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Stratasys, Inc. (NASDAQ:SSYS)

Q4 2008 Earnings Call

February 17, 2009 8:30 am ET

Executives

Shane Glenn - Director of Investor Relations

Scott Crump - Chairman and CEO

Bob Gallagher – CFO

Analysts

Eric Martinuzzi – Craig-Hallum

Andrew Nowinski - Piper Jaffray

Jim Ricchiuti – Needham & Company

Ryan Thibodeaux - Maple Leaf Partners

Brian Drag – William Blair

Graham [Rain] – Bares Capital

Andy Schopick - Nutmeg Securities

Steve Denault – Northland Securities

Clint Morrison – Feltl and Company

Jeff Evanson – Dougherty & Company

Operator

(Operator Instructions) Welcome to the Fourth Quarter 2008 Stratasys earnings conference call. I would now like to turn the call over to your host for today's call, Mr. Shane Glenn, Director of Investor Relations.

Shane Glenn

Welcome to the Stratasys conference call to discuss fourth quarter financial results. Representing Stratasys executive management on the conference call today is the Chairman and CEO of Stratasys, Scott Crump, and CFO Bob Gallagher. A quick reminder that today's conference call is being transmitted over the web and can be accessed through our Investor section of our website at www.Stratasys.com.

We'll begin with the safe harbor statement. All statements herein that are not historical facts or that include such words as expects, anticipates, projects, estimates, vision, planning, believes or similar words constitute forward looking statements covered by the safe harbor protection of the Private Securities Litigation Reform Act of 1995.

Except for historical information herein, the matters discussed in this news release are forward looking statements that involve risks and uncertainties. These include statements regarding projected revenue and income in future quarters, the size of the 3D printer market, our objectives for the marketing sale of our Dimension 3D printers and our Fortus 3D production systems, particularly for use in direct digital manufacturing, the demand for proprietary consumables, the expansion of our paid parts service, and our beliefs with respect the growth in demand for our products.

Other risks and uncertainties that may affect our business include our ability to penetrate the 3D printing market, our ability to maintain the growth rate experienced in this and preceding quarters, our ability our ability to introduce, produce, and market new material such as ABSplus and ABS-M30 and the market acceptance of these and other materials, the impact of competitive products and pricing, our timely development and acceptance of new products and materials and market acceptance of those products and materials, the success of our recent R&D initiative to expand the DDM capabilities of our core FDM technology, and the success of our RedEye on demand and other paid parts services.

Actual results may differ from those expressed or implied in our forward looking statements. These statements represent beliefs and expectation only as of the date they were made. We may elect to update forward looking statements but we expressly disclaim any obligation to do so even if our beliefs and expectations change.

In addition to the statements described above, such forward looking statements include the risks and uncertainties described more fully in our reports filed or to be filed with the Securities and Exchange Commission including our annual reports on Form 10-K and quarterly reports on Form 10-Q.

The information discussed within this conference call includes financial results and forward looking guidance in accordance with US generally accepted accounting principals. In addition, non-GAAP financials are provided in an effort to give information that investors may deem relevant to the company's operations and comparative performance, including the identification and exclusion of expenses associated with stock based compensation required under SFAS 123R, impairment charges and restructuring expenses.

Appropriate reconciliations between non-GAAP and GAAP financial measures are provided in a table at the end of our press release.

Now I'd like to turn the call over to our CEO, Scott Crump.

Scott Crump

During the quarter we generated 11% revenue growth in our proprietary products and services despite the challenging economic environment. Sales of our high end FDM systems grew by 41% during the quarter and 40% for the year. We recently repositioned our high FDM systems as 3D production systems under the Fortus brand name.

This performance is a result of several new product introductions and our successful expansion into new direct digital manufacturing applications or DDM Applications. DDM Applications also had a positive impact on our RedEye paid parts business which grew by 36% during the fourth quarter. Fiscal 2008 represented another record year for revenue and operating profit for Stratasys. In 2008 we introduced five new products and reached a major milestone upon installing our 10,000th system since our company’s inception.

