3D Systems Corp (DDD) 2014 Q3 法說會逐字稿

Good morning, and welcome to the 3D Systems Conference Call and audio webcast to discuss the results of the third Quarter and first nine months of 2014.

My name is Rob, and I'll facilitate the audio portion of today's interactive broadcast.

(Operator Instructions)

As a reminder, this conference is being recorded.

At this time I would like to turn the call over to Stacey Witten with 3D Systems.

Good morning, and welcome to 3D Systems Conference Call.

I am Stacey Witten, and with me on the call are Avi Reichental, our CEO; Damon Gregoire, our CFO; and Andy Johnson, our Chief Legal Officer.

The webcast portion of this call contains the slide presentation that we will refer to during the call.

Those following along on the phone who wish to access the slide portion of this presentation may do so via the web at www.3DSystems.com/investor.

Participants who would like to ask questions at the end of the session related to matters discussed in this conference call should call in using the phone numbers provided on this slide.

The phone numbers are also provided in the press release we issued this morning.

For those who have accessed the streaming portion of the webcast, please be aware there may be a few-second delay, and you will not be able to pose questions via the web.

The following discussion and responses to your questions reflect Management's views as of today only, and will include forward-looking statements as described on this slide.

Actual results may differ materially.

Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K.

During this call we will discuss certain non-GAAP financial measures.

In our press release, slides accompanying this webcast and our filings with the SEC, each of which is available on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures.

Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2013.

Now, I will turn the call over to Avi Reichental, 3D Systems President and CEO.

Good morning, everyone, and thanks for joining us today.

Before we get into our financial results, I want to go over a few key trends that shaped our third-quarter results, and continue to inform our overall business outlook.

First, our inability to fulfill available demand for our direct metal and consumer product restricted our organic growth during the quarter.

Second, our bold investments in health care and metals are delivering category growth rates that substantially out-performed current industry growth, validating our early and decisive move into this space.

Third, our effective integration of acquisitions is already delivering synergies and expanded margins in our Quickparts and health care businesses.

Fourth, our stepped-up growth investments that started some 12 months ago are leveling off, and our operating leverage is returning.

Fifth, our ability to acquire strategic assets affordably, and to bring on board the leadership talent required to scale our business provides us with immediate opportunities to deliver greater value, and positions us best for sustainable profitable growth.

Back to the financial results.

I want to highlight a few drivers that shaped our third-quarter results.

First, we sold 57% more design and manufacturing printer units than the same period last year.

This category includes our plastic, nylon, composite, and metal printers.

Second, our services revenue increased 29%.

Finally, our materials revenue increased 18%.

Some of our revenue shortfall contributed to a higher order book, which increased by $14 million, or 44% sequentially, to $46 million.

And included $4 million increase in printer orders in hand, compared to the second-quarter order book, more accurately reflecting the robust demand for our products and services.

What's more, approximately 70% of our order book was comprised of organic products and services.

Our decision to delay shipments of our consumer printers, and our continued direct metal printers manufacturing constraints, restricted our organic growth rate to 12%, and held our total revenue growth to 23%, or $166.9 million for the quarter.

We're very disappointed that we were not able to monetize all the available demand for our metal printers, and capture a greater portion of the consumer printers opportunity during the quarter.

Having said that, during the quarter we took decisive measures to remediate these remaining performance gaps.

Specifically, we brought on line a second manufacturing line that now allows us to fulfill the increasing metal printers demand, and we commenced shipment of our latest consumer printers, and believe that the immediate positive user response that these products already received validates our decision to wait until these products were ready.

The decisive and cost-effective investment that we made to build an end-to-end 3D health care business are delivering impressive top- and bottom-line results.

Specifically, for the quarter, health care products and services revenue grew 121% to $37.4 million over the same period last year, primarily driven by strong organic growth.

Earlier this year we acquired Medical Modeling, adding proprietary virtual surgical planning and medical device 3D printing expertise.

During the quarter, we acquired LayerWise, enhancing our capabilities in medical and dental direct metal 3D printer devices and implants.

Also during the quarter we acquired Simbionix, a leading provider of 3D virtual reality surgical simulation and training products, further expanding our reach into personalized medicine.

With these acquisitions in hand, we can now offer integrated 3D solutions that extend from the training room to the operating room, powered by our proprietary digital thread.

Now that we have assembled this strategic portfolio, we're integrating into a cohesive and synergistic family of products and services under the capable leadership of one of our most experienced executives, Kevin McAlea.

We believe that our proprietary 3D health care solutions address a truly open-ended opportunity, and provide long-term profitable outcomes for our users, patients, and our shareholders.

