3D Systems Corporation

Hello, good morning, and welcome to 3D Systems conference call and audio webcast to discuss the results of the second quarter 2022. My name is Kevin, and I'll facilitate the audio portion of today's interactive broadcast. All participants have been placed on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. At this time, I'd like to turn the call over to Russell Johnson, Vice President, Treasurer, and Investor Relations. Please go ahead.

Good morning and welcome to 3D Systems' second quarter 2022 conference call. With me on today's call are Dr. Jeffrey Graves, President and Chief Executive Officer, Wayne Penske, Interim Chief Financial Officer, and Andrew Johnson, Executive Vice President and Chief Legal Officer. The 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 this presentation may do so on the investor relations section of our website. For those who have accessed the streaming portion of the webcast, please be aware that there may be a few seconds delay and that you will not be able to post 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 your financial results is included in last night's press release and our filings with the SEC, including our most recent annual report on Form 10-K and quarterly reports on Form 10-Q. During this call, we will discuss certain non-GAAP financial measures. In our press release and slides accompanying this webcast, which are both available on our Investor Relations 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 2021. With that, I'll turn the call over to our CEO, Jeff Graves, for opening remarks.

Thank you, Russell, and good morning, everyone. I want to thank all of you for joining today's discussion of our second quarter results. As always, it's my pleasure to have this opportunity to speak with you and share my perspectives on our ongoing efforts to make 3D Systems the world's most innovative and successful provider of additive manufacturing solutions. As I look out on the environment in which 3D Systems is operating today, I see much to be optimistic about, but I also see a complex and volatile mix of business conditions that's challenging our ability to deliver consistent results during 2022. On one hand, it's clear to me that the underlying trends supporting the broad adoption of additive manufacturing solutions in production environments are both strong and resilient. Across our diversified economy, in applications ranging from the traditional manufacturing shop floor to the biotech laboratory where lifesaving medical treatments are created, additive manufacturing technologies are enabling new levels of efficiency, flexibility, and innovation. These macro trends give me tremendous confidence in this industry and in 3D Systems' role as a leader in it. It's this confidence that's guiding the strategic actions we're taking this year to consistently invest in new additive technologies and in our internal infrastructure to support future growth. On the other hand, the new normal of our post-pandemic world is proving anything but normal. As we highlighted in yesterday's earnings release, during the second quarter, 3D Systems like many other companies, encountered a more difficult global business environment than we had anticipated when we exited 2021. Our performance this quarter was impacted negatively by various macroeconomic and geopolitical factors, most notably stubborn supply chain issues, foreign exchange volatility, and our exit from the Russian market. While these factors such as these are often hard to predict or control, the reality is that they generated unexpected headwinds for our business during the second quarter, and led to revenue growth and profitability below our internal expectations and no doubt below the expectations of our investors as well. Looking ahead to the second half of the year, we now believe that these factors combined with an expectation of dampened consumer discretionary spending driven by the rapid rise in the price of food, gasoline, and other daily necessities will impact our results. As a result, we're taking a more conservative stance on our outlook for the balance of the year and reducing our 2022 guidance. While we hope that these effects will be short-lived, I feel it's important to be prudent to plan for them until the data suggests otherwise. Fortunately, we have the scale, the balance sheet, and an exceptional customer base, which allows us to weather these short-term headwinds and continue to prudently invest for the strong growth opportunities we see when, inevitably, these headwinds subside. We'll do so with the same financial discipline that I hope you now have come to associate with this leadership team. For today's call, we'll start with my summary comments on the quarter and the full year forecast, and then Wayne Penske will provide more details. For the consolidated company, after adjusting for the significant divestiture program that we completed in 2021, revenue for the second quarter grew 3.2% year over year and 7.8% in constant currency. As I mentioned, Several exogenous factors had an outsized impact on the second quarter top line. These include the rapid strengthening of the US dollar and the frustrating continuation of component shortages and other supply chain disruptions that we experienced during Q1. They also include the ongoing tragedy of the war in Ukraine, which led us to exit the Russian market and has since negatively impacted business confidence in the European countries, such as Germany, where 3D systems, and particularly our industrial segment, has traditionally had a strong presence. Were it not for these headwinds, our consolidated revenue for the second quarter would have grown by healthy double digits year over year as we had anticipated. So while we're by no means satisfied with our quarterly results, it's important to view them in the light of the very challenging and volatile macro environment we face during the quarter. To reinforce the message we have stated previously, with the increasing adoption of additive manufacturing and production environments across both our healthcare and industrial customer base, we anticipate delivering solid double-digit annual revenue growth once these shorter-term headwinds subside. Turning to our divestiture adjusted segment performance, in the second quarter, revenue for our industrial segment grew 3.8% year-over-year and 11.2% in constant currency, while revenue for our healthcare segment grew 2.9% and 4.7% in constant currency. The foreign exchange impact on our industrial segment was quite significant due to that segment's exposure to manufacturers and service bureau customers in Europe and Asia Pacific. Industrial also experienced the biggest revenue impact due to our exit from the Russian market. In healthcare, second quarter revenue came in softer than expected. The slower growth in healthcare was driven largely by a postponement of elective procedures due to both a resurgence of COVID, which once again limited patient access to hospitals, and to greatly heightened inflationary pressures on consumers, which forced them to prioritize their purchases and postpone optional care, particularly in the dental market. Fortunately, once the impact of COVID again subsides and inflation begins to cool, we expect these elective procedures to once again accelerate. However, to be clear in our updated guidance, we've modeled these conditions as now extending through the end of the year. So in short, we're reducing our revenue estimates for the full year, assuming that the challenges we saw as we exited the second quarter continue throughout the remainder of the year. These primarily include the impact of currency, inflation, and supply chain disruption. In addition to these objective factors, we're also receiving clear signals from selected customers that their visibility into near-term demand trends has diminished. In response, they're slowing their expansion plans and adjusting purchases, to more tightly control inventory levels until their visibility into demand improves. Major drivers of this uncertainty are the potential impact of recessionary pressures on consumer confidence and the stubborn high inflation environment, which is an important driver of reduced discretionary healthcare spending. Secondly, but not an insignificant factor driving us to be conservative in our forecast at this point, is the potential impact of energy supply constraints on our European customers stemming from increased EU government efforts to reduce their dependency on Russian oil and gas supplies. The net effect of any such effort, which looks increasingly probable, would be further dampening of demand on capital or capital investments, particularly in Germany. One obvious area that influences our second half forecast is our dental business, which had previously enjoyed very strong double digit growth in the US and internationally. Given the current geopolitical tensions, the resurgence of COVID in China, and the curtailing of consumer discretionary