3D Systems Corp (DDD) 2008 Q2 法說會逐字稿

Good morning and welcome to 3D Systems' Second Quarter and First Half 2008 Earnings Results Conference Call and audio webcast.

My name is Crystal and I will facilitate the audio portion of today's interactive broadcast.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session.

(OPERATOR INSTRUCTIONS).

At this time, I would like to turn the call over the 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 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.

For those that would like to ask questions related to matters discussed on this 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 that have accessed the streaming portion of the webcast, please be aware that there is a three second 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 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 believes, beliefs, expects, estimates, intends, anticipates or plans to be uncertain and forward looking.

Forward-looking statements may include comments 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 that 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.

Good morning, everyone, and thanks for taking the time to listen to our call this morning.

As you already know, yesterday we issued our second quarter and first half earnings results for '08 and also file our quarterly report on Form 10-Q 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 year over year 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 that offset this increase.

The result was a 70-basis point decrease in gross profit margins of 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 offsets our 3% increase in revenue for materials and 4% increase in revenue from services in the six months period.

Gross profit for the six months of '08 decreased by 9% to $26.7 million and gross profit margins decreased to 39% from 40% in the first six months of '07.

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 '07.

I'd 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 mid-June expectations.

This shortfall was primarily the result of this years continued uncertain economic environment and with that shortfall we missed several other key targets that resulted in disappointing results.

On the surface, we returned to modest topline 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 '08 was very different from that in the second quarter of '07.

This reflected in part the positive contributions from our integrated materials strategy and initial traction for our recently introduced 3D 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 3D printers during the second quarter but this increase in revenue was not enough o overcome the revenue shortfall from large frame systems and used equipment sales.

Revenue from 3D printers was helped by growing demand for our dental professional printers and amounted to 26% of total system sales.

Small frame systems and 3D printers increased as a percentage of total system sales accounting for the remaining 75% of systems revenue compared to 70% of systems revenue in the second quarter of '08.

As a general matter, our small frame systems and 3D 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 lowered demand for paid parts from our preferred service providers in the 2008 period.

As the 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 '08.

On the other hand, revenue in the 2008 quarter benefited from higher material sales and the favorable effect of foreign currency translations.

However, as I just indicated, this benefit was largely offset by lower unit volume from sales of our large frame systems.

And it was also largely offset by a higher than normal incident of used equipment sales.

We believe that this is another symptom of the current economic environment as certain customers tightened their purse string and settled 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 system sales of the second quarter.

Of the used equipment sales, 33% in units and 40% in revenue involves the resale of systems that we acquired from tangible expressed in the first quarter of '08.

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 '08 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 '07.

The recovery that we experienced in systems and material sales during the second quarter of '08 was well below our expectation 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 '08 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 six months period, a 25% decrease in systems revenues which more that offset our 3% gain in revenue from materials and 4% increase in revenue from services.

Gross profit for the second quarter of '08 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 system 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 profits.

Higher sales of used equipment combined with certain costs of goods sold items negatively affected our gross profit margin in the second quarter of '08 by approximate 500 bases after reflecting the offset in 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 build up of V-Flash finished goods inventory in anticipation of commercial shipments once we are fully satisfied with it, higher warranty costs, duplicate supply chain cost related to our efforts to discontinue the outsourcing of our domestic logistic 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 a net basis, reduced our gross profit margin by 60 basis points for the second quarter.

Damon will cover both the quarter and the year end gross profit analysis in more detail.

We are very disappointed that the items discussed above have 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.

As we also expect that our V-Flash activity will suppress our gross profit margins by between $0.5 million to $1 million per quarter for the near terms, we continue our planned build up of V-Flash inventory and subsequent shipments.

I want to spend a few minutes also talking about the results that we are 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 '07.

This was primarily due to the growing contribution of recurring revenue form our new integrated systems notwithstanding a lower demand for parts.

In fact, we are very pleased that the integrated material sales increased by 32% sequentially over the first quarter.