Our bold investments in acquiring and developing proprietary direct metal printing technology contributed revenue growth of 241% in the first nine months of this year, compared to the pro forma results over the same period last year.

In fact, we out-sold our growing manufacturing capacity in every reporting period since we acquired Phenix Systems, and sales to add incremental capacity fast enough to meet rising demand for our metals printers.

Now that we are ramping up production in a second direct metals facility, we expect to be able to meet this rising demand during the fourth quarter and beyond.

We believe that industrial-grade, direct metal printing represents significant growth opportunities in the manufacturing of flight-ready aerospace parts, functional automotive assemblies, production tire molds, and ready-to-use medical devices.

Armed with the complementary direct metal printing technology that we have acquired from both LayerWise and Phenix, we believe we are best-positioned to satisfy this open-ended opportunity well into the future.

For the first nine months of this year, our effective R&D investment delivered 33% revenue increase from new products to $207 million that was primarily driven by strong adoption of our latest design and manufacturing products.

This investment already delivered 11 new products, and we're poised to unveil several new design and manufacturing products during the up-and-coming EuroMold 2014 show, including new production printers and materials.

With that, I will now turn the presentation over to Damon Gregoire, our Chief Financial Officer.

Damon?

Thanks Avi, and good morning everyone.

For the third quarter we announced net income of $3.1 million, and earnings per share of $0.03.

On a non-GAAP basis, we earned $0.18 per share.

For the first nine months, we increased revenue 30% from the prior year to $466.2 million, and reported net income of $10.1 million, and earnings per share of $0.09.

On a non-GAAP basis we earned $0.48 per share.

For the quarter, we enjoyed a 27% increase in revenue from our design and manufacturing category to $155.2 million.

Revenue from our rapidly expanding health care category increased 121% from last year, and 36% sequentially.

Consumer revenue decreased 13% to $11.8 million, as a result of our decision to delay launch of our latest consumer products.

Despite delayed availability, our quarterly consumer revenue expanded some 60% sequentially, reflecting the early impact of our latest products that began shipping late in the quarter.

For the first nine months of this year, products revenue grew 27% to $195.6 million, driven by strong placement of our plastic, nylon, composite, and metal 3D printers.

An expanding customer base and increasing printers utilization fueled the materials revenue increase of 29% to $117.5 million.

Services revenue rose 35% to $153.1 million, as we expanded our footprint and our range of services.

For the first nine months of this year, we continued to experience robust growth in all geographic regions.

Specifically, EMEA revenue grew an impressive 47% in the first nine months.

Asia Pacific revenue grew 39%, and the Americas grew 19% over the same period

In the third quarter, organic revenue from design and manufacturing products and services grew 26%, despite the capacity constraints for direct metals printers, which limited overall shipments from this category.

Software grew 23% and materials revenue grew 18%.

We expect our products, materials, and software categories to continue to contribute substantially to rising total organic growth rates.

Due to the continued shedding of less-profitable activities, Quickparts contributed moderately to our organic growth, and we expect that to continue for some time.

We expect revenue from printer service to remain relatively flat, as we have shifted much of that business to our reseller network.

Our decision to delay our latest consumer products decreased our consumer growth rate by 43% compared to last year's third quarter.

Now that we have begun shipping our latest consumer products, we expect this category to contribute favorably, and return to more healthy organic growth rates over the next periods.

Sequentially, materials gross profit margin rebounded to 73.1%, and Quickparts gross margin expanded to 44.7%, despite greater drag from concentrated service bureau acquisitions during the quarter.

Notwithstanding these gains, consolidated gross profit remained sequentially flat at 47.8% on the current sales volume and mix, and the residual costs of manufacturing ramp-up.

Transitional forces related to our new product launches and production ramp pressured our gross profit margin this year, but set the stage for us to enter next year poised for accelerated growth and gross profit margin expansion.

During the quarter we continued to make greater R&D investments, and our stepped-up SG&A investments, including amortization costs related to acquisitions, increased our SG&A expenses by 7% sequentially.

Even with that, we held our SG&A expenses to 33% of revenue, or $152.7 million for the first nine months.

As you can see on this slide, after four consecutive quarters of stepped-up investments, our operating expenses flattened, and our operating leverage is on an expansion trajectory.

Consistent with our previous statements, we expect operating leverage to continue to expand through the end of this year and into 2015.

We generated $8.6 million of cash from operations during the quarter, and ended with $377.3 million of cash on hand.

Our total working capital increased $120.8 million to $534.2 million.

During the first nine months of the year, we paid $244.6 million for acquisitions and venture investments, and $17.3 million for capital investments.