spending throughout Europe and the US, we're projecting slower growth in our dental segment in the second half. We once again view this as transitory, but still material in our full year forecast. As we exited the second quarter and evaluated all of these risk factors, we've updated our forecast and are now taking a more conservative view of our projected four-year performance, all of which is reflected in our updated four-year guidance that Wayne will discuss in a few moments. While we're disappointed in having to take this step, we're doing so out of an abundance of caution and in the spirit of transparency to our investors. I can assure you we don't take this decision lightly. and you have my commitment that we'll work hard through the balance of this year to regain momentum in our financial performance that we've built over the last two years. Actions we're taking include a variety of steps to optimize our cost structure, improve the efficiency of our operations, and refine our technology portfolio to assure exciting and profitable growth in the years ahead. Reflecting this focus on operational efficiencies, in July we took a major step forward by transitioning the sourcing and manufacturing activities for much of our polymer-based printers in-house and terminating our agreement with a major contract manufacturer. Insourcing these high-tech, high-mix, low-volume printer platforms took months of planning and required us to incur some upfront exit and inventory costs. But over time, we believe this approach gives us much better control of our critical supply chain elements, resulting in reduced manufacturing costs, improved inventory management, and improved customer-facing metrics such as quality and delivery performance. This step, in combination with our new product design efforts, is a key element in delivering higher gross margin performance, the goal of which is to exceed 50% in the years ahead. We have additional efficiency actions in flight, and we'll update you on our progress as we move through the year. Before I end my remarks and hand over to Wayne, I want to comment on important progress and collaborations between 3D Systems and what I believe are two of the world's most innovative technology partners. First, in June, our longtime biotechnology development partner, United Therapeutics, announced that in close partnership with 3D Systems, they have successfully printed the most complex object ever produced by mankind, a complete human lung scaffold. consisting of over 4,000 kilometers of pulmonary vasculature and airways with wall thicknesses measured in fractions of the diameter of a human hair. The complexity and precision that we've now demonstrated using biocompatible materials and our most advanced production printing platform technology is truly groundbreaking and represents a key milestone in our regenerative medicine efforts. In the first unveiling of this incredible capability, United Therapeutics President and CEO, Dr. Martine Rothblatt, and 3D Systems Founder and Chief Technology Officer for Regenerative Medicine, Chuck Hull, appeared at the CNN-sponsored Life Itself Conference hosted by Dr. Sanjay Gupta and Mark Hodosh. In her presentation, Dr. Rothblatt declared for the first time publicly her vision to have these personalized bioprinted lungs cleared for human trial within five years. With our team's increasing momentum, earlier this year we expanded the scope of our collaboration to include the manufacture of human livers and kidneys. All of these efforts are tied to the singular goal of producing an unlimited supply of fully biocompatible human organs for transplantation to people who need them around the world. While the goals are ambitious, I believe more than ever that we'll meet them. And I want to thank Dr. Rothblatt for her vision and unwavering support in leading us there. With the foundation of progress that we've made in materials, hardware, and control technologies for printing human organs, which I believe are quite unique in the world, one of my most important goals for 3D Systems has become the building of a world-class regenerative medicine business around the emerging science of photopolymer-based bioprinting. Building upon the incredible work our teams conducted with United Therapeutics, in 2021, we acquired two development companies, Alevi and Volumetric Biotechnologies, in order to bring additional technology and specialized technical skills to our regenerative programs at 3D Systems. Having now integrated these exceptionally talented scientists and engineers, I'm extremely pleased with our accelerating progress and committed to this groundbreaking technology, which offers the potential to improve countless lives of people who are suffering from chronic diseases or injuries around the world. With the progress that we've now made and the expanded capacity and capabilities we have in our program, two very exciting adjacent fields of applications have now opened up to us. One is the printing of non-organ human tissue for a wide range of applications within the body. We're actively working on a targeted subset of these high-value non-organ applications, and we'll be discussing progress publicly when appropriate. The second application field, and one that we believe offers exciting and potentially nearer-term opportunities, is the printing of vascularized tissue for use in drug discovery. With our ability to now print vascularized tissue that enables very precise, predetermined blood flow while accommodating an enormous range of human cells, including both healthy and diseased cells, the effectiveness of developmental drug therapies can rapidly be evaluated in the laboratory. is to reduce the development time for new drug therapies and over time reduce or even eliminate the need for animal testing. Given the ongoing exploratory efforts we have underway with leading pharmaceutical companies, we're excited about the potential of this technology and are now investing in both the people and the infrastructure we'll need in order to bring this to commercial operation. You can expect to hear more about these efforts later this year. In support of these developmental efforts, we're also now putting in place, for the first time in our company's history, a medical advisory board to provide input on each of our regenerative medicine programs. Under the leadership of Dr. Steven Klasko, a recognized visionary leader in the global healthcare community, in the second quarter we were pleased and honored to announce the appointment of the Honorable Dr. David Shulkin, former Secretary of Veterans Affairs, and more recently, the Honorable Alex Azar, former Secretary of Health and Human Services and a recognized leader in the pharmaceutical industry. This distinguished group of advisors, along with additional members soon to be named, will play an important role in our development and commercialization of these remarkable new products. In addition to the progress we're making in regenerative medicine, we were very excited to announce this week an agreement to acquire DP Polar, the Germany-based developer of the industry's first additive manufacturing system designed for true high-speed mass production of customized components. DP Polar's technology is truly path-breaking. It features multiple fixed printing heads and a rotating build platform that enables continuous high-speed 3D printing at industrial scale. Among its many unique features, it can embed objects such as sensors, electronics, or magnets, into printed parts by using inline robotic pick and place capability. With its ability to achieve production speeds up to five times higher than traditional batch process printing platforms, which represent the standard in the industry today, this novel technology opens up many new exciting high volume applications for the future. We're extremely excited to join forces with DP Polar at this pivotal time for additive manufacturing when interest in production scale applications is rising fast. While their machine is still in beta testing and therefore the acquisition will not benefit our near-term results, DP Polar's technology is an ideal fit with 3D Systems' broad portfolio of polymer materials and production-focused software systems. We believe that integrating this platform with our existing industry-leading solution set will drive its rapid adoption into a wide range of high-speed, automated production environments. In summary, I want to emphasize that despite near-term headwinds that are challenging our results this year, we remain confident in our long-term outlook, the targets we laid out at our investor day in May. With a strong balance sheet and a disciplined approach to running our business, we will continue to look for ways to invest strategically for long-term growth with a focus on key healthcare and industrial markets. With that, I'd like to turn the call over to Wayne. We'll describe our second quarter financial results, and our 2022 guidance revision in more detail. Wayne?

