3D Systems Corp Q4 FY2022 Earnings Call

Hello, and welcome to the 3D Systems Fourth Quarter and Full Year 2022 Conference Call and Webcast. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to your host, Russell Johnson, Vice President, Treasury and Investor Relations. Please, go ahead.

Good morning, and welcome to 3D Systems' fourth quarter 2022 conference call. With me on today's call are Dr. Jeffrey Graves, President and Chief Executive Officer; Michael Turner, 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 access to 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 discussions and responses to your questions reflect management 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. With that, I'll turn the call over to our CEO, Jeff Graves, for opening remarks.

Thank you, Russell, and good morning, everyone. I'll begin this morning with some comments on 3D Systems' performance and achievements during 2022, and then I'll share my thoughts on the company's outlook for 2023 and what we'll be focusing on in the year ahead. After that, I'll hand the call over to our CFO, Michael Turner, for a more detailed discussion of fourth quarter and full year 2022 financial results as well as our guidance for 2023. So with that, let me turn to slide five and start with a quick recap of last year. I'll say upfront that while we came in short of our original financial goals set at the beginning of the year, I'm very proud of what our company ultimately achieved, particularly given the headwinds that we encountered during the year, a few of which were common to many companies and one of which was unique to ours. It's important that we be as clear as possible about these factors, as they directly relate to our view of the year ahead and actions we're taking in response to them. First, while COVID-driven supply chain issues were nagging problems throughout the year, they were no worse than what we had anticipated and they continued to improve throughout the year as expected. Much more impactful, however, was the rapid rise in inflation, which reduced consumer demand for a variety of elective medical procedures. At 3D Systems, we felt this most acutely as a significant slowdown in our dental orthodontic business, which declined significantly as consumers shifted their spending to more basic necessities such as groceries, clothing and energy for their homes and cars. This inflation also manifested itself in higher labor and material costs in our products, which created challenges in gross profit margins as our pricing opportunities at times lagged the cost trends. Second, economic uncertainty and recession fears at some of our customers, particularly in the industrial manufacturing space caused them to become more cautious and defer new investments in equipment and inventory. Third, while the COVID situation improved in the United States, economic activity in parts of Asia continued to be disrupted by factory shutdowns and restrictions on daily life. And finally, the tragic war in Ukraine not only led us to halt sales into Russia but also dampened demand for key European markets in general. Taking into account these factors, we updated our external financial guidance and took a number of concrete steps to control costs and drive near-term operational efficiencies. I want to commend our entire global 3D Systems team for staying nimble and working hard to manage what proved to be a very challenging year. Thanks to their efforts, we had a solid second half of 2022, delivering well on our key customer commitments. One of the most important things to emphasize regarding 2022 was that it proved to be an extraordinarily productive and strategic year for our company when you consider the foundation we put in place for future growth. Last year, we made it clear that 2022 would be an investment year for 3D Systems. And indeed, we invested during the year in a number of key areas, refreshing our product portfolio, continuing to build a world-class regenerative medicine business, and improving our corporate and regulatory infrastructure such that it can be leveraged to support future growth. I'm pleased to say that we're already harvesting the benefits of some of these investments in the form of important new technologies, new customers, and new sources of revenue. Capitalizing on these early wins will be a key focus for us in 2023, and I'll speak more about that in a moment. It's also important to note that we invested heavily during 2022 in the highly attractive emerging businesses such as regenerative medicine. While these efforts are largely pre-commercial today, their future impact will become increasingly apparent over the next two years. And while this investment spending impacted our 2022 results, I'm committed to stay the course in 2023 and beyond, prudently balancing these expenses with efficiency initiatives that are needed in order to assure customers of our ability to support their growth needs over the long term. These investments are absolutely the right strategic decision for 3D Systems, given the continued acceleration of additive manufacturing and production environments and the opening of entirely new markets as the cost of adoption continues to fall. We're at the forefront of this dynamic and well positioned to deliver on the value and promises for all of our stakeholders. Moving to Slide 6. During 2022, a crucially important investment focus for us was updating and expanding our industry-leading product portfolio, including hardware, materials, and software. In particular, our hardware teams undertook a comprehensive effort to refresh our most critical printer platforms and they've already achieved several important milestones on this front. Last year, we launched the SLA 750 and SLA 750 Dual, our fastest-ever stereolithography printer that's ideal for large format and high-volume polymer applications. This all-new platform is the largest, fastest, and most precise SLA printer on the market, and has enjoyed an enthusiastic reception from our industrial, aerospace, and automotive customers. Just last week, we announced the BWT Alpine F1 team has purchased four of our new SLA 750 printing systems after having extensively tested the product during its beta phase. The Alpine F1 team is currently producing 25,000 additively manufactured parts per year using 3D Systems equipment and materials. The team will use our SLA 750 to accelerate their builds of complex aerodynamic parts for wind tunnel testing, as well as small composite tools and high-temperature bonding jigs. The SLA 750 evolution is a perfect illustration of the strategic capability we're building at 3D Systems, the ability to drive growth through rapid innovation by accelerating new products from the design lab to the customer market. And two weeks ago, we