We received $299.7 million of net cash proceeds from our equity raise in May, and inventory increased to $104.9 million, primarily from acquisitions, and to a lesser extent from our expanding product lines.

During the quarter we also entered into a $150-million, five-year unsecured revolving credit facility, with an option to increase the aggregate principal amount availability by an additional $75 million.

At this point, this facility remains fully available.

Factoring our third-quarter revenue shortfall and outlook for the remainder of the year, we are reiterating our previous guidance for the full year of 2014.

Accordingly, we expect to deliver annual revenue in the range of $650 million to $690 million, and GAAP earnings per share of $0.18 to $0.28, and non-GAAP earnings per share in the range of $0.70 to $0.80.

As a reminder, our guidance is fully tax-affected, and inclusive of our acquisitions completed to date.

Our expected blended annual tax rate is 32% to 35%, and is reflected in our annual guidance.

I'd also like to remind you that this guidance is based on current plans and assumptions, and is subject to risks and uncertainties, including those detailed in our Risk Factors in our Safe Harbor statement, annual report on 10-K, and other filings with the SEC.

That concludes my comments.

Back to you, Avi.

Thanks, Damon.

During the third quarter, we added powerful synergistic technologies, domain expertise, and complementary sales channels through several acquisitions that are all in line with our growth initiatives.

We expanded our Quickparts capabilities through the acquisition of three US-based regional service boroughs that added to our expertise in aerospace and industrial applications.

We substantially advanced our leadership in direct metals 3D printing technology, and the manufacturing of medical, dental, and industrial precision parts at convincing scale through the acquisition of LayerWise.

We completed the acquisition of Simbionix, the global leader in 3D virtual reality surgical simulation, extending our digital thread in health care from the training room to the operating room.

Finally, in anticipation of future growth, we recently leased and began outfitting a 200,000-square-foot manufacturing facility in Rock Hill, South Carolina, that is designed to further expand our manufacturing capacity.

We expect this new facility to become fully operational during the first quarter of 2015.

During the quarter we continued to expand our senior leadership team.

We appointed Ted Hall as our Chief Financial Officer, effective November 11 of this year.

Ted will succeed Damon Gregoire as he transitions to the role of Executive Vice President, Mergers and Acquisitions.

Ted brings a wealth of experience in integrating, scaling, and fine tuning high-growth tech companies.

He previously served as the Chief Financial Officer of Fusion IO, and prior to that as Vice President of Finance at Cisco.

We appointed Mark Wright as Chief Operating Officer, previously as Senior Executive at EMC.

Mark will work closely with other senior leaders in our Company to scale our commercial and manufacturing operations, and to leverage our recent investments further.

We also promoted Kevin McAlea to the position of Chief Operating Officer, Healthcare.

Most recently, Kevin oversaw the successful development of our direct metal printer line after we acquired Phenix Systems.

Kevin will now be responsible for execute our health care growth strategy, integrating recent acquisitions into a cohesive and synergistic portfolio of products and services.

We promoted Jeff Blank to the role of Chief Development Officer.

Jeff joined 3D Systems through the acquisition of the Xerox Wilsonville engineering team, where he held the position of Vice President Engineering.

Jeff brings decades of relevant engineering leadership expertise, and is now leading our global engineering team of 400 strong, working out of 12 R&D locations around the world.

We also appointed Peter Theran as Vice President Consumer Retail.

A former senior executive at Bose responsible for consumer sales, Peter will lead our consumer retail operations, and broaden the reach and penetration of our latest consumer offering.

We enter the fourth quarter of 2014 with an all-time record order book, and positive sales momentum.

We have now closed our recent product availability gaps in consumer and metal printers, and expect those categories to contribute favorably to our growth in the fourth quarter.

The same accelerated investments that pressured our short-term performance also delivered the most comprehensive portfolio of self-developed and acquired 3D product and services available to date.

We believe we are now on a stronger footing as we shift forward towards fine-tuning these investments, and leveraging them into profitable and sustainable growth.

With that, we will now gladly take your questions.

Stacey?

Thank you.

(Operator Instructions)

Our first question is from the line of John Baliotti with Janney Capital Markets.

Good morning.

Damon or Avi, I'm not sure if you can break out the non-recurring margin impact from what you described as transitional costs, the launch delays in capacity, but the operating expense as a percent of sales you pointed out were down versus the second quarter and the first quarter.

Given that you expect continued margin leverage through this year and into next year, can you give us a sense of mix in terms of contribution -- where you think it's coming from gross margin, SG&A, R&D?

Because those -- certainly SG&A and R&D are showing good trends, back to more normal levels starting from the beginning of the year.

Good morning, John.