Thanks, Jeff. Good morning, everyone. We had three significant divestitures in 2021. As we discussed the non-GAAP measures from the tables we presented in last night's earnings release, and as we'll discuss today, we excluded from the 2021 results the impact of the divestitures. We did this to make the 2022 results comparable to the 2021 results. As Jeff discussed, revenue for the quarter did not meet our expectations due to three factors, the strengthening of the U.S. dollar, persistent supply chain issues, and geopolitical factors such as the Russia-Ukraine war. Revenue for the second quarter was $140 million, a decrease of 13.8% compared to the prior year. Excluding divestitures, revenue increased 3.2%, and on a constant currency basis, revenue increased 7.8% compared to the prior year. This top line growth reflects continued solid demand in both our healthcare and industrial segments and demonstrates our ability to grow the business against a very challenging background of supply chain, macroeconomic, and geopolitical pressures. Just to put dollars behind the three factors, nearly $6 million of this impact was attributable to the sharp appreciation of the US dollar that occurred during the second quarter and reduced the US dollar value of our international sales made in different currencies. which typically represent about 40% of our total sales. In the second quarter of last year, we had approximately $4 million of sales in Russia that did not repeat in the second quarter of this year because we exited the Russian market. If you exclude Russia's sales from 2021, then our adjusted growth rate is 11.3%. Finally, supply chain issues, in particular component shortages, prevented us from filling more than $9 million of firm customer orders. By way of comparison, in the first quarter of 2022, we were unable to ship approximately $7 million of customer orders because of supply chain issues. Jeff discussed a few of the actions we are taking to reduce these late shipments. Looking at the first half of the year, revenue excluding divestitures grew 6.5% year-over-year to $273 million, and on a constant currency basis, first half revenue grew 10.4%. So even in a very challenging operating environment, we were able to achieve double-digit year-over-year growth in the first half of 2022. In the second quarter, we had a loss per share of $0.26 compared to a loss per share of $0.08 in the second quarter of 2021. The current quarter includes a $11 million non-recurring charge, or $0.09 per share, for certain estimated legal costs and other settlements. The divestitures had contributed $0.05 of earnings to last year's second quarter. Our non-GAAP loss per share in the second quarter was $0.07 compared to non-GAAP earnings per share of $0.06 in the second quarter of 2021. The year-over-year decline reflects inflationary impacts on input costs, impacts from acquired businesses, as most are in development stage or just beginning commercialization, and continued growth-oriented investments in R&D, including to enhance our product portfolio and improve our corporate infrastructure. Our revenue excluding divestitures on a constant currency basis for our healthcare segment increased 4.7% and our industrial segment revenue increased by 11.2% as compared to the second quarter of last year. The healthcare growth was fairly consistent across all markets and products. Software discretionary spending likely limited growth in end markets such as dental and elective surgeries. Our industrial revenue growth was driven by continued strength and precision microcasting applications such as jewelry, by demand for production machines for aerospace applications, and by continued pull-through of materials by our significant installed base of printers. Partially offsetting the sales growth industrial is our exit from the Russian market, weaker machine and material sales in Europe due to macroeconomic concerns, and to China due to COVID-related lockdowns and supply chain disruptions. The gross profit margin was 37.9% compared to 42.4% in the prior year. Gross profit margin was lower due to multiple factors, including the 2021 divestitures of non-core assets, the input cost and freight inflation that was an effect of what we were able to pass through to customers by way of price increases, and manufacturing variances within certain of our contract manufactured products. We also saw small impacts in gross margin due to mixed effects of selling more printers and less materials than the prior year. As reflected in our revised guidance, we expect gross margins to remain steady as we move through the year to the continued impacts of inflation on input costs. Our operating expenses increased 7.7% to $85 million in the second quarter of 2022 compared to the same period a year ago. This includes the $11 million non-recurring charge previously discussed. On a non-GAAP basis, operating expenses were $60.9 million as compared to $48.9 million from the same period a year ago. The higher non-GAAP operating expenses reflect spending in target areas to support future growth. About half this increase was due to expenses from recently acquired businesses, while the remainder reflects increased research and development costs to refresh and enhance our product portfolio and investments to strengthen our corporate infrastructure. Adjusted EBITDA defined as non-GAAP operating profit plus depreciation. was a negative $2.6 million for the second quarter compared to $12.9 million for the second quarter of 2021. The year-over-year decline in adjusted EBITDA margin reflects all the factors that we've previously discussed. We now turn to the balance sheet. We ended the quarter with $638 million of cash and short-term investments on hand. Our cash and short-term investments declined approximately $151 million since the end of last year, driven primarily by $83.3 million paid for acquisitions and equity investments, cash used in operations of $38.2 million, and capital expenditures of $10.4 million. We continue to have a strong balance sheet with sufficient cash to support organic growth, including in regenerative medicine. As previously stated, we regard 2022 as an investment year during which we will make additional targeted investments in high potential growth areas of our business, and in our corporate infrastructure as part of our overall strategy to profitably grow revenue in both the healthcare and industrial segments. After we complete the acquisition of DP Polar that Jeff discussed, we will likely take a pause in acquisitions to make sure we focus on execution and fully integrate the recent acquisitions we have made. Nonetheless, we will always remain alert for any game-changing investments. In 2021, we began providing guidance on full-year non-GAAP gross profit margins. And in this year, we expanded our guidance to include revenue and non-GAAP operating expenses. Given our lower than expected performance in the second quarter, combined with the challenging macroeconomic environment we foresee for the second half of the year, we are revising our full-year 2022 guidance. We now expect revenue to be within a range of $530 to $570 million, which reflects an estimated $20 million of negative foreign exchange impact for the full year, as well as additional negative impacts from reduced spending in selected end markets, such as dental, elective surgeries, and international manufacturers caused by the challenging environment. We now expect non-GAAP gross margins to be in the range of 39% to 41%, due to the reasons mentioned earlier. We are narrowing the range for non-GAAP operating expenses to be between $245 to $250 million. This revised 2022 guidance assumes no significant additional changes in the macroeconomic environment that could negatively impact business demand or disrupt our supply chain, such as COVID, geopolitical events, or foreign exchange volatility. I'll now turn it back to Jeff before we transition to Q&A.

