3D Systems Corporation (NYSE:DDD ) Q1 2022 Results Conference Call May 10, 2022 8:30 AM ET

Dr. Jeffrey Graves - President and CEO

Jagtar Narula - EVP and CFO

Andrew Johnson - EVP and Chief Legal Officer

Greg Palm - Craig-Hallum Capital Group

Brian Drab - William Blair

Troy Jensen - Lake Street Capital

Good morning, and Welcome to 3D Systems Conference Call and Audio Webcast to discuss the Results of the First Quarter of 2022. My name is Kevin and I’ll facilitate the audio portion of today’s interactive broadcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to turn the call over to Melanie Solomon, Investor Relations. Please go ahead.

Thank you, Kevin. Good morning. And welcome to 3D Systems conference call.

With me on the call are Dr. Jeffrey Graves, our President and Chief Executive Officer; Jagtar Narula, Executive Vice President and 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 our 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.

Now, I am pleased to turn the call over to Jeff Graves, our CEO. Jeff?

Thanks, Melanie, and good morning, everyone.

As you all know, the beginning of 2022 has already thrown significant challenges at the entire market, no matter what portion of the economy you serve. Whether it’d be continued supply chain pressures, significant rise in the rate of inflation, the ongoing impact of the pandemic or the tragic circumstances that we’ve seen unfold with the Russian invasion of Ukraine, the operating environment has been difficult and largely unpredictable.

With that said, I’m very proud of how our 3D Systems team has continued to stay focused and executing well for our customers throughout this period. Ironically, in the longer term, these same factors that make our life more difficult today are increasing our opportunities for growth in the future as our customers continue to reevaluate their critical supply chain strategy and increasingly consider additive manufacturing as a key element in the production strategy of the future.

As we’ve discussed on previous calls, after two years of hard work, we’re now fully organized into our two core business units, Healthcare and Industrial Solutions. This structure distinguishes us from others in the industry, allowing us to execute on what we do best. Namely, solving the most valuable production application needs of our customers by offering the strongest and most complete portfolio of additive manufacturing technologies brought together with the most knowledgeable and creative application engineering teams in the industry.

The double digit growth in our core additive manufacturing business that we’re now experiencing, even in this difficult market, validates our approach and gives us confidence in our future. To meet the increasing demand that we’re now facing, we’re making key investments in new products and in our operating infrastructure, combining rigorous financial discipline with an overlay of strategic perspective on future value creation for all of our stakeholders. Despite the challenging macro backdrop, I’m happy to say that 3D Systems has started off the year on a strong foot, and we expect 2022 to be a year of exciting growth and investment as we continue to strengthen the Company for the future.

I’ll keep my comments brief today, as we have our Investor Day next week, where we plan to share more detail on our vision and strategy for the future. Today, I’ll share with you a few key highlights from the first quarter.

On the top line, while supply chain challenges were a significant headwind, we delivered double digit revenue growth over Q1 of last year, when adjusted for divestitures. We continue to see increased demand for our products across both business segments. At a business unit level, our Industrial Solutions business continue to accelerate in both, Europe and the U.S., in this case, delivering growth of over 15%, excluding divestitures of noncore assets.

This continued strengthening validates our observation of increased adoption of additive solutions among the world’s manufacturing community. Particularly strong was the demand for high-precision micro-castings. This is a reflection not only of the printing technology itself, but the unique materials we’ve developed that enable casting of highly complex, fine structures, and a deep understanding of the workflow for optimum economics for these solutions.

Healthcare growth of approximately of 5% excluding divestitures was softer than we would’ve initially anticipated when we started the year, being driven in part by the introduction of our new DMP 350 Dual, a high productivity version of our well-proven metal printer, the DMP 350, which has been a mainstay for many of our Healthcare customers in recent years.

These customers are now qualifying the new dual laser system and updating their procurement plans to optimize their production workflow, which in healthcare takes careful planning and formal approvals. These acceptance qualifications are proceeding very well, and we expect increasing sales of both our 350 platforms later this year.

In addition, COVID resurgence and the resulting postponement of optional elective procedures are particularly impactful in Healthcare, as certain customers, delayed capital purchases and experienced slower than anticipated growth rates. Given the underlying fundamentals and customer feedback on market conditions, we expect these factors to lessen as we move through the year.

To support the strong engagement and demand that we’re seeing from our customers broadly, we’re continuing to invest in both, our product portfolio and core technologies, as well as in our business infrastructure, including information technology, finance, and accounting, investments that will enable us to efficiently scale for double digit growth that we see ahead. The fruits of these investments will become increasingly apparent as we move through the year, but even in the first quarter, we announced several new opportunities that we’re really excited about for the future.