Let me begin, and I'll ask Damon to end and follow up on my answer, and expand on it.

I think that we have a few elements here to consider.

One is, we're still getting through the transitional costs in scaling up the concentrated introduction of new product.

Certainly, the combined impact of all of that has dragged certainly our systems' gross profit margins.

Notwithstanding the fact that material gross profit margins rebounded nicely, as we expected and as we said previously, and notwithstanding the fact that our effective integration capabilities expanded our Quickparts gross profit margins, even in a quarter that we had a fairly high concentration of original Quickparts acquisitions, which typically introduces margin headwinds.

So, notwithstanding that, in those categories we continue to expand margin nicely.

And our expectation is that, as we complete the ramp-up and the introduction of what's in the pipeline, systems' gross profit margins will rebound as well, and that the mix we expect to improve as well, based on what we have teed up.

On R&D and SG&A, I think Damon said it very well in his prepared remarks that those have flattened, have been held as a percentage of revenue more or less constant.

As you can see in one of the slides that Damon showed, clearly leverage is returning.

With expected increased revenue, we expect greater leverage in the P&L going into next year.

Damon, I'm sure you're itching to add to what I had to say.

You covered things pretty well, but I will say -- to answer you, John -- about what the big drivers are, Avi mentioned the different categories for sure.

But continued Quickparts margin expansion will help drive ultimate operating leverage, because that's becoming a much more significant part of the business every period, both through growth and through acquisitions that we have done.

We are very happy with how those margins have been expanding, and even in a high time of acquisition.

Materials margin will -- materials sales and margin will help expand gross profit margin, both from growing and returning to be a part of the mix at the percentages that we would expect it over time.

And also, not just the rebounding of the materials gross profit margin, but expansion of that gross profit margin that we had talked about before.

The flattening of SG&A and R&D as a percentage of revenue, or even coming down a bit as a percentage of revenue will help, but the big drivers to operating margin ultimately are those gross profit margin expansion opportunities.

Our next question is from the line of Jim Ricchiuti with Needham & Company.

Thank you, good morning.

I guess you're about 10 months into the acquisition of the Xerox engineering team.

I wonder if you could talk about the progress you're making in that area, and more broadly, the new product development that you have under way in industrial-grade printers, particularly in light, I think, of the competitive developments we've seen.

Well, Jim, I think that in all material respect, when all is said and done, the wisdom of us taking earlier and bolder decisive actions, and making investments before the tea leaves were readable, is going to continue to bode well for us.

We made the Xerox Wilsonville investment, as you said, about 10 months ago in anticipation of not just existing competitive development, but new competitors entering the arena.

We felt that we had a unique, if you will, once-in-a-decade opportunity to acquire an assembled team that spent decades mainstreaming and simplifying a very complex 2D full-color printing technology, productizing it in a way that was faster, simpler, more affordable, and with increased user satisfaction.

That same team now is fully integrated.

In fact, we recently promoted the head of that team, Jeff Blank, to head our global engineering development team as our Chief Development Officer.

That team is working and is involved with the development of a series of new products that you will see coming on to the market throughout next year.

They're plugged into all of our jetting projects, our color, and multi-materials and composites.

They are obviously leading our developments in high-speed continuous 3D printing, which we believe will completely shift the landscape in terms of what's possible to manufacture at convincing scales, with functionality and precision -- the kind of functionality and precision that is relevant and pertinent to aerospace and automotive and medical device and consumer electronics at convincing scale.

With all that said, Jim, we are also continuing to advance primarily as we enter the EuroMold season, we are continuing to advance our current professional design and manufacturing systems.

And you can expect to see several significant announcements in connection with EuroMold of the expansion of our SLA, SLS, and direct-metal platforms, and materials and software capabilities.

Our next question is from the line of Bobby Burleson of Canaccord Genuity.

Hi, thanks for taking my question.

I guess this one's for Avi.

Just looking at the organic growth, certainly there was a deceleration there in Q3.

I'm wondering what gets us back to that 20%-plus?

It looks like you're getting towards that, maybe in Q4.

The view on organic growth seemed to shift a little bit during the quarter last quarter.

I'm wondering what the cause of that was, and what gets us back to a nicer trend on the organic revenue growth going forward?

Thanks.

Well, I think, Bobby, that when we look at our organic growth, we have to look at organic growth in which category, specifically.

Because, for example, as we said in our opening remarks this morning, we sold 57% more design and manufacturing units in the quarter than we did a year ago.

If you look at the entire design and manufacturing category, it organically grew by 26%.

Software organically grew by 23%, and materials organically grew by 18%.

What was hard for us to do is to make up the shortfall that we have from our deliberate decision to delay consumer.