We also completed a major development project within our 3D printing business and launched a revolutionary new product uPrint the world’s first personal 3D printer, all of this despite a very challenging economic environment. I’ll return later to discuss some of our strategic initiatives but first I’d like to turn the call over to our CFO, Bob Gallagher, who will further highlight our fourth quarter results.

Bob Gallagher

Prior to discussing the details of our financial results we would like to outline the relative impact of discontinuing our product distribution agreements in 2007. As we have previously outlined, we discontinued the distribution of Arcan products in 2007 which has created certain issues when conducting year over year comparative analysis of our financials.

In the fourth quarter 2008, we recognized no revenue related to discontinued products compared to approximately $1.4 million in the same period last year. Starting with the first quarter 2009 the prior year’s quarterly revenue comparisons should be relatively free of distributive product revenue.

Total revenue increased by 6% to $31.9 million for the fourth quarter 2008 compared to $30.2 million for the same period last year. Revenue from proprietary products and services which excludes the $1.4 million in distributive product related revenue from last year increased by 11% in the fourth quarter over the same period last year.

The company shipped 570 systems during the fourth quarter versus 536 last year. Our 3D printer sales continue to be negatively impacted by the weak global economy as our users deferred capital investments and cut back on discretionary expenditures. In addition, the fourth quarter results include a limited number of Dimension uPrint.

We began limited distribution of the system in December to better position for the products immediate availability in January of this year. As we will discuss later, we believe the anticipated availability of the uPrint 3D printer may have impacted our 3D printer sales during the fourth quarter.

Fourth quarter product revenue as reported increased by 1% to $25 million when compared to $24.7 million for the same period last year. We recognized no distributed product revenue during the fourth quarter compared to $1.4 million in revenue we recognized during the same period last year. Excluding this revenue proprietary product revenue increased by 8% over the same period last year.

Three main factors impacted our proprietary revenue growth in the fourth quarter. First, revenue from proprietary high end systems which we are now calling Fortus 3D production systems increased by an impressive 41% when compared to last year. This was the result of the positive momentum we are experiencing from our new systems combined with our successful efforts to expand into new direct digital manufacturing applications. We continue to be pleasantly surprised by the outstanding performance of our Fortus line.

Second, although 3D printer units increased by 5% during the fourth quarter 3D printer revenue declined by 12%. As we mentioned earlier 3D printer sales continued to be negatively impacted by the weak global economy. However, 3D printer revenue was likely negatively impacted by the anticipated rollout of our new personal 3D printer the uPrint, which we announced publicly in January but began limited distribution of in December 2008.

The uPrint may have been the most highly anticipated product in our company’s history. During the fourth quarter certain orders for our existing 3D printer line may have been delayed to provide customers with the option of purchasing the new revolutionary low priced uPrint in January.

Lastly, our consumable revenue was flat during the fourth quarter a function of the inconsistent buying patterns of our resellers, combined with the likely negative impact from the slowing economy.

Fourth quarter service revenue as reported increased by 25% compared to the same period last year. We recognized no distributive product related service revenue during the fourth quarters of 2007 or 2008. Our paid parts revenue increased by 36% for the fourth quarter compared to last year which represents an acceleration in the growth rate experienced during the third quarter. The RedEye paid parts business continues to improve on their execution particularly for low volume direct digital manufacturing applications.

Gross profit was flat at $15.9 million for the fourth quarter 2008 when compared to the same period last year. Gross profit as a percentage of sales declined to 49.9% when compared to 52.7% for the same period last year. The decline in gross margin percentage was driven by a major shift within our 3D printer business as we began distribution of our uPrint 3D printers in the fourth quarter.

As we discussed earlier, the anticipated introduction of uPrint likely disrupted sales of our legacy Dimension 3D printers during the period. These legacy printers carry relatively higher margins. As you’ll recall our 3D printer mix over the prior quarters has been favoring our higher priced, higher margin, 3D printers.

In the fourth quarter 2008 uPrint represented approximately 30% of all 3D printers shipped in the fourth quarter and although we continued to generate solid gross profit margin on uPrint system sales the system represents our lowest margin 3D printer. It’s important to emphasize that we believe that uPrint can significantly expand our install base of systems going forward which bodes well for future sales of high margin consumable revenue.