First was our investment in a unique company called, Enhatch, which brings to us another unique software solution for use in our Healthcare business that will further strengthen our core capabilities. More specifically, this software solution is directed at the personalized healthcare solutions market for which we have a long-established market leading position. In short, through the use of artificial intelligence, the enhanced software streamlines and scales the design and delivery of patient-specific medical devices by automating the planning and design process. These efficiency increases will further the growth of personalized healthcare solutions, improving patient outcomes, and reducing treatment costs for hospital systems.

In addition, in the first quarter, we announced our joint venture with Dussur, the Saudi Arabian industrial investments company. This venture’s designed to bring additive manufacturing into the Middle East and North Africa by enabling domestic production capabilities within Saudi Arabia. We believe this investment will accelerate the adoption of production scale additive manufacturing, particularly in the oil and gas sector, utilizing our leading polymer and metal technologies, and then expand to additional market sectors over time, such as industrial, aerospace and healthcare.

The partnership highlights the increasing focus of additive manufacturing by large global organizations and our opportunity in important and largely untapped market verticals, such as oil and gas. This new venture is expected to begin ramping in scale in the fourth quarter of this year.

And finally, this past quarter, we announced a very exciting new product platform, the world’s first synchronous dual-laser SLA printer. It delivers up to twice the speed and 3 times the throughput for cost efficient high-quality production manufacturing. This market leading platform reinforces the strong position we’ve had for decades in stereolithography, in this case, addressing the unique requirements of production applications, while leveraging our portfolio of advanced polymeric materials and our software capability.

We’ve begun taking orders for this new printer and are seeing strong demand in both, healthcare and industrial markets. Specific to our healthcare business, I’m very pleased by the recent 510(k) clearance from the FDA for our VSP Bolus, a solution designed for improved radiotherapy treatments. Approximately 50% of patients that are diagnosed with cancer receive radiotherapy as a part of their treatment plan. This translates to millions of procedures worldwide each year.

To help target the radiation on the desired location during a treatment, the radiotherapy provider often uses a bolus, which is a flexible material that’s meant to conform to a patient’s anatomy. A poorly constructed or off the shelf bolus can often leave large gaps between the device and the patient’s skin, which can result in insufficient or unintended dosing levels, may also expose adjacent anatomy to undesired radiation. With our VSP Bolus solution, 3D Systems can design and deliver boluses that are customized to a patient’s specific anatomy and treatment plan, improving the effectiveness of the radiation treatment and the productivity of the treatment center. This mass customization of printer devices for healthcare addresses both, patient outcomes and provider costs, which is the fundamental goal for all of our healthcare solutions.

We’ve begun marketing the bolus solutions with key customers and expect to see solid demand for this family of products in the future. This is about one example of a broad trend in healthcare toward mass customization enabled through 3D printing of patient-specific solutions. This is the key growth driver for our Healthcare business across all of our end markets.

In addition to the 510(k) for our new bolus product, within days of closing our acquisition of Kumovis at the end of the quarter, we were able to apply to the FDA for 510(k) clearance on the use of printed PEEK polymers for craniomaxillofacial reconstruction indications. We expect this solution will be the first FDA cleared 3D printed PEEK medical device. Kumovis brings this advanced polymer technology to our healthcare business, which will serve as a complement to our existing titanium implant solutions, allowing surgeons to optimize individual patient treatment plans.

Customer interest in these solutions is very strong. And following FDA clearance, which we expect later this year, we believe adding that Kumovis product line will further solidify 3D Systems as a leader in 3D printed craniomaxillofacial and orthopedic implants over the full range of metal and polymer grade solutions. Once these initial indications are approved by the FDA, others will undoubtedly follow, driving exciting growth into years ahead for our orthopedics business.

So, to quickly summarize, while the first quarter is typically a seasonally slower quarter for us and was clearly impacted by the significant headwinds I mentioned previously, we were still able to deliver solid double-digit revenue growth versus last year, again, when adjusted for divestitures.

Looking ahead, we expect the remaining quarters to be even stronger, following a pattern similar to the seasonality we experienced last year. Supply chain costs and inflation levels remain elevated and have clearly impacted our results. However, we’re taking continued steps to mitigate their effects, which Jagtar will speak to in a few moments.

In total, we’re reasonably pleased with the first quarter results, especially given the macroeconomic conditions and ongoing geopolitical events, which we hope will abate as we move through the year. Importantly, our results show that demand for additive manufacturing and production environments is resilient and continues to grow. Even in these current, less than ideal conditions, industries are recognizing that the benefits of additive manufacturing can help protect them from the risks such as supply chain disruptions and skyrocketing costs.

With that, let me turn the call over to Jagtar who will now describe our first quarter financial results in more detail. Jagtar?

Thanks Jeff. Good morning, everyone.

Echoing Jeff, we started off 2022 with good revenue momentum. Given the macro headwinds, I’m especially proud of our team’s execution, which has once again delivered solid top-line results. I’ll begin the discussion with first quarter numbers starting with revenue.