Consumer actually contributed negative to organic growth.

It was negative 43% contribution, although I have to add that, sequentially, consumer from the second to the third quarter -- just on the tail end of the quarter commencement of shipments of the new products -- consumer already improved sequentially 60% quarter over quarter.

It's early days.

We expect much greater contributions in the fourth quarter.

Our field services, primarily related to printers, are holding flat.

That is part of a deliberate decision to basically pass most of the growth opportunity to our extending reseller network, and giving them an incentive to stay engaged and involved with resellers in the field.

Quickparts has only grown 10% organically for the quarter.

This is the continuation of us integrating and shedding less-profitable activities.

For the full nine months it has grown much nicer organically, and we expect that it will take us several more quarters of slower growth from Quickparts before we get it up to a higher level.

Finally, remember that a lot of our organic growth is sitting in our order book.

Some of it is directly related to our metals capacity, but as Damon said in his opening remarks this morning, about 70% of what is currently sitting in the order book is organic.

Our organic growth improved somewhat sequentially.

It was about 10% in Q2.

It's up to 12%, but it's clearly understated by the current mix and by the significant shortfall that we had, some of which is clearly sitting in an order book that expanded substantially on a sequential basis, and hauled some of the yet unrealized organic growth.

Our expectation, Bobby, is that, in the same way we have 26% organic growth in design and manufacturing, and 23% organic growth in software and so forth, the rest will come up to the level of what this industry will support.

It will come up as we remediate it now, our performance gaps and shortfalls in direct metals and in consumer, which we expect to recover nicely in the fourth quarter.

I will also add to that, that we have some categories that greatly outperform even the most optimistic industry growth rates, like our health care, which has been growing by 121%, primarily on organic growth of about 79%.

Our next question is from the line of Ben Hearnsberger with Stephens.

Hi, thanks for taking my question.

Avi, can you speak to how quickly you think you can take the new metals capacity up to full productivity, and if you are running the new line at 100%, what type of revenue opportunity this gives you on an annual basis?

We believe that, at this point in time, we are ramping in direct relation to existing demand.

We clearly believe that we can, with a second line fully operational, keep up with demand for the foreseeable future.

We have been guiding for the year to be somewhere in the range, I believe, of $25 million to $50 million, and we still believe that we will finish closer to the upper end of that guidance as we exit the year.

As to the potential for next year, we will deal with that when we provide our 2015 guidance in connection with the full-year report.

But I think the fact that we were able to, for the first nine months, grow this product by 241%, based on last year's performer revenue -- even with the shortfall factored in -- should speak volumes about the kind of potential that this product line holds for the future.

Add to that the second strategic investment that we made with LayerWise, which also brings proprietary complementary direct-metal technology to the table.

We believe that, that will substantially enhance our portfolio going into 2015.

As we said previously, and I'll reiterate this morning, we plan to unveil at EuroMold 2014 a larger direct-metal machine that we are going to call the ProX 400.

We will provide more details on it in the coming days.

That will further expand the attractiveness and open new applications for our direct-metal platform as we go forward.

Our next question comes from the line of Jason North with Jefferies.

Hi, thank you.

I was wondering -- you made several acquisitions in the quarter for smaller service bureaus.

I was wondering, if you could, with the organic growth for services overall being fairly flat, just where your thought process is for this acquisition strategy.

Thank you.

Well, our thought process is that we are consolidating and adding coverage in regional capabilities.

We believe that, ultimately, Quickparts represents a very significant profitable growth platform for us, not just in our ability to supply customers with what they need, and create more meaningful and deep long-term relationships with customers, but Quickparts has been our most powerful demand-generation platform for all of our extending design and manufacturing portfolio.

Quickparts has a significant ecosystem of professionals that are doing business with us every day of the week the world over.

Quickparts continues to represent one of the most attractive growth opportunities with expanding margins.

The nature of consolidation and integration is such that, given that we like to do it in a way that's accretive and profitable, we are shedding unprofitable growth and replacing it with profitable growth.

When you do it, and in every period you continue to add acquisitions, the underlining net progress is not as clear as it would be had we ceased to make those acquisitions.

And I think what you should really take note of is that, even in a period that we had a high concentration of acquisitions, we still managed to expand our gross profit margin, which for that particular business right now is our primary objective -- to fully integrate, to put it all on the same platform, and to continue to expand margin.

We have done it really well, and we expect that, that will bode well for us in the future.

I also want to point out to you that, unlike some of the other players in this space, we are vertically integrated all the way to the materials and the systems with our Quickparts integration, which gives us we believe a significant long-term and scalable advantage.