introduced a major upgrade to our industry-leading jetting printer, the MJP 2500W Plus, which is ideally suited for jewelry and other small precision casting applications. This upgraded platform is specifically designed to produce complex, high-quality pure wax 3D printed jewelry patterns with new levels of speed and precision. It was developed in close collaboration with end-users, responding directly to the needs of our customers operating in mass customization production environments. As I noted earlier, a key focus for 2023 will be to harvest the near-term benefits of these technology investments. The SLA 750 and refreshed MJP 2500 are two early examples of the investments we're making in rapid customer-focused innovation. We'll accelerate the cycle of performance upgrades during 2023 with a number of new platforms scheduled for launch throughout the year. Now moving to slide seven. In addition to these organic investments in our legacy print platforms, in 2022, we further accelerated the expansion of our hardware offerings by acquiring three early-stage production printing platforms, Titan, Kumovis, and DP Polar, each of which offers unique advantages in specific markets. We're very optimistic about the potential for each of these new systems. While still in the early stages of launch, we're already seeing exciting signs of what these revolutionary technologies can accomplish. Let me take a minute to share one example with you. Just last week, we witnessed the achievement of a major milestone for our Healthcare Solutions Group, when a surgical team at Austria's University Hospital in Salzburg executed the first clinical implantation of a 3D printed cranial plate manufactured from medical-grade PEEK polymeric materials using a Kumovis printer. This printer was specifically developed for precision printing of medical-grade high-performance polymers, such as Polyetheretherketone or PEEK. Using the Kumovis printer installed at the point of care inside the hospital, the surgical team customized and printed a cranial implant to precisely match the patient's specific anatomical profile and related physiological needs. In this instance, it was critically important to not only create a suitable scale plate for protection of the brain but given the size of the replacement section needed to also lightweight the unusually large cranial plate by 3D printing with a porous honeycomb internal structure, an outcome that would have been impossible using traditional manufacturing techniques. This type of personalized patient-specific point-of-care implant application, which takes advantage of the performance and biocompatible properties of PEEK material, is exactly why we acquired Kumovis and are integrating their platform into our overall portfolio. As this technology now comes online, we're uniquely positioned to provide surgeons a full spectrum of printed solution options ranging from titanium and cobalt chrome for joint and bone replacement to advanced medical-grade polymers for spinal, cranial, and other targeted orthopedic applications, each of which is customized to precisely match patient needs using the digital tools and processes that we've pioneered over the last decade in our healthcare business. These solutions provide better, faster, and lower-cost outcomes to patients in a rapidly growing range of orthopedic applications, which will drive sustained long-term growth in our existing healthcare business. When combined with our Oqton software platform, which is now in process, the ability to standardize and automate orthopedic workflows will further accelerate the application of this technology for patients around the world. I'm proud to say we're the leader in this market, and we're making the key investments required to remain so. As we move forward with these and other investments in our product portfolio, our goal is clear: 3D Systems will continue to offer the most complete innovative lineup of 3D print solutions in the industry, and we'll remain the partner of choice for customers wishing to unlock the vast potential of true serial-scale additive manufacturing. Moving now to Slide 8. Another strategically important area of investment focus during 2022 was regenerative medicine. As I've shared with you previously, I believe that regenerative medicine is the next frontier for additive manufacturing. Moreover, I'm convinced that 3D Systems is uniquely positioned to lead this emerging growth industry. We combine a set of attributes that no other company can claim, including a 30-year-plus track record of developing high-resolution 3D printing applications, deep expertise in material science, a strong foundation of quality and regulatory expertise to draw upon and hands-on experience in human tissue engineering, gained through both strategic acquisitions and through our multi-year organ partnership with United Therapeutics. Over the last 12 months, our regenerative medicine program has achieved remarkable milestones that offer a preview into the extraordinary growth potential of this emerging business. In 2023, Systems and our long-time biotech development partner, United Therapeutics, publicly unveiled a 3D printed lung scaffold that represents the most complex 3D printed object ever manufactured. This extraordinary engineering achievement has already demonstrated functional gas exchange in animal models. Based upon our progress made last year, we believe that our 3D printed lungs could enter human transplantation trials within five years, a significantly accelerated time frame from what we just envisioned back in 2021. Also in 2022, we announced the formation of Systemic Bio, a wholly-owned startup company leveraging our expertise in vascularized tissue printing to develop and manufacture a unique organ-on-a-chip technology called HVIOS for use in drug discovery and development by the pharmaceutical industry. I want to remind everyone that Systemic Bio will not be a traditional vendor of 3D printers and materials; instead, Systemic Bio will partner directly with major pharmaceutical companies to jointly develop HVIOS chips tailored to specific organ and disease functions, which market directly to pharmaceutical and biotech companies engaged in drug discovery. I'm sure you can all appreciate the substantial increase to our company's baseline profitability that we would drive by becoming a major supplier of customized high-value biotech products for the pharmaceutical industry, as well as the re-rating of our company's valuation multiple that could result from this change. As we speak, our Systemic Bio team is actively engaged in commercial discussions with potential partners and customers. I look forward to having more news to share with you on this front in the near future. Just two weeks ago, we announced we had another