Revenue for the first quarter was $133 million, a decrease of 9% compared to the prior year. This decrease was due to the divestitures of non-core businesses. When adjusted for those divestitures, first quarter revenue increased 10% as compared to the first quarter of 2021. The continued growth validates the transformation efforts we have guided the Company through and demonstrates our ability to deliver results in a challenging environment.

Our focus on providing additive manufacturing solutions for industrial and healthcare customers, utilizing our broad portfolio of hardware, materials and software solutions combined with applications expertise is continuing to deliver consistent double-digit revenue growth, when adjusted for divestitures.

In the first quarter, we had GAAP loss per share of $0.21 compared to a GAAP earnings per share of $0.36 in the first quarter of 2021. The decrease was primarily due to the gains recognized on businesses divested in 2021.

We reported non-GAAP loss per share of $0.06 compared to non-GAAP earnings per share of $0.17 in the first quarter of 2021. The year-over-year decrease was primarily a result of the divestiture of profitable, but non-core businesses in 2021, combined with higher spend on core investments in our business, including software, new printer development and our essential general and administrative infrastructure to support future growth. In addition, we saw one-time impacts that reflected challenging business and geopolitical environment, including negative impact from bad debt associated with our decision to exit business in Russia and an impact of FX as the dollar strengthened against other currencies, primarily the euro. Combined, the FX and Russian related bad debt had approximately a $0.025 impact to earnings per share.

Next, let me discuss revenue by market. Our revenue growth continues to be driven by strong demand in both, the Healthcare and Industrial segments. Adjusting for divestitures, revenue in the first quarter for Healthcare increased 4.6% and Industrial increased by 15.7%, as compared to the first quarter last year. The rebound in Industrial began in Q4 of 2020 and continued through 2021 and into the first quarter of 2022, making the fifth consecutive quarter of year-over-year organic growth in the Industrial segment. This highlights the strength and opportunities in our Industrial segment and is a direct result of the strategic investments we have made. And examples are acquisition of Titan Robotics, which closed subsequent to Q1. With this acquisition, we have entered the market for large format, 3D printing systems using pellet-based extrusion. We believe our strong portfolio, including the new printers from Titan Robotics offers ample opportunity for our Industrial business to continued growth.

Now, turning to Healthcare. Our Healthcare segment growth ex-divestitures continued in the first quarter, although at a slower pace than we would have initially anticipated, as Jeff mentioned. In particular, revenue in our non-dental segment of Healthcare, which we call medical devices, declined approximately 12% year-over-year. This decline partially is a result of supply chain impacts for our manufacturing operations that produce end use medical devices. Customer purchase delays due to Q1 COVID resurgence that Jeff spoke about earlier, and also partially as a result of device manufacturers delaying printer purchases to qualify our new Flex and Factory 350 Dual laser printers. We believe these new printers will provide strong productivity enhancements to our Healthcare customers. As a result, once customer qualification is complete, we expect robust demand for these new products.

Now, we turn to gross profit margin. Gross profit margin for the first quarter was 40.4%, compared to 44% in the prior year. Non-GAAP gross profit margin was 40.6%, compared to 44% in the prior year. Gross profit margin, decreased due to multiple factors, including divestitures and related Q1 product fix and inflationary pressures, particularly in freight costs. We expect gross margins to improve as we move through the year as production volumes and mix improves combined with the impact of recently announced price increases across multiple product lines.

GAAP operating expenses increased 16.4% to $77 million in the first quarter of 2022, compared to the same period a year ago. On a non-GAAP basis, operating expenses were $57.8 million, a 13% increase from the same period a year ago. The higher non-GAAP operating expenses reflect the impact of divestitures offset by higher spending in targeted areas to support future growth, including research and development and general and administrative infrastructure, as well as expenses incurred by acquired companies and the previously mentioned bad debt expense associated with our exit from Russia.

Adjusted EBITDA, defined as non-GAAP operating profit plus depreciation, was $1.9 million in the first quarter of 2022 or $1.4% of revenue compared to $19.8 million in the first quarter of 2021 or 13.6% of revenue. The year-over- year decline in margin was primarily due to continued focus on investing in growth areas of our business and product portfolio combined with the impact of divestitures.

Now, let’s turn to the balance sheet. We ended the quarter with $745.6 million of cash and short-term investments on hand. Our cash and short-term investments declined approximately $44 million since the end of Q4 2021, primarily as a result of our operating loss, higher inventory levels, advanced tax payments, our investment in Enhatch and cash payments related to net share settlements of stock-based compensation.