In addition to that, we're operating as an integrated business unit that works off our proprietary Q-Soft platform, and, finally, that we expect to continue to increase our Quickparts gross profit margin further as we continue to increase utilization, get all the synergies out of the recent acquisitions, and complete the shedding of the less-profitable activities.

We think that this is a strategy that has served us extremely well.

We were the first to do it before it became popular and mainstreamed.

We've done it much more affordably than others, and we will go the distance.

Our next question comes from the line of Wamsi Mohan with Merrill Lynch.

Can you comment on the organic growth in the fourth quarter?

When we think about it in terms of ex-metals and consumers, especially given your comments on very strong quarter-on-quarter growth rates for those two categories, those two combined still only account for less than 20% of your business.

When you look at your guidance change for the full year, and relative to the $20-million or so shortfall you experienced in the second quarter, it seems that -- the third quarter, excuse me, it seems like the fourth-quarter numbers are moving even further down, despite the fact that you're ramping all this capacity.

I'm trying to understand, what is the actual organic growth rate of the core business, ex the metals and ex-consumer?

Thank you.

We have given it to you, for the third quarter, on slide 17, right?

When you look at it, you can see.

Design and manufacturing 26%, software at 23%, materials 18%, and so forth.

Remember, Wamsi, that we can't make, in a single quarter, the shortfall of the first nine months from our consumer delays and from our capacity constraints in metals.

Since we are not giving quarterly guidance, we adjusted our annual guidance.

In fact, in terms of real growth rates, we believe that what we see in design and manufacturing, and in software, and in materials, clearly reflect and project the core business growth rates.

We have seen a real strengthening of design and manufacturing, primarily led by our SLA and SLS printers.

We see real growth in materials that is organic.

And we expect that, once we begin to benefit during the first quarter from available consumer product, that will contribute to organic growth.

Of course, the ability to shift booked metal orders will also contribute to it, and will restore our organic growth to original expectation.

Our next question comes from the line of Patrick Newton with Stifel.

Thank you for taking my questions.

This is Rob Richardson on for Patrick this morning.

I have a specific question on a release we saw last week, where you recently announced a 3D printer value bundle offer, consisting of three different PolyJet printers.

To our knowledge, this is the first time that you've ever discounted your products.

Can you discuss the strategy behind what drove the decision to discount?

Should we expect to see discounting become a more integral part of your sales strategy?

And is this discounting due to any competitive dynamics in the market?

Thank you.

A couple of clarifications.

We do not sell PolyJet printers.

That must be somebody else that you refer to.

The package that we put together, if you study it very carefully, actually doesn't offer any additional discounts to what is typically available.

These are incentives to allow people to actually purchase the complete capability that they need for their design and manufacturing needs in a company.

It's a very popular way for customers today to purchase.

The combination of the three printers in question that are in this package, even after the incentive to purchase them as a package, is still accretive to our upward-selling prices.

And it is extremely well positioned vis-a-vis the price of a single unit of competitive offering.

It is central to our believe that there is no one printer and that there is no one print engine that can solve all of our customers' needs.

It's at the heart of our strength, which is seven print engines and the ability to match the right tool for the right job.

It is very empowering and democratizing to our users to be able to get the complete toolbox of everything that they need for their design and manufacturing requirements in one package.

We're actually excited that we could offer it this way.

Our next question comes from the line of Ken Wong, Citigroup.

We're nearly halfway through the quarter.

Can you give us some color on the early demand trends in the consumer space?

And should we be expecting a meaningful sequential increase here, just given that there's probably some pent-up demand from the delay?

Clearly you can discern, not just from our prepared remarks, but what you can read on blogs and message boards that the early reception for our Cube 3 and Cube Pro have been phenomenally positive.

We believe that we have here a couple of products that represent a giant leap versus the competitive landscape, and, more importantly, matching what customers are really looking for in a plug-and-play capability for the consumer, and in a professional capability for the engineer's desktop.

Even with just very limited late third-quarter availability, we have seen a sequential uptick in consumer revenue of about 60%.

Clearly, with some of that pent-up demand in the order book, and with shipments now in full swing, we expect to see greater contribution from our latest consumer product in the fourth quarter -- and, by the way, well into next year.

We're just beginning.

We have lots of activities, activations, and promotions for our consumer product line.

We just hired a very experienced senior executive from Bose in Peter Theran to help us lead the expansion of our retail and consumer activities now that we believe that we succeeded in delivering world-class product.

And that is only the beginning of what we believe will become a much more meaningful part of our business going into 2015 and beyond.

Our next question comes from the line of Ananda Baruah with Brean.

