&A and the realization of our gross profit improvement plan, will result in returning and exceeding our historical performance in these categories and convergence to the threshold of our target operating model.

Finally, we believe that we are continuing to build a stronger company and to place it on solid longterm sustained profitable growth paths by continuing to work towards the right revenue mix within our business model by meeting our customers' needs, leading in innovation through technology, continuing to improve our financial strength, developing new products globally, and creating new marketplace opportunities, particularly in Rapid Manufacturing, 3-D Modeling, and digital dentistry by providing measurable value to our customers and stockholders. Thank you very much.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Eric Martinuzzi - Craig-Hallum.

Eric Martinuzzi – Craig-Hallum

I am curious to know what gets the Large-Frame moving again, and I would like you to comment in your response in both the SLA and the SLS. If you could also talk a little about the sales force, the number of sales reps, the tenure of the sales force, because I don’t think we will get the whole company going again until that's working for us.

Abe Reichental

I think what gets the Large-Frame sales going both in SLA and SLS is greater demands for those parts. These larger systems are more reliant on the manufacturing economy. They tend to go to service providers. They tend to go to automotive companies. They tend to go to other related motor sports, aerospace, and large durable goods and consumer goods customers. Primarily what drives growth in those systems, in our opinion, is greater demand for parts, either paid parts from service bureaus or parts for projects and parts for shortrun manufacturing opportunities.

Within SLA, the driver for growth for Large-Frame will be the combination of what I mentioned, but it will also be driven by digital dental applications as systems will continue to be deployed into those applications driven by companies like 3M, Sirona, and others.

In SLS, the driver will continue to be primarily in the plastics, automotive; in the metals, it will be dentistry and other related metal applications.

With regard to the sales force, the tenure of our sales force, by and large we have a thoroughly mature and experienced sales organization that is well qualified to sell and place these Large-Frame systems. I would say over 80% of the sales force is with a tenure that is over 5 years, so I don't think this is a question of sales capability. I think this is reflecting some of the realities that we experience in the marketplace.

Probably the harshest reality, if you will, for the first half of the year, at least by our surveys, is that parts demand is flat, relative to last year, based on our surveys and our sources.

Eric Martinuzzi – Craig-Hallum

Are those service providers that you're talking with, have they given you any indication as to potential light at the end of the tunnel or is it just things are tough and we don't see any end at this point?

Abe Reichental

There is always some optimism and light at the end of the tunnel when we look just at the historical behavior of this market, first half versus second half. We are continuing to place systems. We did grow our material revenue by some 9 percentage points overall. As I said earlier, the growth of our newer integrated materials was over 30% sequentially.

What we are hearing and what we are seeing is that we can still grow, even with our service providers during a flat economy, with parts when we brand and differentiate the parts that we sell. So, it's a mixed bag in the sense that we're very successful with our more differentiated and integrated materials; and we're less successful with the legacy materials that are more commoditized and more susceptible to the downward momentum in the parts market.


Your next question comes from Cliff Ransom - Ransom Research, Inc.

Cliff Ransom – Ransom Research, Inc.

I'm not sure when you're using the thirdparty contract manufacturer, why you're experiencing this heavy buildup of finished goods. Can you drill down on that and give us some granularity?

Abe Reichental

At a certain point in time, as we begin to place orders with the thirdparty suppliers, and we do that on a quarterly basis, we take in some of those units after we contract for them and the vendor completes them within X numbers of days. We then take them in. In the case of VFlash, specifically, because we have encountered the electrical noise problems and because of the certain point in time the vendor completed their obligations to assemble and build X number of units, notwithstanding those delays, we have to take those units into inventory because we decided that it would not be responsible to ship them until we resolved all the issues.

Cliff Ransom – Ransom Research, Inc.

I understand that you need to take in the materials, the machines, that were in the pipeline that had to be delayed. Is that the right way to think about it?

Abe Reichental

That's how you should think about it.

Cliff Ransom – Ransom Research, Inc.

Then why does it continue to grow in the third and fourth quarter?

Abe Reichental

We didn't say that it will continue to grow in the third and fourth quarter. We said that in view of all the additional products that we are selling right now, several additional new 3-D Printers, including the Flash, and direct metal systems that come in at several hundred thousand dollars a click per machine, our ability to reduce inventory to below the $20 million target is going to be hampered by that. Realistically, by the end of this year, we will only be able to reduce inventory in the range of $20 million to $22 million, giving effect to the portfolio that we're carrying.

Also, in the buildup that Damon mentioned, the $3.7 million buildup, we have a couple of very large purchases on behalf of different 3-D Printer models. We had the onetime large purchase of a component because it was end-of-life. That would be depleted over a couple of years as a major component on some of our larger 3-D Printers. And we also had a high volume purchase for VFlash with regards to the Flash imaging unit that is installed on it.