Subsequent to quarter-end, we closed on our previously announced acquisitions of Titan Robotics and Kumovis for approximately $80 million in cash, net of customary closing adjustments. The acquisitions were funded with cash on our balance sheet. We continued to have a very strong balance sheet with ample cash to fund organic growth opportunities and potential acquisitions. We believe investments, both organically and through acquisitions support our strategy of driving recurring revenue growth and higher adoption of additive manufacturing in both, the Industrial and Healthcare segments.

Beginning last year, we provided guidance on full-year non-GAAP gross profit margins, and for 2022, we have expanded our guidance to include revenue and non-GAAP operating expenses. We are narrowing our full-year guidance to reflect our performance in the first quarter and expectations for the full year. Given our strong demand outlook, we now expect revenues to be within a range of $580 million and $625 million, a tightening of the range that we have reiterated a few weeks ago. We are narrowing our non-GAAP gross margin guidance to a range of 40% to 43%, and our planned investment profile leads us to believe that non-GAAP operating expenses will now be between $235 million and $250 million.

This 2022 guidance assumes no additional significant macroeconomic events that negatively impact our business, such as COVID-19, geopolitical events or other factors that could impact, either demand or disrupt our supply chain.

I’ll now turn it back to Jeff to comment on our upcoming Investor Day, before we take your questions. Jeff?

Thanks, Jagtar. And before I do that, I want to thank you for your dedication and leadership and your time with us here at 3D Systems, Jagtar. As we’ve executed on the transformational plan to refocus our business portfolio on additive manufacturing, driving improved growth and operating performance, while significantly strengthening our balance sheet, your contribution and leadership has been greatly appreciated by me and the entire 3D Systems organization. And we wish you very well in your new role.

Finally, we’re thrilled to be within one week of our Investor Day event. We look forward to sharing more about our company vision and our plans for the future. The event will be held on Monday, May 16th in Detroit, it’s prior to the opening of the RAPID + TCT tradeshow, a leading additive manufacturing conference. We’ll begin with lunch and spend the afternoon discussing both, our Healthcare and Industrial Solutions business, including more detailed presentations on key technology elements of our business and applications that are driving our growth.

On Monday evening, we’ll provide dinner and a very special presentation on our regenerative medicine efforts, which I think you will find fascinating. We’re excited about that this will be an in-person event and look forward to having many of you there, to hear from our executive team and see our products in the days to follow our RAPID, including the new SLA 750 as well as our extrusion printers from Titan and Kumovis. Seats are filling fast, but there’s still time for registration at the event. Please contact our Investor Relations folks for more information.

And with that, Kevin will open it up for questions.

[Operator Instructions] Our first question today is coming from Greg Palm from Craig-Hallum Capital Group. Your line is now live.

I want to start with the revenue guidance. It’s still a pretty large range here. So, maybe help us understand some of the assumptions that are still kind of baked into that. And more importantly, what are the call levers that get you either to the high end or lower end of the range at this point?

Yes. Greg, it’s a pretty simple story right now. We’ve got more demand than we can fill, given the supply chain issues that we face. So, it’s really our best estimate of -- and we anticipate being -- continue to be supply chain limited in hitting revenue. So, it’s our best guess at how that looks for the rest of the year. Given the strength of demand, we were happy to tighten it up a bit and it slightly raised the midpoint. The only reason we have the breadth of range we have right now, Greg is supply chain issues that we can’t fully quantify. We left significant revenue on the table, again this quarter, so very similar to Q4 of last year, which is disappointing to us and to our customers. And we’re hopeful that drops off. That would take us to the top end of our range. And that -- just the easing -- general easing of supply chain.

Jagtar, do you have anything else to add?

No, I think you captured well. It’s primarily just looking at supply chain, Greg. I’ll mention, we left about $7 million to $8 million of revenue on the table this quarter. Had we gotten that revenue, we would’ve been -- we would’ve had 16%, 17% growth year-over-year adjusted for divestitures. So, the supply chain constraints are frustrating. Our teams are working heroic efforts to work through it. And as we see improvements, we’ll hopefully move up to the higher end of the guidance range.

Greg, what’s really exciting is to see the breadth of interest in additive manufacturing for production environments. So, it’s -- I’m sure it’s true for the entire industry, certainly very true for us, given our breadth of technology, but customers are really aggressively looking at how they could use additive. Now, some will adopt, some may not. But in general, the opportunities are out there to drive some real exciting growth. It’s frustrating to be limited by supply chain. I’d much rather have that condition than the opposite. And I see no end inside from a demand standpoint right now, looks very positive.

Yes. It’s good. I mean, maybe digging into the supply chain discussion a little bit further. Is your sense that there are new customers that are looking at this technology as a way to, either onshore or transform supply chains? I mean, that’s certainly something that everybody seems to be talking about. But, maybe give us a few examples if you can about what you are seeing exactly.