Operating profit including discrete items declined by 20% to $4 million for the fourth quarter 2008 compared to $4.9 million for the same period last year. Operating expenses including discrete items increased by 9% to $12 million during the fourth quarter compared to last year. The fourth quarter 2008 included restructuring expenses totaling $545,000. The restructuring expense net of tax was approximately $357,000 or $0.02 per share. These restructuring expenses are associated with the recent change in the company’s North American sales and marketing organization.

With this restructuring we changed our distribution model for our high end systems now called Fortus 3D Production Systems from a direct sales model to an indirect sales model. Under this new structure a select group of geographically located resellers will sell the Fortus line allowing us to eliminate certain fixed expenses associated with our selling and distribution efforts in favor of the cost structure that is more variable and remains greater flexibility.

SG&A expense included $361,000 of stock based compensation expense required under statement of financial accounting standards or SFAS 123R compared to $232,000 for the same period last year. Stock based compensation expense net of tax was $341,000 or $0.02 per share in the fourth quarter compared to $202,000 net of tax or $0.01 per share for the same period last year. A table provided within our press release provides itemized details surrounding this and other discrete items incurred during the period.

Pre-tax profit including discrete items declined by 44% to $3 million for the fourth quarter 2008 compared to $5.4 million for the same period last year. Total interest and other income for the fourth quarter decreased to a loss of $923,000 from a profit of $470,000 last year. Other income in the fourth quarter 2008 included an asset impairment charge of $831,000 for an adjustment to fair value of an auction rate security in Jefferson County, Alabama. The impairment charge net of tax was approximately $512,000 or $0.03 per share.

The fourth quarter also included approximately $535,000 in foreign currency transaction losses which was attributable to the strengthening dollar during the period. Income tax expense as reported amounted to $1 million or a rate of 33.7% in the fourth quarter compared to $1.1 million or $20.2% for the same period last year.

As you may recall, income tax expense for the fourth quarter 2007 includes approximately $710,000 or $0.03 per share in previously unrecognized state tax credits for prior year’s research and development expenditures.

Net income including discrete items declined by 53% to $2 million for the fourth quarter 2008 or $0.10 per share compared to $4.3 million or $0.20 per share for the same period last year. Excluding stock based compensation expenses as well as all other restructuring items and non-recurring expenses net income declined by 15% to $3.2 million for the fourth quarter 2008 or $0.16 per share compared to $3.8 million or $0.17 per share for the same period last year.

Our diluted shares outstanding declined by 782,000 shares from the fourth quarter last year a result of our lower stock price as well as significant share repurchases.

Our cash and investment position amount to approximately $48 million at the end of the fourth quarter compared to approximately $61 million at the end of fiscal 2007. We have no long term debt on our balance sheet. The change in cash and investments from the end of fiscal 2007 is the result of cash used for stock repurchases combined with higher working capital requirements offset partially by cash flow from operations. We generated approximately $8.7 million in cash from operations just during the fourth quarter.

Inventory balances were $19.9 million at the end of the fourth quarter which is up from the $12.8 million at the end of fiscal 2007. Our build up in inventories in 2008 was attributed to four main reasons. A build up of inventory to support new product introductions particularly the 900 MC and uPrint. Last time buy for legacy system inventory and increase in consumable inventory to meet future customer demand and additional strategic buys of consumable raw materials in anticipation of future needs.

Accounts receivable at the end of the fourth quarter was $26.5 million compared to $26.3 million at the end of fiscal 2007 but down significantly from the $31.5 million at the end of the third quarter. Day sales outstanding or DSOs was 76 days compared to 80 days at the end of fiscal 2007 and down significantly from the 94 days at the end of the third quarter.

I would like to summarize some key financial highlights for the quarter. Continued strength in our Fortus 3D production system business driven by our new products and emerging DDM applications. Continued weakness for the sale of our legacy Dimension 3D printers driven by the soft economy and disruptive impact of introducing the uPrint 3D printer. Continued strength of our RedEye 3D parts business as we improved upon our execution and benefited from emerging DDM applications.