That has to do with our supply arrangements with the proprietary supplier of that Flash imager. Those two elements that went into inventory in the course of the second quarter would be depleted over several quarters, actually probably over a 12month period. And so, giving effect to that, we also decided to adjust our inventory targets for the remainder of the year.


Your next question comes from Bill Gibson - Nollenberger Capital.

Bill Gibson – Nollenberger Capital

I'd like to zero in on a part of the business that seems to be going right, and that's the emerging dental lab business. In terms of the people you sell to, what kind of feedback are you getting on what it takes to get a lab to change the way it does business and what are the main objections to somebody buying the system?

Abe Reichental

First, let me quickly reiterate that even in this difficult economy, we actually experienced an increase in units and in revenue from placements of 3-D Printers; and a lot of that was helped by demand from dental labs for our new ProJet DP 3000. We believe, and you can see it by talking to labs and by reading the dental industry magazines that are published on a monthly basis now, that the whole industry is undergoing a significant transformation to a digitized workflow.

I think what's helping us here is that we are not trying to change the industry; the industry is being changed by significant workflow forces from the shapers of the industry, the 3Ms of this world, the Sironas of this world, the [inaudible] of this world, and so forth. They're all going there with their own digital workflow solutions, starting with scanners and software packages that enable that; and we have a proprietary component that is neatly bolted into this overall digital path.

We are enjoying an increasing acceptance. We have heard very favorable feedback from most everybody that received one of our new systems. We have, we think, a very interesting channel into that market in various parts of the world. We believe that the ROI for at least the top tier of laboratories is very attractive. The resistance to change here is diminishing very quickly, simply because the whole industry is headed in that direction, as I said, being shaped by the major providers. So for us, this one is more of a pullthrough as opposed to a push.


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

Jay Harris – Goldsmith and Harris

On the Tangible Express inventories, it seems to be about $1.5 million worth leftover in inventory. Do you have any idea how long it will take you to sell that?

Abe Reichental

I think that the number is $1.2 million. Our expectation would be to sell it as quickly as we can to the right customers at the right price. My sense is that certainly by the end of the year, it would be fully sold.

Jay Harris – Goldsmith and Harris

Is the margin lower on that because of selling price or because of you paid more than newly manufactured equipment?

Abe Reichental

It would probably be a combination of both. However, let me answer a question that you are not asking directly. I said earlier in my remarks that we had a higher incidence of used equipment sales in the second quarter. Only 33% of the units sold were Tangible Express, but they represented 40% of the revenue from the used equipment. So clearly we did not give those units away; but in the mix of a much larger component of used equipment, it certainly suppressed our gross profit margins and systems.

Phil Goldsmith – Goldsmith and Harris

With regard to target markets that you're optimistic about, aside from dentistry that you mentioned, could you just prioritize those that you feel are the most fertile at this point?

Abe Reichental

We have different fertile markets for different systems. I think, particularly in this somewhat uncertain economy, it's a strength. We see opportunities to place quite a few metal systems for the balance of the year, simply because of the unique fully dense metal capabilities with six different alloys. We see that going into many different end use opportunities. We see our ability to place additional microcasting systems, which to us is 3-D Printers, the ProJet series, into additional microcasting opportunities well beyond jewelry, where we have been quite successful in the last couple of years.

We see opportunities with some of our new SLS materials like the HST materials to actually break into production of unmanned military vehicles, drones and on-the-ground kind of vehicles as that material is being tested and spec’d by a variety of unmanned vehicle manufacturing companies related to the defense industry. We see, obviously, great opportunities in the dental arena, both for our Large-Frame SLA machines as centralized production systems for dental models and others, but also for the ProJet dental professional systems in laboratories for coatings and partials and also for our direct metal systems in some instances for precious metal crowns and so forth.


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

Bill Gibson – Nollenberger Capital

Just one little followup on Grand Junction, is anything in the works on getting that sold and freeing up the cash?

Abe Reichental

We have been working on Grand Junction in every reported period since the building became available to be sold, actually before it became available to be sold. There hasn't been a period yet that we didn't either have a very serious interested party or, actually, a signed agreement that was going through its various due diligence and a prospective buyer was trying to qualify for financing, etc.

So, even in this period, we have a very interested party; and one hopes that in that tiny little isolated real estate market called Grand Junction that one of these days, we'll find a buyer that, not just has the interest, but also the ability to raise the required money to purchase the facility. The facility is ideally located. It's in great shape. We appraised it several times, and we think it can fetch a nice price. What's missing is to find the right buyer, but it's not for lack of effort. We don't want to give it away.


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

Cliff Ransom – Ransom Research, Inc.

You gave us some wording on the increased second half R&D number, and you said it was due to VFlash and to some additional new products. Can you expand on those two sides? Why is there additional VFlash work? Is it aimed at derivative machines, and what are the kinds of things? When will we hear about what the other new products are?