Yes. And it’s -- customers are very sensitive about -- for a variety of reasons about what they want to onshore. But in general, Greg, I can tell you it’s absolutely true. There is no doubt about it and it’s broad based. And it is just exactly like our company is looking at our supply chain. How do we lessen the risk of supply disruptions? How do we bring closer to home and how do we save money? And our customers are doing exactly the same thing. They are looking at -- in the older days, it was performance driven for parts. You make a part with additive, it’ll perform better in the system. The big driver now is, on top of that is, de-risking the supply chain and reducing cost. And the reason that we’ve made the investments we have particularly in software in the last 12 months is the rate limiting step, we really believe. Given the pace that printer technology is moving at, the rate limiting step is going to be much more in the field of materials and in software for bringing the products, the fleets of printers into the factory.

So, from our customer standpoint, I think we are talking a lot about how they bring fleets in efficiently. And then, obviously, we are providing as many new materials as we can for printing because that’s what customers want to have. And so, great demand. The technology in printers is moving forward as it always has, very quickly. And we’re qualifying multiple suppliers on all key components to make sure we can meet the demand we see. But, what you see from a demand standpoint, Greg, is exactly what you would read in the newspaper. It’s every industrial company I would guess in the world, especially in U.S. and Europe is looking at how they derisk and bring their supply chain closer to home, but do it in a cost-effective manner. So, automated systems, AI applied to fleets, all of that in order to minimize the labor content. And obviously labor costs are up. So, they’ve got to not only bring production in house closer to home, they’ve got to drive it down in cost by automation and which again, gets back to software. So, long-winded answer to your question. I hope the color is helpful.

Yes, very much so. I appreciate that. And Jagtar, best of luck to you going forward. Enjoyed working with you here.

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

Good morning. Hey. First, just echoing Greg’s comment there. Jagtar, best of luck and it was good working with you.

Yes. So, there has been slowdown in volume at your largest customer. You had a record year. I think dental was up like 90%, dental revenue for you was up like 90% in 2021. And I don’t know if you said today, but we are backing into somewhere in the 20% range for the first quarter -- growth in dental revenue. And I’m just wondering are there any adjustments you’re having to make in terms of costs or production given the volumes there -- for dental aligners that have declined materially?

Maybe I’ll comment and Jagtar can supplement as well here, Brian. Very good question. I would tell you, Brian, the demand is still very strong. It’s unfortunate that things in the world have become more difficult for dental in general. I mean, things that are viewed as optional procedures, it’s unfortunate that that’s become a more difficult environment, but in terms of demand and demand outlook and things, it may shift a little bit over time, but it’s not led to any significant changes on our part in terms of supply of product to our customers or how we’re managing our supply chain. We want to make sure we’re not holding them back in growth.

And their numbers may fluctuate a little bit, but they take a long-term view and invest for the future. Given what they’ve said publicly about their market share penetration and things, their growth prospects look tremendous for years and years to come. So, no real changes to us. There may be fluctuations quarter-to-quarter, but nothing significant. It’s -- we run on a pretty long-term game plan with all customers of that scale.

I’ll reiterate what Jeff said. I mean, I think our customers in that market still see themselves as widely penetrated into a big opportunity. And while they may see short term impacts in ‘22, I think their stance with us is really much more focused on the long term potential of that market and making sure they have the infrastructure to support it. And as we reiterated it in -- or we indicated in Greg’s question. Our guidance range reflects supply chain more than it does our perceptions of customer demand. And that would include the dental segment.

Okay. So, just one follow-up question on that topic. So, you’re not seeing in 2022, and I guess your guidance reflects this any material decline in their -- in your customer spending, CapEx spending on the type of equipment that you sell.

Yes. I want to be careful, Greg, to not talk about sensitive information -- or I’m sorry, Brian. I’m sorry. I want to make sure not to talk about sensitive information to them. But I would tell you in general, our guidance fully bakes in input from -- and obviously that customer and all others. So, we feel really good about our revenue profile this year. There’ll be individual fluctuations, but by and large, it’s great to have a customer that takes a long term view and appreciates that they needed to keep their suppliers moving along. And we’re very happy with the relationship.

Okay. Got it. And then, just the last questions, where do you think gross margin? You said it should have improved throughout the year. Where do you think the gross margin can get to as you’re exiting ‘22, what would be the goal? Thanks.

Well, I think, we mentioned in the script, and Jagtar, you correct me, if I’m wrong. I think we see it rising throughout the year. The lower -- it was lower in Q1 than we would have anticipated, primarily for cost reasons with the supply chain, both labor and materials for cost reasons. Now, we’re driving pricing, we see volumes continuing to rise. So, we should get some economics back. But so I would expect it to rise throughout the year, Brian. But, I think it became less realistic to say we had a shot at the very top end of the prior range. So, we brought it down a point. And now, that could flip. The supply chain thing is God knows, when it’s going to clear. It could clear suddenly, things could happen. But I think we always want to be pretty realistic with you guys. So, bringing that top end down a point was important to us. And if we -- we will hope to revise that every quarter going forward and give you our best view. Jagtar, anything else?