Flat consumable revenue driven by a weaker economy and inconsistent buying patterns of our resellers, gross margin contraction driven by a major shift in 3D printer mix and extremely strong balance sheet and improvements in working capital allocation. We believe our business model is very much in tact.

I’d like to provide a few highlights regarding the full 2008 year. Fiscal 2008 represented a record year for units shipped, revenue, and operating profit. Revenues rose to a record $124.5 million for the 12 months ended December 31, 2008, over the $112.2 million reported for the same period last year. Revenue from proprietary products and services increased by 15% in the 12 month period over the same period last year.

Despite the weak global economy and restructuring charges operating profit increased 11% to a record $20.6 million for the 12 months compare period compared to operating profit of $18.5 million for the same period in 2007.

Now I’d like to turn it over to our Director of Investor Relations, Shane Glenn, to outline our financial guidance.

Shane Glenn

We appreciate the need to provide financial guidance to our shareholders and the investment community. Based on the current economic environment, Stratasys is currently not providing financial guidance for the fiscal year ending December 31, 2009. Although we have performed well during periods of economic weakness in the past, we are currently operating in an environment with unprecedented economic uncertainty. This uncertainty, combined with the many changes in our go to market and product strategies over the past few months make visibility into 2009 extremely difficult.

We will continuously reevaluate our position and provide you with updates as conditions change and our visibility improves. However, I would like to highlight that we have strong positive cash flow and maintain a business model with significant recurring revenue components that maintain strong contribution margins. We generated approximately $14.5 million in cash from operations in 2008. We are also financial solid with no long term debt with a cash and investment balance that is approaching $2.50 per share.

Now I’d like to turn the call back to Scott Crump.

Scott Crump

Fiscal 2008 generated record revenue and operating profit for Stratasys. We introduced five new products during the year and reached a major milestone with the installation of our 10,000 systems since our company’s inception. In 2008 we also made changes to our distribution strategy, announced a major collaboration with a world leader in digital design technologies, and completed a major product development initiative in 3D printing. Yes, 2008 was a very busy year.

We recently announced the repositioning and re-branding of our high end FDM systems which we are now calling 3D production systems under our Fortus brand name. Starting in January this year we began selling our Fortus line through a select group of Dimension resellers in North America. These new resellers will continue to support our Dimension 3D printer line but also have committed additional resources that will greatly expand the sales and support of our Fortus line in North America.

This is similar to our successful international model where resellers support both product lines and it leverages the company’s success with what we believe is the strongest sales channel in the industry. We now have a three tier distribution model, full line Stratasys resellers which sell the entire Stratasys product line, full line Dimension resellers that sell legacy Dimension 3D printers which also includes the new personal 3D printer the Dimension uPrint. Lastly, uPrint resellers which will sell only the Dimension uPrint 3D printer.

We believe our uPrint distribution provides the most opportunity for expansion over the coming months. We believe this new distribution structure will make the most of our expanding product lines and our new DDM initiatives. DDM will remain a focal point for our Fortus line in 2009. As you recall we recently announced the addition of Jeff DeGrange to spearhead our DDM initiatives internally. Jeff is a former senior project leader from The Boeing Company.

Our DDM effort should be bolstered by our recent introduction of a strong lightweight and flame retardant thermal plastic material called Ultem which is now available on our 400 and 900 MC systems. Ultem is used on commercial aircraft and is widely used in aircraft interiors. The material was recently developed to help the aerospace industry boost fuel efficiency as well as safety. It offers strength and flexibility while producing 5% to 15% lighter interior parts than other aerospace plastics and is a production grade thermal plastic.

The introduction of Dimension uPrint in January the world’s first personal 3D printer represents a major inflection point in our goal of expanding our 3D printing business. This new product was received with great enthusiasm at our global retailer meeting last month in Anaheim, California which was attended by over 250 channel partners and industry professionals.

With uPrint we have improved upon several key whole product characteristics that are critical for our ongoing success. These characteristics include produce price, functionality, reliability, ease of use and office compatibility. Specifically, the uPrint has a smaller footprint, higher reliability and easier serviceability compared to previous products.