Thanks, Wayne. Before Wayne and I take your questions, I'd like to add one more additional comment. As you likely saw last week, we announced that Michael Turner will join 3D Systems as our new Chief Financial Officer at the end of this month. I'm delighted to have Michael join our team. He's an accomplished financial executive with a strong technical background. He's ideally suited to lead our finance and accounting function. I encourage all of you to connect with Michael after his arrival to introduce yourselves and get to know him as you wish. I'd like to also take this opportunity to thank my colleague and good friend Wayne Penske for so ably serving as our interim CFO for these last several months. Wayne will be staying on for a while to ensure that Michael has a smooth transition into his new role, but then will be returning to his well-deserved retirement. So Wayne, thank you very much for all you've done for us. So Kevin, I think we can now open up the line for questions.

Certainly. When I'll be conducting a question and answer session, if you'd like to be placed in the question queue, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star one. One moment, please, while we poll for questions. Our first question today is coming from Greg Palm from Craig Hallam Capital Group. Your line is now live.

Yeah, good morning. Thanks for taking the questions here. I wanted to first dig into the guidance a bit because last quarter when you provided guidance, you talked about demand outstripping your ability to fulfill. So I guess if we think about the reduction for the second half, how much is incremental FX headwinds relative to where we were last quarter? Was that the $20 million? How much, you know, if any, is additional supply chain challenges that you're now running into and how much is true demand falling off? And I guess of the demand, any way you can break out more specifically the impacts across the various end markets or geographies?

So with respect to FX, you're correct that the $20 million is the difference between what we did last guidance versus this guidance. With respect to supply chain, I wouldn't view that really as a factor in terms of changing our guidance. We didn't assume any improvement. We didn't assume it was going to get any worse, so I wouldn't view supply chain as a factor for reducing the guidance. The rest is really about the slower demand in the end markets, primarily dental, and then the rest is if you think about what's happening in Europe in terms of slowdown of our customers in terms of their ability to Just the manufacturer, I think everybody's taking a pause. Their inventories probably went up in the past, and they're probably trying to manage that inventory down, and they're much more cautious about their own outlook.

Yeah, Greg, it's very much what you'd see in the newspaper every day. People are having to spend more money on gas and food, and basically they're cutting back certainly on discretionary items, which is particularly impacting the dental industry. So that's a major second half effect for us as that rolls through the supply chain. And again, we view that as temporary. The outlook for that business is quite strong. But undoubtedly, it's projected to have an effect in the second half of the year, hopefully with inflation. peaking soon, that'll start rolling back. But it's prudent at this point to assume it just lasts throughout the year and we go on. The other effect clearly is with COVID spiking up in different parts of the country and the world, it's nudged out. The treatment in hospitals for COVID patients has nudged out discretionary operations, especially around orthopedics. So that outlook has slowed somewhat too, and it's much like the initial spike in COVID did, you know, back in late 20 and early 21. So we'd expect it to be transitory and somewhat highly transitory, but you just don't know how many of those variants are still out there. So, you know, instead of looking at it quarter by quarter, which we'll continue to do, we just assumed this condition lasts throughout the year, and we updated our guidance.