Yes. Brian, we obviously give guidance for the year. We don’t give guidance for where we think we’ll exit the year. What I’ll say is, there’s various moving parts that feed into gross margin. And so, the puts and takes of it is kind of what leads to our guidance range. If I look at Q1, we saw parts costs a little higher than we anticipated and we saw freight costs higher than we anticipated. Both those combined probably impacted gross margins by about 2 points. We’ve as a result implemented price increases that went into effect in Q2 to help solve that. We’re continuing to look for the year to see if we should expect further increases and be prepared to respond accordingly. We also have the impact of production volumes. You saw what our tremendous production volumes did in Q4 to our gross margins.

As we go through the year, we obviously expect revenue -- Q1 is our seasonally light quarter. So, we expect production volumes to increase and therefore help on the margin side. And we expect changes in mix as well as we sell more software materials. So, all those are kind of the ups and downs and gross margins, which is why we don’t provide an exit guidance. We provide more of an annual guidance based on where we’re sitting around those ups and downs.

[Operator Instructions] Our next question is coming from Wamsi Mohan from Bank of America. Your line is now live.

Hello. Thank you for taking the question. This is John on behalf of Wamsi. I just want to talk about the guidance for OpEx. So, it seems like it slightly went up at midpoint. Just wondering how should we expect this OpEx to ramp throughout the year? And where is the incremental OpEx being invested in to?

I’ll let Jagtar speak to the ramp because I’m not -- may be more of a steady state spend, but I I’ll let Jagtar speak to the ramp. The increased spend is being driven by a couple of factors. And it gets down fundamentally till we see great demand going forward for additive. We want to make sure that we have the product technologies that folks need and both metal and polymer and particularly materials and software. So, we continue to spend heavily on R&D and we’ve got to make sure our infrastructure is -- has the robustness, we need this for sustained double digit growth. Because we really believe going forward with the demand profile we see we’re going to be able to deliver -- have the capability to deliver double digit organic growth for several years here to come. And there’s a certain scale of infrastructure. You need to do that.

So, we’re investing in, as we mentioned IT, finance all the automation, all the basic foundational infrastructure, you need to be at our scale and grow at double-digits. So, that’s where you see the increased spending level this year driven by. And, Jagtar, in terms of ramp?

Yes. John, we don’t expect a significant ramp over the balance of the year. We -- part of the increase is the acquisitions of Titan and Kumovis. Those are now fully on board in Q2. We don’t expect any further ramp in them.

And then, outside of Titan and Kumovis, we’ve baked spending plans for the product development things and the infrastructure things that Jeff had talked about. And that’s partially the result of the range, because we’ve begun that spend, but to the extent we don’t hit the spend in Q2, that doesn’t necessarily get pushed to Q3 or Q4. So, we are really expecting it to be kind of flat over the three quarters.

Okay. Got it. Thank you. And if I may, for a quick follow-up. You’ve referenced the supply chain issues. I mean, I’m just wondering what the specific areas are you seeing the most impact? Is it the sourcing, the freight, logistic cost, et cetera? Thank you.

Yes. Freight is an ongoing issue and it’s driven, I’m sure by freight utilization in general and then obviously fuel. The componentry, John, I tell you, I cannot give you an answer. It changes by the day. I think everybody is -- around the world is hand to mouth in a lot of componentry. So truly, I heard somebody call yesterday on one of the news networks, the whack-a-mole, it truly is. So we are deploying excessive resources, if you will, on supply chain, working with our suppliers, qualifying new suppliers, just making sure we can meet the demand that’s out there. So, it is a challenge. And embedded in that are our labor costs across the board from components to freight costs, things like that and embedded labor content as well. So, it’s a challenging environment. And I’d just remind myself on the worst days that we see, I’d rather have this problem than lack of demand. But, is true challenge, right now, I think for all companies.

Yes. John, I’ll add, as Jeff said, it’s component sourcing, component costs freight. We were up roughly $1 million year-over-year in freight costs. Part of that is higher freight rates but part of it is also because of slower shipping times at sea. We’ve had to air ship more. We do expect hopefully that piece will improve as we go through the year, because we are now adjusting our model to plan for a longer shipping times. And so, moving back more to see shipment, which will help our freight costs, means slightly higher inventory levels, but we are adjusting and reacting as quickly as we could.