milestone, a new regenerative tissue program that's a direct outcome of the success we've achieved in 3D printing human organ scaffolds. This internal research and development effort is combining bioprinting technology, biocompatible 3D printing materials, and patient-derived cells to manufacture vascularized hydrogel scaffolds that mimic a patient's anatomy and physiology and can deliver improved outcomes in a variety of surgical applications. The first 3D printed product that we have under development is regenerative breast tissue. This breakthrough application could offer dramatically improved implant-based reconstruction options for millions of women diagnosed with cancer each year. It could also open up a significant new market opportunity that 3D Systems is uniquely positioned to address. A key point regarding our ongoing investment initiatives is we are only pursuing R&D programs and new additions to our product portfolio that we believe offer attractive returns and are consistent with our company's mission to provide application-focused solutions to high-value, high-growth industrial and healthcare markets. Given its strategic importance, we maintained our heavy investment focus during 2022 despite macroeconomic and geopolitical headwinds as well as greater-than-expected softness in our key orthodontic market. Doing so requires us to target our investment spending very carefully, control our operating costs, and utilize our strong balance sheet. I remain convinced that the programs we supported during 2022 and will continue to fund in 2023 are building a solid foundation for future growth and profitability that we'll be able to leverage for many years to come. Moving now to slide nine. I'd like to highlight several recent internal activities that have already provided us with important performance benefits and will continue to do so as we move through 2023. Last year, we achieved meaningful success in better aligning our manufacturing and supply chain operations with our company's operating profile and emerging product portfolio. During the second half of 2022, we completed a major step in this process by insourcing a significant amount of our polymer printing platforms into our South Carolina manufacturing operations. This transition required us to incur some one-time costs as well as to take inventory onto our books ahead of need, which in part explains our elevated inventory levels at the end of the year. The change has already improved our gross margins and positively impacted delivery reliability and product quality for our customers. In 2023, as we accelerate the pace of new product releases that track to our financial performance targets, you have my commitment that we will be laser-focused on driving operational excellence and cost efficiency. Yesterday, we announced an important step in this process, a restructuring initiative that will improve our 2023 profit profile by better aligning our European engineering and manufacturing operations for our three metals platforms, streamlining our software organization, which is now consolidated under one leader and focusing our product portfolio on platforms that bring the highest long-term value to the market. These actions, which are the culmination of integration activities and optimization planning conducted throughout 2022 will allow us to achieve significant cost synergies in 2023 and beyond, as Michael will detail later for you. Beyond these discrete measures to maximize efficiency, during the fourth quarter of 2022, we laid groundwork for further operational improvements by undertaking a major reorganization of our operations and engineering functions. We've now aligned all 3D Systems engineering, design, product management, procurement, manufacturing, and logistics under a single member of my executive team, Dr. Joe Zuiker, who recently joined the company to take on this new role. Under Joe's leadership, our operations and engineering teams will work together to drive an organization-wide focus on operational excellence. Their primary mission will be to ensure a seamless progression from product design to full-scale manufacturing for every element in our portfolio. Before handing the call over to Michael, I'd like to provide my broad perspective on our outlook for 2023. In our new full-year guidance, which Michael will present to you shortly, we're prudently assuming that the dental market slowdown that we experienced in the second half of 2022 will persist throughout 2023. Outside of dental, we see considerable strength in virtually all other markets across our Healthcare and Industrial Solutions segments. Putting this all together, we expect to achieve consolidated revenue growth for 2023 in the mid-single digits, supported by growth rates in the mid-teens for our non-dental markets. This growth profile plus the operational cost efficiencies that will drive throughout 2023 should allow us to generate positive adjusted EBITDA and free cash flow for the full year, excluding any one-time restructuring costs that we may incur. I want to emphasize that our 2023 guidance fully reflects continued investments in growth areas of our business, including new product development, R&D, and creating a world-class regenerative medicine business, all of which are critically important activities designed to support future growth. As we enter the New Year, I've never been more excited and confident in our company's leadership position in the 3D printing industry, particularly given the technology, application expertise, and operational foundation we've worked so hard to put in place over the last few years. In 2023, we're committed to driving financial results in line with our leadership position. Finally, before concluding my remarks, I'd like to note one additional topic. Earlier this week, the US Department of State, Justice, and Commerce announced that these agencies have settled their open investigation with 3D Systems into alleged export control violations that previously took place between 2012 and 2019. We disclosed this matter in our SEC filings for some time now. Under the settlement, 3D Systems will be subject to civil monetary penalties as well as certain remedial compliance measures as a part of our three-year consent agreement. The company is pleased to have reached a settlement with the agency and remains committed to continuing to enhance its export controls program. Looking forward, I'm very proud of the compliance culture, processes, and infrastructure we've now established with 3D Systems and that we'll continue building upon. We are fully committed to not only meeting all required standards but being a true leader in what is an essential element of all complex global businesses today. With that, I'd like to turn the call over to Michael Turner, our CFO.