That's helpful. I mean, Jeff, presumably the dental that you're alluding to is more of the big project type stuff. I mean, do you have any visibility into, you know, whether that's just getting pushed out to next year or is it unclear still at this point?

Yeah, I think the demand is going to, I mean, just my opinion, Greg, demand is going to remain for those products. They're very popular. And I think people are just having to make short-term decisions with gas and food becoming so expensive. And I use that symbolically. I think everything is becoming more expensive. People have had to just put off things that are truly discretionary. but still highly valued. So all the feedback we get is that it's temporary and it will pass the growth outlook. In fact, if you listen to that customer base, which they are public companies, you can listen to them, what they say is their long-term outlook is still for very strong double-digit growth. And the numbers I've heard are 20% to 30% that they talk about publicly. But for this year, it's been ratcheted back to low double digits, high single digits, and that ripples through the supply chain. So we see no other indications that they're planning for long-term dampening. I mean, all of the other discussion and things are all around continued strong growth. It's a very short-term factor.

Understood. And I guess last one, I mean, just in light of everything going on, it's surprising that you're raising your OpEx guide? I mean, I guess going forward, how should we think about, you know, investments on a go-forward basis as we get into next year and beyond?

Well, no, it's good questions, Greg. It's funny when, you know, when challenging economic environments hit, I think historically you see companies do one of two things. Obviously, everybody becomes more prudent and they watch their spending and But for folks with a strong balance sheet, I think you see them saying, look, some of the weaker competitors in our space are going to really struggle in this environment. They weren't built for short-term headwinds. And with our scale and our balance sheet coming into the year, we were very well equipped to deal with a downturn and continue investments. So we're able to pick up talent. We're able to pick up, you know, I look at this DP Polar group, an outstanding group of people. that small companies struggle in these environments because they have to rely on longer-term revenue projections, and that becomes more variable, and they burn through their cash. So in essence, for bigger companies like ours with a strong balance sheet, it gives us an opportunity to really kind of double down and say, we're going to come out of this really strong. And when you look at our infrastructure investments, if you make the assumption you're coming out of it strong, you better have the infrastructure then to support the growth. So that's why we're maintaining the infrastructure investments we're making. Now, I won't tell you we're not looking at all of them and we're cutting back where we can and we're managing through our costs. We definitely are. We're going to run a good business. We believe in running a profitable, cash-generating business. But there are certain periods of time where you have an opportunity to really move ahead, and I think that's us right now. If you look at regenerative medicine, which are really organic investments at this point, and you look at this high-speed production process that DP brings us, those types of investments really pay dividends in the long term if you can maintain them. So, you know, while everybody's struggling, it's our chance now to really kind of push ahead.

Okay, good. All right, well, best of luck going forward. Thanks.

Thanks, Greg.

Thank you. Next question is coming from Troy Jensen from Lake Street Capital. Your line is now live.

Hey, gentlemen, thanks for taking my question. Maybe to follow up on Greg's question line here, supply constraints, it seems like it's been three or four corridors now that Wayne and Jagtar have talked about, you know, $6 to $8 million of demand that you guys couldn't fulfill. And to me, you guys would be building a big backlog, right, with these orders that you can't ship. So you factor that in with... just kind of the reduction of about $50 million in revenues with the growing backlog. I just wondered if you can touch on what's happening to these orders, and is the backlog visibility improving at all?

It's an insightful question, Troy, as always. Yeah, so backlog is building. There's no doubt about it. And we don't usually talk about those numbers, but there's no doubt about it. Backlog's building. We left more on the table in Q2 than we did on Q1. And we don't want to use that as an excuse in the second half, because I do think that things are going to plateau and then get better. But we thought the second half would be significantly better when we entered the year. And at this point, we're going to wait until the data says it is better to really talk about it. So in terms of the durability of orders, when you push orders out, obviously there is a fraction of people that may choose to cancel. But by and large, we're not seeing any diminishing of demand. Folks are willing to wait for product. And part of our move in manufacturing, Troy, to bring our largest contract manufacturer operation back in-house is we really believe we can better control it and meet our delivery commitments and manage our supply chain. It's a big move for us. It required a lot of planning. But especially when times get tougher, you just don't get the attention from big contract manufacturers that you want. And it's much better to run it in-house. So we're making that move. I think it's a permanent move with the high mix of product that we need to provide to our customers. It's a better way to manage the supply chain. So we took a big step in July to bring that in-house. And I think you'll see incremental improvements going forward. Between that and supply chains truly getting better around the world, I think we'll come closer and closer to meeting our growing demand that we see out there. All right, got it. Thank you.

Just a follow-up for you, Jeff. You have DP Polar. I guess when I think of inkjet, I think more of prototyping, and I think that's because, you know, material properties. I believe these machines need to use acrylic materials. So when you talk about a production machine, are you producing molds, right, which I kind of think is kind of indirect production, or is it actually in parts?

And with your background, Troy, you'd particularly appreciate this machine. They have a great – by the way, if you go to the DP Polar website, they have a fantastic YouTube video posted there of the machine, and it demonstrates the technology. With their printing technology, their inkjet printing technology, it can actually accommodate much more of our current portfolio of materials that are printed. So a lot of our materials will be able to be printable, if not now, in the near future. And those heads can be interchanged with other printing technologies. So you can substitute other printing technologies for those print heads. And they're stationary, which makes it much simpler. And it prints on a rotating platform. So no, no, it is particularly geared toward continuous production and high-speed production of products. Our estimates are, Troy, anywhere from three to over five times more productive for production applications. And the doubly cool thing when you watch the video is you can use pick-and-place robots to put electronics or magnetics within the component as it's printed, which really gives you another capability with 3D printing that you don't have in the current batch processes. Can it do multi-materials? Yes. It can do multi-materials. You can build components of all different geometries continuously as you rotate the platform. It is just a fantastic technology. And one of the key pieces of IP here, Troy, is the machine intelligence. Because the spinning platform, the spinning base plate is so large, there's a big velocity difference between the inner radius and the outer radius. So the intelligence of the machine to be able to uniformly print across broad through multiple printheads across a broad radius is really exceptional. And they've been working at it for several years, and they've got a great concept that's now been demonstrated and moving into beta shipment phase now. Gotcha.