John, it’s amazing. Machines are made up of hundreds or thousands of components and in normal times, you don’t think about that. But in supply chain constraint times, you can be hamstrung by anything in the machine that can cause you to not ship it. So, it’s truly an education process every day, I think for leadership teams at all industrial companies right now to look around. And it is what I believe is really fundamentally driving the demand for additive manufacturing is people don’t want to be left short on a component that they didn’t even really realize was at risk of being in short supply. So, they look at additive. It opens the door for additive. And then, as you bring it in and you look at the economics, you say maybe I should make more and more things with this process. So, it’s really -- on one side, it’s giving us a lot of growth opportunity and that’s tremendous. And that will not go backwards. That’s truly -- once they’ve got this in place, it’s exciting and they want to grow it. But it is an ongoing challenge in terms of delivering to demand. So, it’s two sides of the same coin.

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

Hey gentlemen, congrats on the solid results in a tough environment.

Thank you, Troy. Good to hear your voice.

Hey guys. So, I guess, Jeff for you, maybe couple. I think it was three months ago, you talked about refreshing the product line over the 18 months. And I think we’ve one, right, with SLA 750. I’m just wondering if, next week’s going to be a big week for new product introductions.

Troy, we have -- what I think is a really exciting product lineup for the next 18 months. So, you’re going to hear regularly of new products being launched. You go through a debate internally of well how much do you really reveal at any one time, that you are talking about? I can -- so you’ll get more information on Monday, and we’re excited about telling you about it. It will be a little judicious because there’s competitive issues and things like that. So, we’ve got to be a little bit guarded. But I would tell you, Troy, you see a theme in the 750 release. And you particularly with your knowledge, the industry would appreciate this is backward compatibility and forward upgradeability is a really big deal.

So, like this new 750, you can buy it as a single laser system or a dual laser system. You can upgrade it in the field. It’s got modularity. That’s kind of the theme that our technology folks are working toward in our new product platforms. So, the customers are not stuck having to reinvest significant capital. They can do incremental investments and make sure they also have backward compatibility with products. So, I’m going off on a little bit of a tangent. We’ll tell you as much as we can next week. And I would encourage you please ask a lot of questions, which you always do. We’ll have a 750 in the booth at RAPID, and we’ll tell you as much about the roadmap as we possibly can. Okay?

Okay. Perfect. Jagtar, will you be at the event?

I will not be at the event. We will have our new starting interim CFO at the event.

I wish you good luck. But maybe one quick follow-up question. So, it seems like every CEO’s applauding the Biden administration in this AM Forward initiative. So, I’m just curious, Jeff, have you seen any more details, and what exactly are they going to do to incentivize adoption?

It’s a point of great discussion, Troy. And I would tell you, Troy, been around long enough. I don’t -- I rarely make any definitive plans based on federal actions and intent and direction. But, I do think it reflects the sensitivity in Washington to the benefits of additive, and what it can do for the robustness of the U.S. economy, and the resiliency, reducing our dependence on overseas sources of things. I was in Washington a couple of weeks ago, and I would tell you, the discussion around 3D printing, additive manufacturing is on everybody’s lips. It’s -- there’s a defense component to it. There’s a national interest component to it. And there’s a resiliency factor that we don’t want to be brought down by other countries and pandemics and things like that.

I think it’s great. My interpretation of bill, which is strictly layman, is it’s intended to help smaller businesses adopt additive. And so, I think in terms of driving demand for us, it’s a great thing. I’m not sure that the OEMs of additive will benefit directly. I don’t know that we need to benefit directly. But certainly, if it helps our customers adopt additive, particularly small companies, helps them grow, I think it’s fantastic. So, I applaud what they’re doing directionally, and it’ll be interesting to see what they are. We rarely modify plans to meet it, but it’s consistent with what we’re investing in anyway. So, I’m all for it, and great to see the sentiment in an industrial direction there.

Thank you. Next question today is coming from Kieran McCabe [ph] from Stifel. Your line is now live.

I just had a question, given kind of the continued resilience and demand and further adoption of additive manufacturing. And you had the acquisition of Oqton back in September. I wonder if maybe you can kind of give an update or kind of a sense with conversations with customers about really using software to drive the adoption into production environments and the need for software and sort of -- kind of, since the Oqton acquisition kind of any update you could provide on that. Probably you would have a lot of details with that next week, but anything you could kind of touch on that now that’d be great. Thank you.

Sure. I’ll make a couple of comments, and it’s so important to us quite honestly in the future that Ben Schrauwen, a leader of Oqton will be at our Investor Day event to talk about the Oqton’s software platform and where it’s headed. Yes. I would tell you, for all the folks on the phone, the software is an incredibly important issue in bringing additive into production environments. Again, it did use to be to put it in a laboratory, a one-off machine. It didn’t really matter as long as -- they wanted a machine that was easy to use and smart, but to put fleets of machines. And we’re talking guys about hundreds and thousands of printers in a factory, you had -- to avoid process variability and the use of large amounts of labor. You absolutely have to have a robust software environment to run them, a manufacturing operating system.