The consumable delivery system has an eco friendly design which also offers an ability to lower our costs on the consumables and provides the user with uninterrupted print capability. The product comes ready to use at only $14,900 and will be serviced by a third party service company. We believe the new price point represents a significant milestone in a market we continue to believe is price elastic and right for expansion.

Seven years ago during a recession we launched the first successful 3D printer at $30,000 proving an inflection point in this price elastic market as our sales increased significantly. Two years ago we set our next tipping point price point with the launch of our $19,000 3D printer in the education market. Now we have set our next significant inflection point at $14,900 and our long term strategy to make the printers more affordable.

One other notable advantage of uPrint is the opportunity we have to greatly expand our points of distribution. The new price of $14,900 combined with its attractive features and third party service agreement will lend itself to new distribution opportunities which we’ll be addressing in the coming months. Bottom line, we believe uPrint is a product that can ultimately propel our 3D printer unit volume to the next level. Most importantly, the uPrint will ultimately accelerate our highly profitable reoccurring consumable and revenue streams.

It’s important to remember that 3D CAD seats rapidly exploded upon hitting their $15,000 inflection point and now over 15 million seats. Understand that this is for the same user, the same applications and the same budgets for our uPrint 3D printer. If you have not yet seen the uPrint we’d like to encourage you to view our new product demo that can be accessed on the Dimension website DimensionPrinting.com.

Our RedEye paid parts business increased 36% during the fourth quarter as business continues to gain traction with DDM customers that require low volume manufacturing of finished parts. This easy to use online parts quoting, ordering and fulfillment service is ideal for the entire spectrum of new product development from functional prototypes, jigs, fixtures, as well as low volume manufacturing of in use parts.

The RedEye team was excited to announce in December a major collaboration with AutoDesk a $2 billion size world leader in digital design technologies. The new offering allows users of AutoCAD design software to order digitally manufactured parts quickly and easily from RedEye through a printing feature imbedded in AutoCAD.

In conjunction with that announcement our technology took center stage at the AutoDesk University in December where AutoDesk displayed a full scale motorcycle model built at RedEye from the designs generated in AutoDesk and Inventor software. The motorcycle is now on display at the AutoDesk new demo technology center in San Francisco. We were pleased that companies like AutoDesk are increasingly recognizing the value of incorporating additive fabrication technologies into the design process.

Although consumable revenue was flat during the fourth quarter we believe uPrint can generate significant growth in unit volume during 2009 which bodes well for our future consumable and maintenance revenue. It can’t be overstated that the introduction of uPrint represents a significant milestone in our goal to greatly expand our install base of systems.

Since the introduction of our first 3D printer in 2002 our system unit sales have grown at a compound annual rate of 34%. Over that same period our consumable revenue has grown at a compound annual rate of 28%. We plan to continue this strong trend over the coming years.

I will return with some closing comments but first we’d like to address any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Martinuzzi – Craig-Hallum

Eric Martinuzzi – Craig-Hallum

I understand your reluctance to give revenue guidance in the current environment but I was wondering if you could give some directional if not specific commentary regarding gross margin expectation or maybe operating expenses. In other words, the 49.9% that we saw for Q4 do you view that as something from which to grow or is that a peak, the impact of the uPrint continuing to weigh there. On the operating expense side I know historically Q1 you’ve had seasonal things like maybe audit charges or reseller conference launch fees. Operating expense commentary anything you can give us would be helpful.

Bob Gallagher

If you look at the product mix and the comments that we’ve made certainly the uPrint is a product that we have great hope for going forward in the future and we did indicate that it’s the lowest margin of our 3D printers. Its going to have an impact on our margins as we look going forward. What should offset that going forward is its going to expand our install base systems. As you know, our consumables have very generous margins.

The timing of the units getting out there and the install base will impact what the margins would be quarter to quarter. The uPrint is going to weigh it down and we should have some up tick coming back on the consumable side.

In terms of operating expenses in this environment we think it’s really important to keep control of our operating expenses. However, we did have reseller meetings for both our Fortus product line with the re-branding efforts in Q1 as well as a large reseller meeting in Q1 as it relates to the public introduction of the uPrint. There’s going to be some significant costs associated with those introductions in Q1.