And for the second quarter of '08, our integrated materials accounted for 26% if 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 material strategy is working.

We also believe that our longer term integrated materials strategy which is at the heart of our longer term 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 a more detailed look in our second quarter and first half '08 financial performance, I will turn the presentation over to Damon Gregoire, our Chief Financial Officer.

Damon?

Thanks, Abe.

Good morning, everybody.

The first thing I'd like to point out this morning is that our recurring revenue continues to move in the direction of our longer term operating model with 69% of our total revenue in the second quarter coming from materials and services and of that, materials accounting for -- to 44%.

The graph on slide 11 also shows that a 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 margins decreased by 70 basis points to 36% for the second quarter of '08.

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 affected 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 good sold that Abe mentioned earlier, along with a 30 basis point adverse affect due to duplicate supply chain costs relating to moving logistics activities in-house and 110 basis point impact of costs associated with inventory of V-Flash machines and finishers as well as higher warranty costs had also adversely affected 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 '08 from 40% in the first six months of '07.

The decline in gross profit margin for the first six months of '08 was primarily due to the factors just discussed that affected the second quarter along with a significant decline in volume of large [string] systems sales that we experienced in the first quarter.

Cost of sales increased by $400,000 in the second quarter of '08 and decreased by $2.3 million in the first six months of '08 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 '08 declining by 12% to $16.1 million from $18.4 million in the second quarter of '07.

This decrease primarily reflected lower selling, general and administrative expenses as research and development expenses were essentially flat compared to the second quarter of '07 not withstanding our continued new product development activities.

The decline in SG&A cost 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 '07.

And 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 '08 included the $2.3 million decrease in the second quarter we just discussed on the previous slide and a $1.8 million reduction in the first quarter of '08.

This reflects the continuation of a trend that established in late '07.

The 2008 six month 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 '08.

Legal expenses for the first six month period, while they were below the level for the first six months of '07, are expected to be higher that the Company's targeted legal expenses for the full year of '08 primarily as a result of expenses associated with the previously disclosed pending litigation.

And we are not at all satisfied with our slower than expected progress on carrying out SG&A cost reductions, and 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 '08 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 mid-year SG&A performance and factoring in our planned marketing activities for the remainder of this year and the uncertainty of our legal expenses arising from litigation from 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 cost associated with the V-Flash 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 days to 70 days, we are working to continue to reduce it back to historic.

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 day's inventory on hand sequential decreased 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 compared to $20 million at the end of '07.

This increase included the remaining $1.2 million from the first quarter purchase of Tangible Express and in 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, 3D printers including V-Flash systems and certain key components to support future production of 3D 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.

And 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 short term inventory investments in support of our expanding 3D printing and direct metal systems portfolio, we have had to take backward step against our previously stated inventory reduction goals.

Based on you're current go to market strategy, we still expect inventories to decline to $20 million to $22 million by the end of 2008.

And we continue to focus on improving our working capital management in order to pursue our near term growth opportunities vigorously.

For the first six months ending June 30, '08, 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 '08.

The remaining $2.8 million decrease in cash rose in the second quarter of '08.

This $10.6 million decrease resulted primarily from $8.4 million of cash used in operating activities, $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 in the effect of changes in foreign exchange rates.

The net use of cash in the first six months of '08 included the inventory investment discussed on the previous slide.

That concludes my comments, Abe?

Thanks, Damon.

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 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.

And not withstanding the uncertain current manufacturing climate, our sales recovered somewhat in the second quarter of '08 and 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 material cartridges improved the profitability of our business as revenue from material continues to outpace the growth in systems.

As a result, the stability of our revenue base should improve as consumables' sales rise as a percentage of the product mix relative to systems.

We believe that in the absence of abnormally high used equipment sales that we experienced in second quarter, gross profit margins should also improve.

Let me also spend a few moments updating you on the progress that we are making with our V-Flash system.