And that operating system cannot disrupt the ongoing factory when you install it, which is what we love about Oqton. It can plug into SAP or Oracle, and then you can plug not only printers, but post print processing, robotics. You can plug all of that in through APIs into the Oqton platform. So, customer interest in that platform, I would tell you, has been enormous. We’re in dialogue with companies every day about it, large companies. I think it’s a new field. So, everybody’s trying to learn what it can do, what they need to do with it, but interest has been quite high. So, I’m very pleased with that.

And I think it will help -- Oqton will help our entire industry, continue to meet this increased demand for additive in production, which is why we set it up as a separate, somewhat independent firewall business is we wanted to help the entire industry and the entire customer base and adopt additive manufacturing. So you’ll hear from the leader of that business next week, in person. And we’ve staked out a fair bit of time on the agenda for software discussion. I think you’ll find it quite interesting.

Next question today is coming from Jared Maymon from Berenberg. Your line is now live.

Thanks for a lot of commentary around the supply side. That’s been helpful. But I did just want to ask a couple questions on demand. So, I’ve been hearing from some other companies that they’re seeing orders slowing. And it sounds like it’s mainly in some cases due to like inflation, interest rate and interest rate rising and then geopolitical risks, just generally increasing uncertainty. So, they’re either, it sounds like in some cases slowing or stalling or delaying their CapEx decision, so -- or CapEx orders. So, I’m wondering, are you seeing any of this -- or is there -- is any indication that you might start to see some of this in customers making that shift in the coming months?

And then, on the flip side, I’m curious if you think this could actually be a bit of a tailwind for additive and you guys, because in some cases it can be a little more cost effective and easier to ramp up and ramp down more quickly.

Yes. And I’ve already gone on about the benefits and the positive drivers that we see based on all these difficulties in the environment, and those are true and they’re profound. There’s a -- they’re big drivers. The only real risk -- and I’d tell you, we have not seen it, manifest itself at all, but in just my opinion. The only real risk is with this rise in -- rise in inflation and the corresponding rise by the Fed and interest rates. It starts tiptoeing toward recessionary pressures. And if our customers finally believe that a recession is coming, everybody starts looking at in detail at their CapEx spending. So eventually that could become a headwind. Right now, there is no headwinds. There is no sign of that happening right now. I would tell you in our company, demand is very high, especially exploring new ways of bringing this into production. And it’s driven by everything we have talked about, and the risk of extended supply chains, supply chain disruption, pandemic, all of that.

On the negative side, in the future, would really only be, I think if the entire economy slowed down to the point where -- and the industrial firms started really looking at how much new capacity they needed to add, I still think there will be an underlying tremendous driver to bring it closer to home, whatever that capacity is, and to make it more robust. At the same time, offsetting that could be a slowdown in the general economy. Again, we see no evidence of that in our demand profile right now. But, if I were to speculate, that’s the one thing that could affect, I think the whole industrial sector. Jagtar, if you have any other views?

The only thing I’d add, Jared, is, obviously I can’t predict what the economy is going to do in Q4 this year or Q1 next year, but looking shorter term, I mean, I’m quite pleased with where our pipeline looks right now for Q2. So, that would seem to indicate that demand is still out there. It’s still strong.

Got it. Okay. That’s really helpful, guys. And then, just as kind of a follow-up. So, I’m just curious, have you guys seen any shift or is it pretty steady from a sequential utilization standpoint? And then, subsequently, consumables from Q4 to Q1. And then, any sort of outlook on that remaining steady, increasing or decreasing for the rest of the year?

Jagtar, do you want to comment on the individual element trends?

Yes. So consumables -- Q1 is typically lower than Q4. It’s easier to do a year-over-year number. I’ll give you some numbers that are adjusted for divestitures. So, materials revenue was up about 11% or 12% year-over-year. I think we felt pretty good about that. Printers were up -- or sorry, systems -- product revenue was up closer to 22%, 23% year-over-year. So, printer sales were quite strong, which bodes well for future materials revenue. I like it when I see materials growing strong, but printers growing even stronger because that means there’s going to be follow-up materials revenue in the future.

And again, Jared, we’ll try to give you a little bit more color on the size of our installed base and our growth outlook next Monday, when we talk. It’s really impressive numbers, quite frankly, the scale of it. So, it’s interesting. I think, we are among the first learning of how to sell and manage large fleets of machines, and especially mixed fleets, not only metal and polymer, but our machines and those from elsewhere in the industry. So, fascinating times. We’ll share some more insight to that on Monday.

Great. Sounds good. Looking forward to the Investor Day. And Jagtar, best wishes in what comes next.

Thanks, Jared. I appreciate it.

Thank you. We reached the end of our question-and-answer session. I’d like to turn the floor back over to Dr. Graves for any further or closing comments.

So, thank you all for joining our call this morning. We hope to see you next week in Detroit and updating you again on our progress next quarter. Thanks and have a great day.

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.