Thanks, Jeff. Before I start, I'd like to remind everyone that 3D Systems made three significant divestitures in 2021. The earnings release that we issued last night contained tables with non-GAAP measures relating to our full-year 2021 results from which we exclude the impacts of these divested businesses. Likewise, on today's call, any reference that I make to our full-year 2021 results will be on the same ex-divestiture basis. The point of this adjustment is to make our 2022 results comparable to our 2021 results on an organic basis. However, it's important to note that we completed our divestiture program during the third quarter of 2021. Therefore, any tables contained in last night's earnings release relating to our fourth quarter 2021 results, and likewise, any reference that I make to our fourth quarter 2021 results on today's call do not reflect any adjustments for divestitures. Turning now to slide 11. I'll start out with a discussion of full-year 2022 results for our consolidated business. As Jeff mentioned, our business encountered a variety of external challenges during 2022 that caused our full-year results to come in below what we expected at the beginning of the year. These challenges include FX headwinds, high inflation, recessionary fears, and the war in Ukraine. And of course, the biggest headwind we faced during the year was that inflation and economic uncertainty reduced the demand for many elective medical procedures. As a result, we experienced an unexpected and significant decline in dental market revenue during the second half of 2022. This was particularly impactful for 3D Systems because dental sales represent a large percentage of our total business. However, after making a midyear adjustment to our 2022 revenue guidance to reflect the above factors, we were able to finish out the year by coming in quite close to our revised revenue expectations. Revenue for 2022 was $538 million, a decrease of 12.6% as compared to 2021. Excluding divestitures and the unfavorable impacts of FX, revenue increased by 3.3% compared to the prior year. This top-line growth, despite a very challenging operating environment, reflects continued solid demand in most of the end markets served by our Industrial and Healthcare Solutions segments. As previously noted, partially offsetting this growth was our exit from the Russia market in early 2022, as well as weakness in dental market revenues, predominantly in orthodontics, which declined by roughly 10% year-over-year. Adjusting for these items, our net sales increased by lower double digits year-over-year. Moving now to quarterly revenue results, which, as noted previously, no longer reflect the impacts of 2021 divestitures on a consolidated basis, for the fourth quarter of 2022, consolidated revenues decreased by 12% to $132.7 million compared to the same period in the prior year. Excluding the unfavorable impacts of FX, consolidated revenues decreased by 7.6%. The decline in revenue primarily reflects sharply lower fourth quarter dental market sales, partially offset by continued solid product and service demand across other areas of the business. Turning now to slide 12 for a review of segment revenues. For our Healthcare Solutions segment, full-year 2022 revenue, excluding divestitures and the unfavorable impacts of FX, decreased by 2.9% as compared to 2021 due to a decline in our dental market of approximately 10% that started in mid-2022. Outside of dental, we saw healthy growth during 2022 in some of the other major business lines within our Healthcare Solutions segment, including strong sales to customers that 3D print various types of medical devices, such as orthopedic implants and surgical guides. Additionally, our sales of virtual surgical planning and point-of-care solutions to doctors, surgeons, and hospitals grew in the fourth quarter. These two areas of our healthcare business often involve medical procedures that are less elective in nature and therefore have proven resilient even in times of economic uncertainty. For our Industrial Solutions segment, full-year 2022 revenue, excluding divestitures and the unfavorable impacts of FX, increased by 9.7% as compared to 2021, driven by continued strength in precision microcasting applications and demand for production machines in energy and commercial space applications. Moving now to quarterly segment results. For our Healthcare Solutions segment, fourth-quarter revenue, excluding unfavorable FX impacts, declined by 16.6% year-over-year due primarily to dental market headwinds, partially offset by continued strength in medical devices. For our Industrial Solutions segment, fourth-quarter revenue, excluding unfavorable FX impacts, increased by 1.1%. Revenue during the quarter benefited from continued strength in precision microcasting applications for jewelry customers, as well as growth in semiconductors and electronics, partially offset by relatively weaker sales to aerospace and motorsports customers, as compared to a very strong fourth quarter in the prior year for both of those end markets. Moving now to gross profit on slide 13. Gross profit margin for the full year 2022 was 39.8% compared to 42.5% in the prior year. The decrease in margins was due to multiple factors including 2021 divestitures of non-core assets, inflationary impacts on input costs, freight, and unfavorable changes in product mix due to selling more printers and fewer materials in 2022 than in the prior year. This year-over-year mix shift impact was particularly impactful in our key dental market vertical. For the fourth quarter of 2022, gross profit margin was 40.9% compared to 44.1% for the same quarter last year. The factors driving the year-over-year decline in margin are largely the same as for the full year. While our margins are down in 2022 versus 2021, we achieved sequential margin improvement in the fourth quarter with a 100 basis point increase from Q3 levels, which followed a similar increase from Q2 to Q3. We have been able to improve margins despite the challenging macroeconomic environment through a combination of price actions and increased focus on operational excellence, which includes the benefit of bringing some of our outsourced printer production back in house during the second half of 2022. Turning now to operating expenses on Slide 14. Operating expenses for the full year 2022 increased by 11.6% to $331.3 million compared to the prior year. The higher operating expenses include spending in targeted areas to support future growth, including the expenses from acquired businesses, research and development and investments in personnel and corporate infrastructure, partially offset by the assets of expenses from divested businesses. The higher expenses also include $17.2 million in accrued expenses for legal