Abe Reichental

Let me say a few things. We said that we expect R&D to be in the range of $7 million to $8 million, and that reflected work on VFlash and other new products. If you look at our history, you know that every year we will develop and introduce a handful of new systems and materials. So it's reasonable to expect that as we continue to spend at the rate we're spending, you could expect to have in any given sixmonth period some new systems and some new materials from us. Specifically, with regard to VFlash, as I said all along, VFlash as a product today is only one of subsequent systems that would come off this fill transfer imaging technology.

Some of the R&D dollars that we spend in every quarter under the heading of VFlash is already looking ahead at derivatives and subsequent generations, understanding that just like we have to refresh every other part of our systems and materials portfolio for VFlash to become a credible, bona fide product, it has to have its own product road map and it has to have future plans for additional price points and for additional models and some of the R&D spending reflects that.

Cliff Ransom – Ransom Research, Inc.

Can you give any sense of when we're likely to hear about it? If you highlighted the spending on both VFlash and new product development, when are we likely to hear about the actual market introductions of those other new products?

Abe Reichental

Certainly, we will be using the time between now and our world conference to possibly introduce some additional new products. We always do that in connection with major events like that. One would expect that we would be ready to introduce some new products between now, the world conference, and the end of the year, simply because we're due.


Your next question is from Jay Harris - Goldsmith and Harris

Jay Harris – Goldsmith and Harris

Will we see a reduction, or do you know, in inventories and working capital in the September quarter?

Abe Reichental

I would be a little bit cautious here simply because we're still in this process of building up certain inventories and getting ready to provide all the support that we need for our gotomarket strategy between now and the end of the year. It is possible that you will see some reduction on a net basis; but as you saw from Damon's presentation, there are right now negating movements within inventory.

Some of the core inventory is going down, and there are some shortterm and longerterm inventory investments in support of our extended gotomarket strategy here. We feel comfortable saying that, by the end of the year, we would be in the $20 million to $22 million. Whether some of it is realized through the third quarter, I can't tell you with pinpoint certainty.

Jay Harris – Goldsmith and Harris

I only asked the question because had you achieved the inventory levels that you indicated, you would have had $5 million of free cash flow generated in the quarter.

Abe Reichental

I understand that you're asking this because of cash. Certainly we're looking at the inventory position that we have and understand its value to cash. Let me also add that, historically, this is in no way certain to happen or to repeat; but historically, in our business, more free cash is retained in the second half of the year than in the first half of the year based on the historical behavior of this business and maybe, Damon, you can elaborate on that a little bit. I know you've studied it. Again, this is no prediction of certainty that this trend will repeat again this year. But this has been the historical trend.

Damon Gregoire

It's been due to sales cycles and inventory cycles and also how our receivables and everything move there, too. Basically, our payoff structure for our capital expenditures is happening earlier in the year and not happening as much later in the year. There's numbers of different factors. Over the last four years, if you looked at it, that has been the trend, that our cash has increased in the second half of the year.

Jay Harris – Goldsmith and Harris

Traditionally, your fourth quarter has been your highest revenue quarter. Given the slowdown in North American and European economies, do you think we'll still see a traditional third to fourth quarter surge in revenues?

Abe Reichental

We would like to hope that would happen. We are doing our part to make sure that we are going to bring as much of that about as is within our control. So, suffice it to say, we have expectations that that behavior will continue, notwithstanding the uncertain economy to some extent. We're going to do our part to make sure that we maximize any surge in that direction. The rest is going to be up to forces that are greater than us.

Jay Harris – Goldsmith and Harris

Do you have any sense that capital spending patterns might be off because the company has reduced the amount of capital dollars they're willing to put in play?

Abe Reichental

What we've been hearing, which is partly responsible for this midJune disappointment, if you will, we heard from quite a few customers that previously told us they had approved capital spending and were ready to place orders, that those funds or those budgets have been temporarily frozen and/or the project was postponed by several months because those companies wanted to wait and see how their year will shape out.

Nobody came back to us and said the project is completely canceled, we’re not going to spend the money this year and that's it. What we heard is we're postponing, the budget is frozen for a few months, come talk to us again in a couple of months. We'll advise you if anything changes. I should also say that we don't believe that we lost any of these opportunities that previously we felt were committed and firmed up to any other competitors.

The uncertainty in all of this is, will these companies relax enough in the course of the third and fourth quarter and find the courage to spend what they budgeted or will they continue to tap on a brake, waiting for better economic news? We're going to find out together.

Chanda Hughes

We will now close the call. Thank you for joining us today and for your continued support of 3D Systems. A recording will be available two hours after completion of the call. To access the recording, dial the numbers you see here on the slide and enter the conference ID number. A replay of the webcast will be available after the call on 3D Systems website under the Investor Relations section.

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