All right, Jeff, well, thank you for that info, and good luck in the second half.

Thanks, Troy. Thank you. Next question today is coming from Ananda Barua from Loop Capital. Your line is now live.

Hey, guys. Good morning. Really appreciate you taking the questions. A couple if I could. Just sort of going over, going back to sort of the commercial context, what you guys talked about, reduced visibility from some of your customers. Are you also yet seeing a meaningful demand impact from those folks, or are you just sort of getting the softer signals that the visibility is being reduced?

No, there's a concrete fall in demand. I'd say it's still positive. There's still demand out there. But it's definitely at a lower rate of demand growth the second half than we had originally modeled. And what they attribute that to, which they pass on to us, is customers are really struggling. Their customers are struggling because they're having to spend more on the basics of life. than they are in, for example, in improving their smiles, you know, things that are truly optional. And, you know, there's sad extensions of that too in orthopedics where procedures that are labeled optional are often very painful for patients and they really would like to take care of them. But hospitals have been managing their capacity with COVID. They don't want to overcommit their capacity. So they've discouraged optional procedures, and we factored that into our second half planning. So both of those factors impact our healthcare business. We view both of them very much and not as transitory. But, you know, I'm tired of waking up every morning saying, oh, it's going to get better next quarter. And at this point, I think we just said, well, we'll project it through the end of the year, and, you know, hopefully it'll be better than that. But, you know, I think it's a good time to be conservative and and just say these pressures are going to be here for the full year.

That's the right thing to do. I mean, investors are going to want to see the guidance lowered anyway. At some point, maintaining the guide probably would just be a headwind to the stock. I mean, you don't like to see this move today in the stock, but it would be a headwind to participation at some point. So it's a wise thing to do, Jeff. There's no doubt about it. And I guess on the non-consumer-adjacent kind of verticals. You know, let's say you're trying to manufacture verticals. What's the context there at this point?

Yeah. So I think, you know, supply chains around the world are trying to catch up. And you probably see this in your personal life. And certainly if you've gone out to buy a car recently or even a spare part for a car, I had to replace a fuel pump the other day. And, you know, it had to be shipped from Germany. And it took weeks. Things that used to take days take weeks. So I think supply chains on the Indian industrial base worldwide are still playing catch-up. So there's really nice demand, and with one exception, I'll tell you that. There's really nice demand in the industrial environment because our customers are looking to bring manufacturing closer to home over time, and they want more flexibility. If they're going to do it, they want more automation, they want more flexibility, they want lower costs. So it gives an opportunity for 3D printing to really move in there and demonstrate its capability in production environments. So that's good. That's really a good tailwind to have. The one area of the world that's problematic a bit is Europe, and particularly Germany, which is an industrial powerhouse. The outlook they have and the concerns they have around the Russian energy supply has caused the government to send signals to to watch industrial production potentially cut back in certain industries and parts. And if you follow their announcements, the big German industrial firms, you get worried about that. Because come wintertime, they need the energy. And companies consume a lot of energy. So they're trying to cut back early, store energy. And I think that's led to an overall concern about capital investment in that part of the world. And again, the war is a tragedy on many fronts. I hope and pray it lifts soon, but I think that's yet a coming risk for everyone, and we have factored that into our guidance. Looking forward, it's hard to estimate, but we factored it in and said, look, we think Europe could get weaker, not stronger over time due to energy and the war. So again, hopefully they'll find a solution and a good outcome there, but I think it's prudent to just have a wait-and-see attitude.

That's helpful context. Thanks, Jeff. I'll see you before there. Thanks a lot.

Thanks, another.

Thank you. Our next question is coming from Wamsi Mohan from Bank of America. Your line is now live.

Hi. Thank you for taking it. Hi, thanks for taking the question. This is actually John on behalf of WAMSI. Just wanted to quickly touch up on gross margin. I know the full year guide midpoint around 40 implies slight improvement in the margin trajectory in the second half. So just wondering what might be driving that improvement and when do you expect these headwinds of consumer spending or supply chain constraints to gradually recover?

You take the first one, Wade. I'll take the second one, which will be pure speculation, by the way.

With respect to the margin outlook within 0.40%, that's not terribly different than how we did in the first half of the year. I think we need to do a little bit better on, one, passing on price increases, and secondly, just in terms of the input costs going up. It assumes a slight improvement there, but not a huge improvement.

And in terms of when things will get better, you know, we came into the year with just a base assumption, and I think we were very transparent about this, that supply chain issues, which impact our gross margins, were going to be a struggle through the first half of the year, and then they would improve in the second half. I think as we exited Q2, you know, the number of risk issues in the world has been probably increased versus the beginning of the year. And as we looked at trends in the second half, we just thought, you know, it's prudent not to really speculate on when things will get a lot better. Let's just assume it stays basically the same and project it through the end of the year now. And I do think by 23, there's a good chance that, you know, the supply chains have straightened themselves out. We do see evidence, and you probably see this in common in everyday things of going to restaurants and things that, The world is returning toward normal, but there's a lot of training. I was in a restaurant this weekend. There's clearly a lot of training opportunities for new people that are taking jobs. And I think every company is working their way through that, and that will happen in the second half. And I think 23 will be better. But at this point, when we're only dealing with 22 guidance, we say, let's just assume everything stays as tough as it is now. for the rest of the year. And I think that's a prudent position to take, and that's what we've done.