and other settlement costs that were largely related to the export control investigation as Jeff mentioned just a moment ago; we've now settled with the U.S. government. On a non-GAAP basis, which excludes non-recurring charges and divestitures, full-year 2022 operating expenses were $241.1 million, a 22.1% increase from the prior year, which primarily reflects spending to support future growth. For the fourth quarter, operating expenses increased by 18% to $82.7 million compared to the same period of the prior year. On a non-GAAP basis, fourth quarter operating expenses were $64.1 million, an 18.2% increase from the same period a year ago. The increase in non-GAAP operating expenses primarily reflects spending to support future growth, including the expenses from acquired businesses, research and development, and investments in personnel and corporate infrastructure. Moving now to Slide 15. Adjusted EBITDA, which is defined as non-GAAP operating profit plus depreciation, was negative $5.8 million for the full year 2022, compared to $56.2 million for 2021. For the fourth quarter of 2022, adjusted EBITDA was negative $4.8 million compared to $17.9 million for the same period last year. The decline in adjusted EBITDA reflects all the factors that we've previously discussed. One point I'd like to remind everyone of, as I did on our third quarter call, 3D Systems' profitability during 2022 was significantly impacted by a variety of growth investments, which includes SG&A and R&D expenses from businesses that we've acquired over the last 1.5 years, including Oqton, Titan, Kumovis, and most recently DP Polar. It also includes investments we're making to build our regenerative medicine business, which is still largely in a pre-commercial stage. We invested on this front in 2022 and will increase our level of investment in 2023. These acquisitions and other investments in emerging businesses are highly strategic to 3D Systems, and we expect them to contribute significantly to our revenue growth over the coming years. However, for the time being, these businesses in aggregate have yet to generate meaningful revenue for us. As such, you should expect our adjusted EBITDA to run below our natural potential for a period of time due to the near-term expense impact of recent acquisitions and investments in pre-commercial businesses. Although, as I will discuss in a moment, we are forecasting a return to breakeven or better adjusted EBITDA in 2023 after a negative year in 2022. And for EPS, for the full year 2022, we had a fully diluted loss per share of $0.96 compared to income per share of $2.55 for 2021, excluding charges for stock-based compensation and other non-recurring items as detailed in the appendix of the earnings release. Our 2022 non-GAAP loss per share was $0.43 compared to non-GAAP earnings per share of $0.33 in 2021. For the fourth quarter of 2022, we had a fully diluted loss per share of $0.20, as compared to a loss per share of $0.05 in the prior year quarter. On a non-GAAP basis, we had a loss per share of $0.06 in the fourth quarter of 2022 versus $0.09 earnings per share in the prior year quarter. The year-over-year EPS decline reflects all the factors we've previously discussed. Now turning to Slide 16 for balance sheet highlights. We ended the quarter with $568.7 million of cash and short-term investments on hand. Our cash and short-term investments declined approximately $220.9 million since the end of 2021, driven primarily by $104.3 million paid for acquisitions and equity investments, cash used in operations of $16.4 million, capital expenditures of $22.5 million, and cash used for financing activities of $13.8 million. We continue to have a strong balance sheet with sufficient cash to support organic growth and our investments in our pre-commercial businesses. I'll conclude my remarks on Slide 17 with a discussion of our full-year 2023 guidance. We expect revenue to be in the range of $545 million to $575 million. We expect non-GAAP gross profit margin to be in the range of 40% to 42%, and we expect both adjusted EBITDA and free cash flow to be breakeven or better. I want to highlight several points related to this new guidance. First, we are not providing 2023 guidance for non-GAAP operating expenses as we did for 2022. However, we have added 2023 guidance for both adjusted EBITDA and free cash flow. We made this change because we believe that these two metrics, one which addresses profitability and the other, which addresses cash generation, are most consistent with how investors will evaluate our overall performance going forward. Given that we are now guiding to new metrics, I want to make sure that we have a common understanding of definitions. For purposes of this guidance, I define free cash flow as adjusted EBITDA plus changes in trade working capital, less capital expenditures. Also, both adjusted EBITDA and free cash flow are meant to exclude any restructuring and/or one-time charges that we may incur during 2023. Lastly, I want to note that our 2023 guidance fully incorporates two known headwinds. It includes increased operating expenses associated with our continued investment in our pre-commercial regenerative medicine business, which we expect to be approximately $9 million higher than in 2022. It also assumes that our dental orthodontic demand will be down roughly 35% versus 2022, primarily driven by customer supply chain and inventory reduction initiatives. Offsetting these headwinds are the favorable impacts of the restructuring that Jeff spoke to you about earlier, and strong growth in our core non-dental markets. The key takeaway here is our guidance for 2023 anticipates breakeven to positive adjusted EBITDA and free cash flow after fully incorporating these known headwinds, which demonstrates that the fundamentals of our core business are sufficiently robust to drive solid overall performance for the company. Finally, although we are not providing quarterly guidance for 2023, I want to make a comment about seasonality. In the past, it has been difficult for 3D Systems to begin each year with a relatively weaker first quarter and then go through a somewhat higher second and third quarter and then end the year with a strong Q4, as customers stopped their annual budgets and stocked up on inventories for the coming year. 2022 did not follow the same pattern due to the decline in our dental markets in the second half of the year, as well as other macroeconomic challenges. Based on the current forecast upon which our 2023 guidance is based, we are expecting to return to normal seasonal trends, as I just described, which should result in a quarterly split of revenue similar to what we experienced in 2021. That concludes my remarks. Operator, we are now ready to open the line for questions.