With the previously reported electrical noise problems related to our V-Flash Desktop Modeler and the resulting delays in our planned commercial shipment which we announced in connection with our May 9, first quarter earnings call and subsequently, as the rapid investor show a few weeks later, we neither made any commercial shipments of our V-Flash modeler during the second quarter nor recognized any revenue from our V-Flash Desktop Modelers in the second quarter or the first six month of '08.

This morning, we are happy and pleased to share with you that we commenced selected shipments of V-Flash Desktop Modelers in early July after successfully resolving the electrical noise problems that previously halted this phase.

And consistent with our previously announced plans, we anticipate a 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 V-Flash Desktop Modeler to be a material revenue contributor during '08.

As I mentioned earlier, we also expect that as we continue our planned build up of V-Flash finished good 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 or portfolio of proven dependable Accura materials in Japan.

We also launched two new professional, high-definition 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 are actively pursuing direct 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 wanted to spend a few more minutes regarding additional SG&A reduction initiatives, particularly in view of what we believe is still our high operating cost and in view of the continued uncertain economic environment, and along with that, we are 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 this quarter -- the third quarter that is, normalize our annual audit and tax review costs, have an absence of expansive 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 short term operating realities we face, we expect SG&A expenses to continue to decline at a 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 this operation improvement was not yet enough to overcome the adverse impact of unabsorbed overhead from lower systems sales and unfavorable foreign exchange effects on our cost of sales.

We believe that the items we identified earlier largely negated our gross profit improvement initiatives during the second quarter and we expect to benefit from our previously disclosed gross profit improvement 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 planned 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 are working to complete this 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 added ERP functionality, and as I just indicated, moved inventory management activities in-house.

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

And fourth, to remedy premature failures of warranty parts supplied by third parties, we are working diligently to improve all identified third-party supply parts quality.

We believe that successful completion of these above-mentioned initiatives will result in improvement to our service margin,

Finally, to mitigate further adverse foreign exchange impact on our cost of sales and to enhance our disaster recovery plans, we started up a chemical blending facility in Rock Hill that is now fully operational and duplicates largely our facility in Marly, Switzerland.

We expect our operational result to begin to benefit from this action beginning in the current quarter.

Regretfully, our third party logistics partner 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 longer term 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 the 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 material 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 3D printers becoming a more significant part of our system sales.

And while we have not completely reduced our topline 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 period that could place us near the lower range of our long term 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 and we ended the first half of '08 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 and we expect to close it over time recognizing an accurately reflecting our anticipated marketing expenses and litigation reality.

All told, while this is taking 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 material 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 resolve in returning and exceeding our historical performance in these categories and convergence to the threshold of our target operating models.

And finally, we believe that we are continuing to build a stronger company around and to place it on solid long term sustained profitable growth path by continuing to work towards the right revenue mix within our business model by meeting our customer's needs, leading in innovation through technology, continuing to improve our financial strength, developing new products, growing 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.

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.

(OPERATOR INSTRUCTIONS).

We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Eric Martinuzzi with Craig-Hallum.

Thank you.

I'm curious to know what gets the large frame moving again and I'd like you to comment in your response in both the SLA and the SLS and if you could also talk a little about the sales force, the number of sales reps, the tenure of the sales force?

Because I think that we really don't get the whole company going again until that is working for us.

Thank you.

Sure, thanks, Eric.

I think what gets the large frame sales going both in SLA and SLS is greater demand 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 and primarily, what drives growth in those systems in our opinion is greater demand for parts.

Either paid parts from service bureaus of parts for projects and parts for short run 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 regards 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 in place these large frame systems.

We say over, just off the top of my head, over 80% of the sales force is with a tenure that's over 5 years.

So I don't think that this is a question of sales capability, I think this is reflecting some of the realities that we experienced in the marketplace -- probably the harshest reality if you will for the first half of the year at least by our surveys is that is that parts demand is flat relative to last year based on our surveys and our sources.