Gotcha. And a quick follow-up, if I may. Just curious, are you seeing the slowdown more related to the system side or the consumables?

Oh, very good question. So it depends on the market and the place in the world. It's a very interesting question, actually. And most of our customers look through this downturn period and they say, okay, let's watch inventories, let's cut down on consumable materials to kind of run leaner. I think in the first half, we probably saw people building because they thought the second half was gonna be strong, so they built inventories, supply chains were disrupted. It caused everybody to add inventories, I think in the second half here, we're seeing people be a little bit more prudent, if you would, in managing their inventories, their cash position, make sure they don't have too much on hand. So I would tell you consumables in the second half we're projecting as probably a bit softer than, or probably, and Wayne, correct me on this, but I think it's consumables in the second half we're probably projecting to be softer, certainly softer than we would have originally imagined.

In the first half.

In the first, yeah, softer than the first half. And then on the capital side, on new printers and things, we see that demand remaining strong basically across the market. So that tells you really basically customers are looking through this and saying, I'm going to need the printing capacity, but I may not need the consumables right now in the next couple of quarters. So it hurts our mix, but it does encourage you that the long term you're installing more printers, there's going to be more consumption of consumables, including materials, and software in the long term, because the capacity will be out there. So that's a good question, and thanks for asking it. Any other color on that, Wayne?

Generally speaking, our forecast is the second half is about the same in sales as the first half.

Yeah, originally we projected it up with a richer mix. Okay, understood.

Thank you.

Thank you. Next question is coming from Brian Drab from William Blair. Your line is now live.

Hi, thanks for taking just a couple quick questions here. In the second half of the year, do you expect the typical – I know it's hard to forecast anything right now, but are you incorporating typical seasonality in the fourth quarter with revenue from the third quarter?

Yeah, typically, Brian, as you know from following it, there's usually a bump in the fourth quarter. It's a little bit stronger going into the end of the year. I would just – Just encourage you, though, if any year is going to be watered down, I think this year will be. I wouldn't expect there to be. We're not expecting a huge change quarter to quarter. If anything, there may be a slight shift towards Q4 over Q3. Is that fair?

Yeah, it's pretty minor. If you look in the prior years, the fourth quarter had a much more noticeable bump than we're forecasting right now.

Right. And fourth quarter is a ways away. I mean, we could still get it. But, again, Brian, we took the approach this time of let's just assume the world just kind of stays, you know, like it is now for the rest of the year. So in terms of building a model, that's the way I favor it for this year.

Okay. And you gave the industrial and health care change in revenue year over year. I may have missed it, but did you tell us what dental – was either up or down year over year in the second quarter?

We did not. We didn't put that out there, Brian. We didn't put that out there.

If you look at it for the first half, dental for the first half was about the same as the prior year. And if you look out for the guidance for the second half, dental will be lower in the second half than it was in the first half. That really goes back to Jeff's comments about if they're forecasting their own growth, if they over-forecasted previously and then drop it down now, they probably need less printers and a little bit of consumption of less materials.

That's just it, Brian. I think they came into the year assuming their growth rates were going to be consistent with prior year growth rates, and they were building fast. I think they've certainly seen a drop-off in their demand due to discretionary spending issues, and that's rippled through the supply chain. So there was clearly an effort to manage inventory on their part and in the face of softening demand for their products here in the second half. And they've gone out of their way to assure long-term growth rates. They're maintaining the same guidance, and I think that's true. But in the short term, it certainly is impactful in the second half.

Yeah, got it, understood. Okay, thanks for that, Collin.

You're welcome, Brian.

Thank you. In the interest of time, we ask you to please ask one question from this point forward. Our next question is coming from Noelle Diltz from Steeple. Your line is now live.

Hi there. So I was hoping that you could expand a little bit on how you have to respond from a production standpoint when you have, say, a slowdown with a large customer in terms of what you're expecting from demand. So for example, are you going to have to work through some excess inventory here in the back half of the year, and how should we think about that from a cash flow perspective? Thanks.

Yeah. Well, certainly we have built inventories, and I'll give a little color and maybe you can comment more from a cash perspective if we can estimate that. We have built, no doubt we've built inventory, Noel. It's been such a difficult time just making sure you have all the components to meet demand in these printers. So we have undoubtedly built inventory. So now as things slow down, we've got to manage through that inventory. And I think part of bringing production back in-house for our biggest plants here is I think we can manage our inventories better that way and better meet demand as well, by the way. But yeah, undoubtedly, I think we have an opportunity actually in inventory management to generate cash over time because we've got a lot of inventory. But it's always a challenge because there is a lot of volatility, if you will, in demand right now across platforms. So it probably doesn't help you much.

Yeah, so Noel, the first half inventories went up about $16 million to sort of reflect how much of what Jeff was just saying. But as Jeff mentioned earlier, we are going to bring some of the manufacturing in-house. And you'll see in the 10Q that was posted this morning, that meant in July we actually bought another $15 million of inventory. So inventory that previously was on our books now came on our books as part of bringing inventory in-house. Now, we think that number is probably too high, and our goal in life is to work that down a little bit. But you will see inventory going up just for that reason.