Thank you. We'll now be conducting a question-and-answer session. Our first question today is coming from Troy Jensen from Lake Street Capital. Your line is now live.

Hey John, thanks for your time. Congratulations on results that I thought were better than expected overall. Just a quick question for you. Michael, can you clarify something? In your prepared remarks, did you say that healthcare was down 35% or are you projecting it to be down at that level in 2023?

We expect our dental markets to decline by 35% year-over-year in 2023.

Okay, cool. I got you. And then just thoughts on like share loss. Is that just customer adoption that stalled that much, or just share is obviously an important topic for this customer. So just your thoughts on that, please?

For that market, specifically, there's no share loss. It's strictly a correction in the supply chain at this point. But if you watch public company announcements, the impact on that business has kind of moderated now. It's flattened out. They've just got to burn off some inventory. They had built inventory pretty aggressively as they expanded their production capability and they got hit with the consumer discretionary spending drop. So, they're just clearing inventory. So, we've tried to just be very realistic in the year to say, it's going to take a while for them to do well and return to normal levels, but no share loss.

Okay, perfect. Jeff, you've mentioned before how crucial profitability is in this industry, particularly for leaders like your company and in additive manufacturing. I was wondering about your thoughts on the operating expenses for bioprinting and regenerative projects that aren't currently generating revenue. However, as Michael pointed out, there's much more to consider beyond just the regenerative and traditional additive sectors that are still pre-revenue. I’m interested in your insight regarding the potential margin profile of this business. What do you think its current state is, especially if you weren’t making these aggressive investments?

We have actively discussed this within our company, especially as we approach the new year to set our budget. For growth-oriented companies, it's easy to cut costs broadly. In 2023, we focused on analyzing our markets to determine what would genuinely drive significant shareholder value over the coming years and ensure that we allocate resources accordingly. We also need to be realistic about revenue projections and aggressively reduce costs where feasible. Our approach involves balancing the future adoption rate of additive manufacturing in key markets that promise valuable growth against the need to cut costs while maintaining profitability. This year, we have committed to achieving a balance between EBITDA profitability and generating positive free cash flow. Our balance sheet remains strong with over half a billion dollars in cash. In these uncertain times, customers want to see us making money, particularly generating cash, to ensure we are sustainable and can support them, especially as we engage with conservative, established industrial companies that are adopting additive manufacturing. They need assurance that we will remain profitable. It's not sufficient to have cash; we need to grow that cash as well. Alongside this, we must continue to invest significantly in long-term growth, as the number of applications in both healthcare and industrial sectors is rapidly increasing. However, not all applications will yield profit, so we must proceed carefully in our choices. The guidance we provide reflects the outcome of this strategy. We are committed to achieving positive EBITDA and free cash flow this year, and we recognize that our inventory from last year provides significant opportunities for working capital reduction. We are being cautious and efficient to meet these goals while also investing as much as possible in growth initiatives to ensure successful results. Regenerative medicine is becoming an important aspect of this. Once the returns on those investments become clearer, I believe everyone will acknowledge they were wise decisions. We are satisfied with our current balance, though challenges arose this year, especially with the downturn in dental, and we are vigilant regarding how quickly that sector will recover. We are confident in our revenue projections for now and will inform you of any changes. We are focusing on cost reductions wherever possible while funding key initiatives with real value for the future. Michael, do you have any additional insights on the operational expenditures related to bioprinting and regenerative projects that are still in a pre-revenue phase?

No, I think you covered. But yes, Troy, that kind of covers it. Any questions because that's a really thoughtful question and it's a subjective answer. I just feel this year, it's important to show our customers and our shareholders that we're positive in EBITDA and that we're going to be positive with free cash flow. And even though we've got a great balance sheet, we want to make sure that stays really strong.

Perfect answer. I have a quick question. I will check out the floor, but I want to address Industrial. I find it impressive that your guidance suggests a 15% growth for them this year, especially considering the possibility of a recession. I'd like to hear your thoughts on that, Jeff, and then I'll step back.

Yes, it's a sign that genuine production applications are starting to expand significantly. We were projecting growth in the mid-teens for this year, and I believe this is just the beginning as we look ahead to the next few years. Many companies are integrating these applications into their factories, and factory managers tend to be quite conservative. While new companies may take risks, factory management usually progresses in a measured way, yet it's impressive to see the increasing number of new applications emerging daily in polymers and metals. Customers prefer working with us because we have expertise in both areas and can meet their needs globally. I feel very optimistic about our prospects. I also looked at that growth figure and assessed our ability to achieve it, and based on our analysis of customer demand, I believe it is very achievable.

Awesome. Awesome guys. Well, good luck this year and, yeah, thanks for all the time.

Thanks, Troy.

Thanks, Troy. Stay warm.

Thank you. Your next question is coming from Greg Palm from Craig-Hallum. Your line is now live.

Yeah. Thanks. This is Danny Eggerichs on for Greg today. Hoping to dig a little bit more into dental here right off of that. Obviously, big year-over-year decrease expected here. I mean, is there anything that could make you more bullish something that could go right in this upcoming year, whether it's on the systems side or the consumable side where maybe there's that 35% is kind of a base case and there's potential upside to that, or you just don't have really good visibility to that?

Yeah. It's a great question. It's great to hear from everybody in the cold climate, first thing in the morning. No, it's a great question. So we have a very intimate relationship with the leader in orthodontics today. And I think, if you look at what they state publicly in terms of their business now kind of bottoming, my interpretation, business bottoming and they're looking at – I think – my guess is that's a culmination of many factors. You've got wars going on and inflation, but things seem to be kind of stabilizing. So I would agree. I mean, just as a consumer, I would agree that outlook is probably reasonable. And when you factor in the supply chain burn down of inventory that they want to accomplish with us, that results in our revenue stream. Is there upside on that? Certainly, I mean it's I hope everybody looks in the mirror and says their teeth need to be straightened, right, that would be great. If there was increased demand that it would flow through to us very nicely and particularly probably the second half of the year as inventories are brought in line. But it is really that simple. How much money will people be willing to spend on straightening their teeth, doing that correction, because that's really the driver in the market? And that I think we've been very reasonable in our projection right now. So there could always be a downturn in the economy again and things could soften. Inflation, I am hoping it comes under control and people have the money to spend on optional items like that. But it is really important in people's lives, and we're really well positioned if there is some upside there in demand. But I think we've been prudent in our projections right now.

Got it. And then I guess industrial and non-dental healthcare, I think that mid-teens growth was better than a lot of us were expecting. Are those – you think growing at similar rates, or is one outgrowing the other? And how has that changed in recent months?