Now, are those service providers that you are talking about, 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 Well, there is always some optimism and light at the end of the tunnel when we look just at this historical behavior of this market, first half versus second half, we are continuing to replace systems, we did grow our material revenue by some nine percentage points overall, but as I said earlier, the growth of our newer integrated materials was over 30% sequentially and what we are hearing and what we are seeing is that we can still grow even with our service providers during a slack economy with parts when we brand and differentiate the parts that we sell.

So it's a mixed bag, Eric, 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 downwards momentum and in the parts market.

Thank you.

Your next question comes from the line of Cliff Ransom with Ransom Research Incorporated.

Can you help me understand?

I'm not quite sure when you're using the third party contract manufacturer; why you're experiencing this heavy build up of finished goods.

Can you kind of drill down on that and give us some granularity?

Sure, Cliff.

At a certain point in time, as we begin to place orders with the third party 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 can take them in.

In the case of V-Flash specifically, because we have encountered the electrical noise problems and because at a certain point in time, the vendors 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 will not be responsible to ship them until we resolved all the issues.

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

That's how you should think about it.

Okay.

But then, why does it continue to grow in the third and fourth quarter?

Well, we didn't say that it will continue grow in the third and fourth quarter.

We said that in view of all the additional product that we are selling right now, several additional new 3D printers including V-Flash direct metal systems that come in, it's several hundred thousand dollars a clip per machine, that our ability to reduce inventory to below the 20 million target is going to be hampered by this, and 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 are carrying.

Also, Cliff, in the build-up that Damon mentioned, the 3.7 million build-up, we handled a couple of very large purchases on behalf of different 3D printer models.

We had the one time large purchase of a component because it was the end of life.

That would be depleted over a couple of years as a major component on some of our larger 3D printers.

And we also have a high-volume purchase for V-Flash 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 in to inventory in the course of the second quarter would be depleted over several quarters, actually over probably a 12-month period.

And so, giving effect to [debt], we also decided to adjust our inventory targets for the remainder of the year.

Thank you.

Your next question comes from the line of Bill Gibson with Nollenberger Capital.

Hi, Abe.

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 a system?

That's a very good question, Bill.

First, just to be clear, reiterate that even in this difficult economy, we actually experienced an increase in units and in revenue from placements of 3D printer, and a lot of that was helped by demand from dental labs for our new ProJet DP 3000.

And we believe, Bill, and we see it you can see it by talking to labs and by reading the dental industry magazine that are published on a monthly basis now, that the whole industry is undergoing a significant transformation to a digitized workflow.

And 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 shakers of the industry, the 3Ms of this world, the Sironas of this world, the Nobel Biocare 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 [chunk going in] to that market in various parts of the world.

And we believe that the ROI for at least the top tier of laboratories is very attractive.

And 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 pull through as opposed to a push.

Thanks, Abe.

(OPERATOR INSTRUCTIONS).

Your next question comes from the line of Jay Harris with Goldsmith and Harris.

Abe, on the Tangible Express inventories, there seems to be about $1.5 million worth leftover in inventory.

Do you have any idea how long it was going to take you to sell that?

I think, Jay, that the number is $1.2 million.

Correct, Damon?

Correct.

And 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.

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

It would probably be a combination of both.

However, let me maybe answer a question that you are not asking directly.

I said earlier in my remarks that we had a higher incident 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's certainly suppressed our gross profit margin on systems.

Thank you.

Abe, this is Phil (inaudible).

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

Well, we have different fertile markets for different systems that I think, in a way, 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's going into many different end use opportunities.

We see our ability to place additional microcasting systems, which to us, is 3D printers, the ProJet series, into additional microcasting opportunities well beyond jewelry where we have been quite successful in the last 12 years.

We see opportunities with some of our new SLS materials like the HST material 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 system for dental models and others, but also for the ProJet Dental Professional systems and laboratories for pulping and partials and also for our direct metal systems, in some instances, for our [purchased] metal [prongs] and so forth.

Thank you very much.