Eric Martinuzzi – Craig-Hallum

The number of uPrint’s you talked about them being about 30% of the Dimension. I missed some numbers there could you go over those numbers again for Dimension in total and then if you could give uPrint specific, i.e. number of units and then revenue.

Bob Gallagher

We said that the unit volume had grown 5% for 3D printers but the revenue had declined by 12%. Those are significant factors in there. We said that we had shipped 570 systems during the fourth quarter versus 536 last year and that uPrint was 30% of the 3D printer unit volume in Q4.

Operator

Your next question comes from Andrew Nowinski - Piper Jaffray

Andrew Nowinski - Piper Jaffray

On the uPrint you said it had a one time freezing effect or disruption effect due to the anticipation of the uPrint. Is that going to further cannibalize any sales of your SST offerings or was that really just a one time slowdown.

Bob Gallagher

If you look that and took the advice that it was going to freeze the rest of them we would never have introduce our whole Dimension product line with the idea that our high end systems would never sell. In 2002 when we introduced the Dimension people believed that it would freeze and cannibalize completely our high end system sales.

As you’ll note throughout the year we’ve been reporting a 41% increase in our high end system sales. We think there’s enough differentiation in the features, etc. that for people who can afford a uPrint they’ll buy a uPrint. People who can afford more features will buy our high end Dimension.

Andrew Nowinski - Piper Jaffray

Could you give percentage of US based resellers are selling the high end this quarter and what you expect it to be at the end of Q1.

Shane Glenn

It’s a few numbers, less than 15 resellers in North America that are selling the Fortus line. There are opportunities to expand that but it will remain a fairly low number relative to the overall distributors that we have in North America

Scott Crump

This is in terms of selling feet on the street its over three times the amount of feet on the street year over year.

Andrew Nowinski - Piper Jaffray

The $3,000 price cuts you guys spoke a lot at a launch of the uPrint have those already taken effect?

Bob Gallagher

Yes.

Operator

Your next question comes from Jim Ricchiuti – Needham & Company

Jim Ricchiuti – Needham & Company

I was wondering if you might be able to comment on the lag that you might anticipate as you get the uPrint units in the field and at what point they’ll be generating consumables. Maybe contrast it with some of the previous 3D printers you’ve introduced.

Scott Crump

We’re very excited the momentum that we saw in the show and we know we have uPrint out there within customers now that are up, running and generating mobile revenues. With any product launch its difficult to predict when exactly they all get out there but we’ll start seeing some consumable revenue for that starting in Q1.

Bob Gallagher

We also typically don’t see a lag because many times customers want a month of consumable with the sale of the system. If there is a lag it usually bridges the lag or the gap.

Shane Glenn

One thing that’s exciting about the uPrint is we talk about ease of use is for someone unfamiliar with the system from the time getting it out of the box, getting it up and network running is well less than a half a days time.

Jim Ricchiuti – Needham & Company

I wonder if you could also comment about the strength you again saw with Fortus in the quarter. Can you give us a sense of what end markets that might be coming from and to what extent you feel that’s sustainable particularly as you transition to this new strategy.

Scott Crump

I can talk generally but I’m not sure I can talk specific. In general there is great traction in aerospace, good traction in areas of automotive and automotive aftermarket. There’s a large automotive aftermarket for custom cars and autos that we’ve been positioned for for about a two year period that we’re going after quite well.

Shane Glenn

The other thing that we’re seeing is some of the applications that we’re seeing from DDM are very unique. For example, we have someone using the system for complete DDM applications within the medical area using it for large medical devices. I think we’re going to see more and more of those types of applications. It’s going to be more to specific applications than reliance on any particular industry.

Operator

Your next question comes from Ryan Thibodeaux - Maple Leaf Partners

Ryan Thibodeaux - Maple Leaf Partners

Could you talk a little bit more, I know you’re not able to give specific numbers but just a little more framework on the uPrint gross margins and how that’s going to impact product gross margins going forward?