Hi, thanks guys for taking the question, and good morning.

On the operating leverage potential for next year, I believe that before the preliminary 3Q results, the view is that there is potentially the ability to get the operating margins to the mid-20%s exiting the year.

Piggybacking off of the previous response you guys gave to the op leverage drivers, how much of the driver of potential operating leverage is actually the revenue dollar amount in the context of what your OpEx plans are, versus what the growth might be, now that we're starting from the lower-rev dollar base going into next year?

I'm really trying to get a sense of, if the leverage potential is still somewhat similar to what you guys previously believed it could be.

Thanks.

We definitely think our operating leverage potential is -- over time, is where we -- it's intact at where we've had it.

Obviously, revenue generation, or increased revenue, is a portion of that, but that's also at higher gross profit margins in the categories we talked about in the question earlier.

We do expect that the operating expenses as a percentage of revenue continue to flatten, and actually decrease as a percentage of revenue.

Right now they've been flat as a percentage of revenue.

But the big operating margin increases are really related to gross profit margin expansion in the categories talked about earlier.

I think that we need to bear in mind a few things here.

We decided to step up our investments in operating expenses about four quarters ago, anticipating that we would need to build that organizational capabilities infrastructure and manufacturing capacity.

We are at the tail end of our investments, and we have done it while remaining profitable, generating free cash, and doing it in a way that is already indicating the return of leverage.

Clearly, we've increased revenues and expanded gross profit margins.

You see even greater operating margin leverage.

But it's important to remember that, as a percentage of revenue, we believe that we kind of peaked.

And, absent unusual events like large acquisitions, on a comparable basis we see our operating expenses not just flattening, but as a percentage of revenue even moderately declining.

You put all that together, we're looking at a horizon with an expectation for a healthy return of leverage in a way that we believe has remained intact.

Our next question comes from the line of Amit Daryanani with RBC.

Thanks.

Good morning, guys.

Just a question I had was around inventory levels at your -- on 3D Systems in the channel.

In the past you've talked about your revenues as a percent of reseller inventories are about 8% to 10% the first half of the year.

Could you tell us what that number was for Q3, and broadly, how do you think of inventory levels at the channel at 3D right now?

Thanks.

We have -- when we file our Q this morning that will be in there.

It is 9% for the quarter, which is consistent with the levels that we expected and we have reported in the past.

That number could go up or down a percentage point in any period.

We still do not have large inventory levels at resellers.

A lot of them, again, still operate in the same way, with drop shipments from us, or other areas where they're not taking inventory until they have sales.

One interesting area, though, is, because of our new products and their demand, we have been attracting larger, more distributor-type, instead of just resellers.

Those might take a little bit of inventory in order to fulfill their sub-distributor or sub-reseller plan; but that's a very validating point to us that actually larger distributors are looking at us, and able to move these products also.

But the simple answer is, it really hasn't moved at all.

It remained at about 9%.

That's what you'll see in the Q. And that has been thoroughly consistent for many quarters now -- so, steady as she goes.

Our next question is from the line of Ajay Kejriwal with FBR.

Thank you, good morning.

Obviously, a lot of ground covered here, so, Avi, maybe a big-picture question on health care.

With all the acquisitions you perhaps have an unmatched portfolio, so maybe just talk about that.

Do you have most of the pieces that you wanted and you can now focus on just driving organic growth, or do you think there's still acquisition opportunities as you think about the healthcare market?

Yes, well I would only slightly correct what you said.

You said you perhaps have the most differentiated portfolio.

We think that we have the only portfolio that takes you all the way from the training room to the operating room with leading technology.

If you look at this -- and we showed in this morning's presentation on one of the slides, the health care revenue growth.

Bear in mind that, that is without any material contributions yet from LayerWise and Simbionix that were added late enough in the quarter that they did not make material contributions to what you see here.

You can see that we have been, over many quarters, delivering very impressive top- and bottom-line results that, with the addition of medical modeling, Simbionix, and LayerWise, we really have the only end-to-end expertise that can allow you to train, simulate, rehearse with patient-specific data, plan virtual surgical procedures, print all the instruments and the implants, and carry it out with improved outcomes in the operating room.

This is what we call the digital thread.

What you see is, you see 121% growth in Q3 over last year, without any meaningful contributions yet from Simbionix and LayerWise.

79% of it was organic.

The rest came from primarily medical modeling.

You see a 36% sequential increase, and you see a 68% CAGR there.

We think that this is still early days.

We see patient-specific healthcare, or patient-specific medicine, as truly an open-ended opportunity.

It's one of the core areas that we invested in decisively, and well ahead of the crowd.