Your next question comes from the line of Bill Gibson with Nollenberger Capital.

Just one little follow-up on Grand Junction.

Is anything on the works on getting that sold and freeing up the cash?

Well, Bill, 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, and 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 the various due diligence and a prospective buyer will try to qualify for financing, et cetera.

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 have 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.

And we appraised it several times, so we think that it can fetch a nice price.

And what's missing is to find the right buyer, but it is not for lack of effort.

Thanks, Abe.

We don't want to give it away, Bill.

I can appreciate that.

(OPERATOR INSTRUCTIONS).

You have a follow-up question from the line of Cliff Ransom with Ransom Research Incorporated.

Give me just a half a second here.

Well, you gave us some wording on the increased second half R&D number, and you said it was due to V-Flash and to some additional new products.

Can you expand on those two sides?

Why is there additional V-Flash 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?

Well, let me say a few things.

We said that we expect R&D to be, I think, what have you said, Damon, in the range of 7 to 8?

Yeah, 7 to 8.

And that reflected work on V-Flash and other new products.

If you look at our history, you know that every year, we would 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 that we are spending, you could expect to have, in any given six-month period, some new systems and some new materials from us.

Specifically, with regards to V-Flash, as I said all along, you know, V-Flash as a product today is only one of subsequent systems that would come off this film transfer imaging technology.

And some of the R&D dollars that we spend in every quarter under the heading of V-Flash is already looking ahead at derivatives and subsequent generation understanding that just like we have to refresh every other part of our systems and materials portfolio for V-Flash to become a credible bona fide product, it has to have its own product roadmap and it has to have future plans for additional price points and for additional model.

And some of the R&D spending reflects this.

And the issue on the - can you give us any sense of when we're likely to hear about it?

If you highlighted the spending on both V-Flash and new product development, when are we likely to hear about the actual market introductions of those other new products?

Well, 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.

And one would expect that we would be ready to introduce some new products between now, the World Conference in the end of the year simply because we are due.

Thank you very much.

Your next question comes the line of Jay Harris with Goldsmith & Harris.

Well, I sort of forgotten my question, I was listening to the answer of the last question.

That means you are paying attention.

Well, occasionally.

Occasionally.

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

Well, I would be a little bit cautious here simply because we are still in this process of building up certain inventories and getting ready to provide all the support that we need for our go-to-market 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 short-term and longer-term inventory investments in support of our expanded go-to-market 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.

I only asked the question because I had to achieve the $18 million - to achieve the inventory levels that you indicated, you would have had $5 million of free cash flow generated in the quarter.

Right, right.

I understand that you're asking this because of cash.

And certainly, we're looking at the inventory position that we have and understand its value to cash.

Let me also -- and 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 maybe elaborate on this a little bit because I know you've studied it.

Again, this is no prediction of certainty that this trend will repeat again this year, but that has been the historical trend.

It has been and it's been due to sales cycles and our inventory cycles and also how our receivables and everything move there too with our --basically, our pay-off structure for our capital expenditures happening earlier in the year and not happening as much later in the year, there are a numbers of different factors.

But over the last four years, if you look at it, that has been the trend that our cash has increased in the second half of the year.

Right.

If I might be permitted to just add another question here.

Traditionally, your fourth quarter has been your highest revenue quarter.

Given the slow down in North American and European economies, do you think we will still see a traditional third to fourth quarter surge in revenues?

Well, we would like to hope that 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.

And 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.

Well, do you have any sense that capital spending patterns might be off because the companies reduced the amount of capital dollars that they're willing to put that away?

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

And so a lot of them came back to us and said, "Hey, look, 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 turned up to any other competitors.

So the uncertainly in all of this is will these companies relax enough in the course of the third and the fourth quarter and find the courage to spend what they budgeted, or will they continue to tap on the brink waiting for better economic news.

And we're going to find out together.

Okay.

Thank you.

I will now turn the conference back over to Ms.

Hughes.

We will now close the call.

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