Net dentals are likely seeing similar growth rates. I want to highlight that the non-dental segment of our healthcare business, particularly orthopedics and point-of-care efforts, is thriving. We've advanced the technology to a level of broad acceptance, and costs are decreasing rapidly, making orthopedic repairs more effective, efficient, and affordable. Consequently, we’re achieving better patient outcomes, quicker turnaround times, reduced hospital stays, and various ancillary benefits. This is all being accomplished at a lower cost while delivering superior technology solutions. I believe we are truly gaining momentum in orthopedic acceptance. We collaborate closely with the FDA on the approvals for each procedure, which takes time, but the economic factors and outcomes are in our favor, making me very optimistic about this area. Orthopedics is genuinely transforming. There are positive ripple effects, such as decreased inventory in the supply chain and improved patient solution matching. An example I'm particularly enthusiastic about involves skill repair, which showcases the full benefits of additive manufacturing, and it's making a significant difference in patients' lives. On the industrial side, we are also experiencing broad acceptance. When considering sectors ranging from rocketry and satellites to electric vehicles and traditional manufacturing, we find ourselves primarily engaging in higher-value markets such as titanium and nickel, which are often the first to adopt additive manufacturing. Younger companies, in particular, gravitate towards additive technologies because they have fewer design constraints, leading to a high percentage of additive parts in progressive industries. In fact, some modern air and space vehicles feature around 70% to 75% of components made using additive manufacturing, either directly or through casting. This trend is impressive. Overall, the conditions are favorable for adoption. The main concern that could hinder progress is a decline in capital spending from companies if they become cash-strapped, but our customers are generally in solid financial positions and are ready to invest in reducing supply chain risks and enhancing turnaround times. Thus, we see clear opportunities ahead. While there are enough concerns in the news, I remain confident in our projected numbers unless circumstances worsen.

Yes. That's all good stuff. Maybe just sneak in one more quick one on your inventory levels. I mean, a pretty big jump again both year-over-year and sequentially. Just update on your comfort levels there and how we should think about that going forward?

We're very comfortable with our inventory levels and have sufficient stock to produce our products. The current cash investment in inventory is significant since we in-sourced manufacturing, which impacted us in the third quarter and likely had some carryover into the fourth quarter. Our inventory levels increased substantially because the previous supplier had a massive amount of inventory, which we took over. We now have that inventory available and will work through it, making it an important cash resource for us in 2023. We plan to reduce our inventory levels to a more manageable range throughout the year. I'm pleased to report that by taking over manufacturing, we immediately enhanced the quality and delivery metrics of our products, which is vital for our customers and their growth. Going forward, we'll focus on managing our inventories. I believe our business model is well-suited for internal manufacturing across many platforms, and while it won't be the complete approach, particularly for our low volume, high mix, complex products, we have a solid manufacturing base in South Carolina and are also developing one in Europe, so you can expect more of this in the future.

Got it. All right. Thanks, everyone.

Thanks.

Thank you. Your next question is coming from Shannon Cross from Credit Suisse. Your line is now live.

Thank you for taking my question and good morning. I wanted to inquire about the cost of goods sold. Your restructuring program is focused on operating expenses, but I'm interested in the cost side. Additionally, I have a broader question regarding the biotech opportunity you mentioned. You indicated that the lung treatment could potentially enter human trials in five years. How should we envision the evolution of the business model over the next few years? While I'm not looking for specific details, it would be helpful if you could discuss in general terms the potential for revenue growth or how to consider comparable margin profiles, since you operate several distinct businesses. Understanding this would help investors better frame their expectations. Thank you.

Yes. Regarding your latter question, we expect to share more about our projections over the next two years, especially concerning FDA processes and volume increases. I'll address that part shortly. For your first question about COGS and OpEx, we believe it’s crucial this year to reduce business costs and improve efficiencies, leading to positive EBITDA and free cash flow. This is vital as we want to demonstrate profitability while still investing in long-term growth. Our goal was to show that it is possible to be successful financially in this industry. With approximately 40% of our polymer platforms now being insourced, we have a promising opportunity to improve COGS, and the supply chain is starting to improve. As we introduce new products, we are focusing on sourcing components that are more readily available, which allows us to negotiate better prices. We are diligently working on both COGS and pricing. While I wish gross margins would improve more rapidly, they are trending upwards, and we aim to maintain that trajectory. In terms of OpEx, we could achieve significantly higher EBITDA in the short term if we focused solely on 2023. However, we are investing in refreshing our existing platforms to ensure they meet the demands of fast, productive, and cost-effective machinery for factories. A great example of this is the SLA 750, along with the latest version of our 2500 jetting platform. We have several more upgrades planned for this year, as we believe it’s important to modernize and refresh our product line. Additionally, we are making substantial investments in regenerative medicine alongside our exceptional partner, United Therapeutics, with whom we are co-developing organs. They are among the best partners I have encountered, and we are deeply involved in developing human organs, which has the potential to transform millions of lives. This core technology empowers us to invest in various projects that promise shorter-term benefits, such as human tissue work for breast reconstruction. While we still need to navigate FDA approvals, this is just one of many potential applications that can yield midterm benefits. We have also begun discussing the development of complex vascularized tissue specimens intended for the pharmaceutical market. This initiative could significantly enhance drug testing, potentially saving years in drug development timelines, which is highly valuable for pharmaceutical companies. We will be producing prepackaged products, known as HBios Organ-on-Chip, featuring printed vascularized tissue containing human cells for testing purposes. We're preparing to announce our new facility in Houston, which will be the first BioFactory dedicated to manufacturing these chips. Currently, we are in talks with many pharmaceutical companies and expect to unveil multiple announcements this year regarding the use of these specimens for drug testing. This opportunity is exciting because it doesn’t require direct FDA approval, only customer acceptance for the tests, allowing us to engage in new drug screening rapidly. Mid-term, we have ongoing projects in human tissue applications, and looking further ahead, we see immense promise in organ development. We are actively focused on short, medium, and long-term goals in regenerative medicine. Through our collaboration with United Therapeutics, we are pioneering technology that is unmatched in the industry. Recently, we established a Medical Advisory Board comprising remarkable individuals who provide insights to advance our programs and facilitate the commercialization of these technologies, benefiting both mankind and our shareholders. I am very optimistic about this work and could discuss it indefinitely.