Bob Gallagher

In terms of the uPrint as we indicated we do not give margins related to our various products. We’ve made it clear in the past that we made great margins on our high end 3D printers as well as our Fortus line. Our uPrint is our lowest margin product that we have so it’s going to have an impact on margins as you see somewhat in Q4. Part of it is what the growth in the consumable usage is that we’re going to see from the systems that are going to offset that. It’s really difficult at this point as the product is just getting out in the marketplace and in end users hands to give you much color related to that.

Ryan Thibodeaux - Maple Leaf Partners

If you’re looking at roughly a 30% price reduction from the $15,000 from the average $22,000 or so we were looking at in the past several quarters is it safe to assume that the costs were not reduced that much as well?

Shane Glenn

No, the company Stratasys has an excellent history of successfully engineering our costs down and now with our supply chain management also getting the quantity costs driven down as well. For the past seven successful years of 3D printers each quarter we’ve had successful reduction in product costs not just in direct labor and materials but then the overhead that drives that. uPrint definitely has the lower product costs then our other Dimension products.

Ryan Thibodeaux - Maple Leaf Partners

In terms of the strategy around uPrint and consumables are you expecting a higher margin on the uPrint consumables or just simply volume driven? If so, on both questions, what kind of data do you have surrounding that that gives you the confidence that consumables are going to more than make up for the margin decrease?

Shane Glenn

When you look at the life of the system and the expectations that we have on the consumable usage and we feel that the consumable use is going to be close to in line with what we’ve seen historically with the 3D printers which is a $2,000 to $5,000 range, I know it’s a wide range, but really strong consumable usage per year per system. When you look at the returns on that over the life of the systems which can be over five years we certainly make more money on the consumable then we do on selling the system.

Specifically to the margins on the consumables the pricing is essentially the same for the consumables for the uPrint as with our other Dimension 3D printers. If you look at the costs of the manufacturing in the consumables we’ve had some improvements there. As we outlined prior, when we introduced the system, we have a brand new delivery system with the consumables for uPrint and there’s no actual case that comes with the consumable like our other Dimension 3D printers, that’s not longer there as a replaceable or a reusable carrier that comes with the uPrint 3D printer which greatly reduces our cost per cartridge.

We have higher margins on the consumables and our expectations are that we’ll see really strong usage in line with what we’ve seen historically. Over a five to seven plus year period that creates a really strong profitable situation for us with that system in the field.

Operator

Your next question comes from Brian Drag – William Blair

Brian Drag – William Blair

On the paid parts business in the previous few quarters not including third quarter ’08 growth had slowed sequentially and now it’s stepped up again in the last couple quarters. You have this interesting agreement with AutoDesk going forward. When you think about that business do you expect that we’re going to continue to see it accelerate through 2009?

Scott Crump

We’re expecting good growth for our paid parts business as we look throughout all of 2009. We’ve got some good momentum there. What we’ve said before on the calls when we’ve had slow growth part of that’s been execution. We’ve put some metrics in place and parameters and new leadership there that will help drive that growth in 2009 especially when you take into consideration our relationship recently announced with AutoDesk.

Brian Drag – William Blair

Stock compensation typically is about $0.01 a quarter, its $0.02 a quarter here. What do you expect for run rate going forward so we can model?

Bob Gallagher

I think you’re going to see a run rate going forward very similar to what you saw in Q4.

Operator

Your next question comes from Graham [Rain] – Bares Capital

Graham [Rain] – Bares Capital

You mentioned the uPrint might open you up to some new distribution opportunities. Were you meaning that you might add on some resellers or are you talking about plugging into someone else’s distribution system? Can you say anything else along those lines?

Scott Crump

We continually grow, while turn over and grow with our Dimension University go through a full training program. We have an ongoing growth plan for resellers and many of the resellers in the CAD markets, that sell CAD, typically don’t do mechanical service. By using a third party to do the service we’re able to on the mid term and long term tap into significantly more resellers at the right time. Yes, we have a history of growing the resellers. That’s certainly the biggest in our industry but we also have a plan to continue that growth.