A lot of it will happen, Noel, when the supply chain just becomes more predictable. We've had to inventory a lot of extra parts because you really didn't know what was going to hang up your shipments. In Murphy's Law, we hung up more shipments than we did in Q1 than we did in Q2. You never quite have all the right stuff. Too much of one and not enough of another. That'll work down as supply chains get smoother. and more predictable, and I think we'll be more efficient at doing it than we would have in an outsourced model. But it'll take a little time. So you'll see a bump up, and it is listed in the queue, right?

Yeah, that's correct.

You'll see a bump up in the queue. A significant bump up is we took that inventory back on our books from our contract manufacturer, and I think you'll slowly see it bleed off over time, which will be a cash generator for us.

Great. Thank you.

Sure.

Thank you. Next question is coming from Paul Chung from JP Morgan. Your line is now live.

Hi, thanks for taking my question. So just on the move back to in-house manufacturing, you know, what percent of the portfolio is kind of moving in-house and where are you moving it? And can you quantify kind of the margin uplift from these actions? And, you know, should we expect kind of higher levels of CapEx kind of moving forward as a result?

There were several. I see you're meeting Kevin's goal of one question. There's several parts of that question, Paul. And they're all good ones, by the way. So one nice thing about this move was the plant is right here in Rock Hill, South Carolina. So it's very close to our current headquarters and a lot of our engineers here in town. So we took the lease back over ourselves. We took production back in-house. And So, there is some incremental cost with that, but in general I think we'll manage those costs. We were paying for them anyway to the contract manufacturer with a markup. So, I think there should over time be a cost savings there as we drive more efficiency out of that plant. Same thing with the inventory. So, it's right here. There is no physical move, frankly, of the production process. It's us taking over the lease again and really running the plant ourselves. So there's no move required. Thank goodness we're not moving product around. In answer to part of your question, though, it is a very significant part of our polymer-based production, and it probably approaches half. It's a very big percentage, and hopefully that'll grow over time. Our industry, Paul, well, I can't speak for other companies, but we offer the broadest range of printing platforms in the industry. It's what our customers want because they want a large flexibility in solving their application issues. So we offer, and it's part of our model, we offer the broadest range of printing technologies in the entire industry, from polymers to metals, and we're going to keep that model. What we're doing to make it more efficient is moving to a modular engineering approach, so we have more part commonality between platforms, and we're bringing manufacturing back in-house, because contract manufacturers notoriously are, they're not as efficient with low-volume, high-mix product lines. and high-tech product lines. So by bringing it back in-house, I think we'll do a better job of managing that. And when you combine it with the move to modular engineering, I think you'll see some significant cost reduction over time in our COGS just due to efficiency of design and manufacturing. But it'll take time. Those are usually multi-year efforts. But I would tell you it's a key part of us getting to 50% gross margins is improving the gross margin on our printer products. Did that cover all the pieces of your question, Paul?

Oh, just the CapEx levels. I assume there's going to be a little bump there.

No, these are assembly operations, so there's really very little capital involved. We'll make some CapEx investments in IT infrastructure and things to run the plant better, but it's largely an assembly operation.

Yeah, it won't be noticeable. Yeah.

Gotcha. Thank you. You're welcome. Thanks.

Thank you. Our final question today is coming from Jim Rashudi from Needham & Company. Your line is now live.

Hi, good morning. This is actually Chris Grangon for Jim. Just wanted to ask him, how do you think about the level of SG&A and R&D in the event that demand softens further? And could you talk about some of the levers that you discussed in the preparer remarks that you have to address cost structure and efficiencies? Thank you.

Yeah, and I'll tell you, Chris, that's the art of it, isn't it? It's how to manage those costs down. When you see this conflicting thing of short-term headwinds and long-term demand growth and pretty exciting demand growth, you need to come out of it on the other side ready for that. And so, you know, the desire is to maintain continuity in R&D spending. Our SG&A we look at because our DNA costs are high right now. But a lot of that is geared toward improving our infrastructure and efficiency. So I think you can quite clearly see G&A coming down in future years. But we've got to invest to make sure our foundation's strong and that we have the platform to support growth. R&D spending, I'm hoping that we can manage that down over time as well. But I would tell you in this industry right now, it's a disruptive industry. And you've got to watch how much you're spending on R&D because those production platforms, when they hit, are going to be very sticky sales. And it's going to drive a lot of consumable utilization. So you need to have the platforms in order to meet that demand. And that's one reason we invested in DP Polar. We picked up years of R&D work that's been done with a machine that's ready to go to beta customers now. to accelerate that whole process. So I'm not giving you a crisp answer. I want to be very, very selective about R&D spending and make sure we're doing it correctly. With the leadership we have in place now, I think there's a really nice opportunity to focus and get more out of our R&D spend with modularity and platforms. In terms of bringing the overall spend down, I really don't want to make commitments on that in the long term. As we grow, they're easier to bear, so the scale really helps. But on a dollar basis, we have to be very careful. G&A, I think we can bring down. And even sales efficiency, we can bring down over time with the scale we have. But G&A particularly, I think we can bring down in future years. Wayne, anything you want to add?

Yeah, I guess the only thing I'd add, you know, we've – With DP Polar, that'll make our seventh acquisition in a little over the last year. And each of those comes with a little bit of SD&A and R&D costs. And so we've added those into the mix. And, you know, most of them are early stage. You know, the development companies are early stage of commercialization. We're not yet bringing a lot of revenue. So as those guys progress, you know, we'll get a little bit more leverage from those. In the interim, we just need to manage them as best we can.

Does that answer the question? You got it.

Sure thing. Yeah, thank you. Thank you. We've reached the end of our question and answer session. I'd like to turn the floor back over to Dr. Graves for any further closing comments.

Thanks, Kevin. So thank you all for joining the call this morning. We look forward to updating you again on our business next quarter, and we wish you all a great day. Thank you.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.