And we believe that, that will bode extremely well, both in terms of top-line and bottom-line contributions in the coming years.

It's another part of our decisive, early-mover advantage in key verticals, and we see this as a very similar story to what we intend to do with direct metals.

Our next question comes from the line of Holden Lewis with Oppenheimer.

Great, thank you very much.

I just wanted to touch on the organic growth driver page again.

I appreciate, by the way, you giving us sort of the organic pieces for those six.

I hope you continue doing that.

For design and manufacturing, I guess I'm trying to get a sense of -- I assume that does include the metals.

You talked about how strong the metals growth is year over year, even if it's not quite what you expected it to be.

But if the metals is included in that 26% organic, then obviously the design and manufacturing piece ex-metals would be quite a bit lower than that, I suspect, and quite a bit lower than what most industry people think the industry is growing at.

I wanted to get some color maybe of the design and manufacturing sector excluding the metals.

Yes, so, what we also said, Holden, is that, actually, our plastic printers are growing very healthily.

In fact, we shared another key point, and that is that design and manufacturing printer units increased 57%.

That was aided by very strong contributions from our SLA and SLS printers, with many, many customers placing orders for multiple units.

On the flip side, Holden, had we been able to ship all the demand for our -- all the book demands for our metal systems, and had we not experienced the consumer product availability delays, we wouldn't be having a conversation about our organic growth rates in total.

It's important to bear that in mind, as well.

Our next question is from the line of Sherri Scribner with Deutsche Bank.

Hi, thank you.

I wanted to get a sense of how -- what types of growth rates do you think the industry is growing at, and what types of growth rates you expect going forward?

Related to that, with HP entering the market, what do you think the impact is, and how do you think that changes growth for the industry?

Thanks.

Let's start by saying that we see the HP announcement as enormously validating to us.

Personally, we think it's a net positive.

We've been expecting their announcement actually for quite some time.

It's been delayed multiple times.

The question is whether or not their technology can find a sweet spot between parts, performance, material costs, unit costs, and speed.

What we have seen from them so far is more of a technology announcement, or a technology concept looking for a sweet spot.

We don't think that it in any way impacts our ability to continue to differentiate and drive adoption in real manufacturing applications that include aerospace, automotive, healthcare, consumer electronics, and the at-home demand.

We really don't see what they announced as being flight-ready or fitting under the hood of automotive companies, or in people's bodies any time soon.

We wish them a great deal of success.

We respect their capabilities, and we continue to differentiate and advance our business model in key verticals.

And, judging by the category results that we shared with you this morning in healthcare and in direct metal, et cetera, we think that we're executing extremely well.

The next question is from the line of Jay Harris with Goldsmith and Harris.

Good morning.

You're building a very powerful enterprise, and I wondered whether any of the financial dynamics of the business would change.

As an example, comparing the fourth quarter to the third quarter, on a $16-million increase in revenues you had a $25-million increase in inventories.

What should we expect in terms of the capital employed in inventories relative to the size of the corporation going forward?

Yes, Jay, we are building a very powerful -- and I would add differentiated -- enterprise.

And we're doing it in a way that has been profitable and responsible in the sense that we've made the investments, and we burdened, or pressured, our P&L this year to do it.

But we stayed profitable and generated free cash throughout the year while doing it, and most of that is now behind us.

As it pertains to inventories specifically, it's true that our inventory increased, primarily on the addition of acquired products -- primarily, in this case, Simbionix, which is a product company and has increased our inventories sequentially over the prior quarter -- and, to a lesser extent, the support of all the new products that we have added to the portfolio: the second manufacturing line for metals; the new consumer products; et cetera.

Going forward -- again, absent significant acquisitions that come with inventory, going forward, expect inventory to level off and to just incrementally fluctuate in support of portfolio additions.

Damon, I don't know if you want to discuss working capital in general.

I'll make one more comment on inventory.

The inventory gains we can make with our -- let's call it core inventories or existing inventories, don't just relate to decreasing amounts on hand.

They also relate to efficiencies and steps in supply chain with the new products.

So, as we start with these new products, the cost is higher until we get to certain volumes.

In the future, we believe that, even with the same amount of inventory, our inventory costs come down.

That was the big point I just wanted to make.

It's a good point.

Thank you.

At this time, we have reached the end of our allotted time for questions and answers this morning.

I would like to turn the call back over to Stacey Witten for closing remarks.

Stacey?

Thank you for joining us today and for your continued support of 3D Systems.

A replay of this webcast will be made available after the call on the Investor Relations section of our website, www.3DSystems.com/investor.

Thank you.

This concludes today's conference.

You may disconnect your lines at this time.

Thank you for your participation.