That's very helpful. I guess the last thing, if I could just touch on it. I realize this was a prior administration. But just with regard to the settlement agreement, I think it was about a $15 million fine, and then you have some more expenditures over the three years. Is there anything else that we should be aware of related to it or that could have any impact on your business, just to sort of close the loop on it? Thanks.

No, Shannon. We're happy to settle with the government. We've dealt with this from 2012 to late 2018, early 2019. Since then, we've made significant improvements in our compliance infrastructure. I've been involved in this process since 2020, and it's strong, and we plan to make it even better. The cash payments owed to the government are spread out over several years, and you'll find the details in the K and subsequent publications. There will be no ongoing impact on the business. Additionally, as you know, we exited the business that caused these issues back in 2020, completing the sale of the Quickparts and OEM business in 2021. That business involved machining work in China, and we decided to move away from it. Alongside this, we have also improved our compliance program. I'm very satisfied with our future direction, and I'm glad to have settled with the government, putting this matter behind us.

Great. Thank you so much.

Thanks.

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

Hi. Good morning. This is Blake Keating on for Brian. I'll just ask a quick one here since we're at it's been an hour. I just wanted to talk about you mentioned in the medium-term, your breast scaffolding and tissue products. I was just looking to dive into that a bit. Is this the application that you've partnered with CollPlant on? And then along with that, what do you think is going to differentiate your product versus the others? There are some private companies that are focused on breast scaffolding with 3D bioprinting. What do you think is going to differentiate that product versus theirs?

Thank you for the question. This program is unrelated to CollPlant. We have developed most of our own materials that we believe are better suited for the application, which is why we are pursuing our path independently. While CollPlant's materials might find a place in some applications, we do not rely on them for our human tissue work. The breast tissue project is just one example of large volume tissue applications in the body, comparable to scenarios where someone suffers trauma and has significant tissue removed. Our ability to print vascularized scaffolds is what sets us apart. These scaffolds can incorporate human cells, particularly in the case of breast tissue, where we often use the patient’s own fat cells for implantation. Our scaffolds and implanted cells are fully biocompatible and are sustained indefinitely by the vascular network printed within them, essentially reintroducing the patient's own tissue material. We are enthusiastic about this solution as it distinctly differentiates us from others in the market, and it represents just one area we plan to expand into with this technology. Maybe one more question, Kevin, and then we'll cut it off. Okay?

Certainly. Our final question today is coming from Ananda Baruah from Loop Capital. Your line is now live.

Good morning, everyone. Thanks for the opportunity. I have a quick question. Jeff, you've provided a lot of valuable insights today, but I'm curious about something related to regenerative technology. As you may know, there was a recent development in the UK where base editing technology has been utilized to treat certain cancers. Interestingly, this technology isn't yet approved by the regulatory agencies, but it can still be accessed with the right paperwork. My question is, do you believe that before receiving FDA approval, there are some aspects of your work in regenerative medicine or orthopedics that could potentially reach the market? Could we see proof of concept for these innovations prior to FDA approval, helping to guide us toward their future applications?

It's a great question because obtaining full FDA approval takes considerable time. There are options like breakthrough designations and compassionate use approvals for patients in critical need. These pathways help expedite bringing new technologies to market. We're committed to achieving full FDA approval, but we also explore opportunities for early use designations, such as the recent instance in Austria where our Kumovis technology was utilized for an implant, significantly impacting patient care. This was a low-risk application from our perspective and beneficial for advancing towards regulatory approval. Your question raises a valid point about pathways for early designation in critical situations, and this is why I established our medical advisory board—to seek guidance on fast-tracking approvals while balancing patient outcomes and data collection. Currently, we are investing significantly in animal testing for various technologies to gather the necessary data before approaching regulatory bodies to determine our discussion depth. We are taking the appropriate steps to bring our products to market as quickly and safely as possible. Initially, we anticipate launching pharmaceutical applications for drug discovery. The advancements we are making with vascularized chips, which can sustain cells for months, represent a significant breakthrough. This capability will enhance our ability to perform drug testing and statistical analysis. Following that, we aim to address human body applications, including tissue and orthopedic solutions, and eventually, organ technologies. We are pioneering in this field, and I am confident in our leadership position.

All right. Thanks, Jeff. That's great context. I appreciate it.

Okay.

Thank you. We reached the end of our Q&A. Over to you, go ahead, please.

I'm sorry. We should probably wrap it up. Listen, let me just thank everybody for the call. I appreciate you guys tuning in and asking such good questions. We'll look forward to updating you each quarter. The world is a very dynamic place. You have our best thinking on 2023, and we'll update you as we go along each quarter. So thanks.

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