Graham [Rain] – Bares Capital

How has the response been so far have you seen these types of resellers that you mentioned that don’t like to do the service jumping at the opportunity to distribute uPrint or is it too early to tell?

Scott Crump

In a ways it’s too early to tell because we’ve just did our launch. However, for three to maybe four years globally resellers have been requesting to pick up the line but without the service. Our policy is to always have the service. We certainly have a long list of resellers that have been bugging us for the last three years that at the right time we can go to expand.

Bob Gallagher

Its important in our reseller channel, our resellers have been long term relationships with us. We’re going to sign up new resellers that are only going to be uPrint but we’re going to make sure that we’re signing up the right ones that are financially responsible as well as ones that we think have good opportunities to sell the products.

Graham [Rain] – Bares Capital

In terms of the capital spending can you say what it was for the fourth quarter, I think it was $6.5 million during the first nine months and then maybe what it looks like for the next year or two?

Bob Gallagher

In the fourth quarter it was approximately $2.2 and $2.3 million for the quarter bringing the total to about $8.5 million for the year. Looking to 2009 I would expect that to actually be trending down.

Operator

Your next question comes from Andy Schopick - Nutmeg Securities

Andy Schopick - Nutmeg Securities

I’m going to ask you my usual questions and a further clarification on the P&L as well. The $1.4 million in the restructuring and asset impairment charges respectively where are they reflected in the P&L, I’m not sure what the other expenses and other income of $778.

Bob Gallagher

From a housekeeping standpoint the things that we had in the table in the quarter was the stock based compensation expense which shows up in SG&A, the auction rate security of $830,000 which shows up in the other income section as a loss, then we had the sales and marketing reorganization which shows up as SG&A. If you look at the table attached to the press release we’ve put specific line items to give you that reconciliation.

Andy Schopick - Nutmeg Securities

Could you give me the capitalized software in the fourth quarter and the amortization of prior deferred software?

Bob Gallagher

The software capitalization was $444 and amortization was $438 so they’re essentially flat.

Andy Schopick - Nutmeg Securities

A question for you about the concerns you may have about the auto industry that particular vertical which is certainly one of your major verticals. What are the concerns that you may have at this time in that particular area of the business what are you seeing?

Scott Crump

Our main focus here in these last couple years has actually been in the automotive aftermarket. Stratasys is in a unique position to be focused on eight major market sectors and selling into three regions meaning selling globally. As one territory or even one region industry is reduced we simply move our resources around to areas that we think have more promise for that time period. We’ve certainly been doing that with the automotive aftermarket where they want to have customization of in some cases one part, two parts, 10 parts and they want to have it quick turnaround.

Operator

Your next question comes from Steve Denault – Northland Securities

Steve Denault – Northland Securities

When do the Dimension printers, the average 3,000 reduction take effect?

Bob Gallagher

Immediate

Steve Denault – Northland Securities

When did it start, January some time?

Bob Gallagher

Yes, late part of January.

Steve Denault – Northland Securities

What is international in terms of percent of mix in the quarter and what was the growth rate there?

Bob Gallagher

International for the quarter represented about 43% of sales overall. Year over year I don’t think we saw any growth in our international business. We had really strong international business in Q4 2007. We actually saw a slight decline in our business in Q4 internationally.

Steve Denault – Northland Securities

How do you guys price your product from a currency standpoint in the various geographies?

Bob Gallagher

Our pricing strategy is we sell in US dollars throughout the world with the exception of Europe where we sell in Euros. Traditionally especially as it relates to the Far East we have a higher dollar price then we do in the US. Also we have a slightly higher, taking currency out of the equation for the Euro for a moment; we have a slightly higher price also in Europe for our products.

Scott Crump

With a higher cost.

Bob Gallagher

Internationally we have slightly higher prices by design then what we offer domestically.

Steve Denault – Northland Securities

Do you think that the product gross margin in the fourth quarter is representative of what we should expect for ’09?

Bob Gallagher

We’ve seen dramatic ranges in our margins especially quarter to quarter as it relates going forward but clearly with the uPrint being a significant new product it’s going to put pressures on the margins as we go out through 2009. What the mix is going to be, again remember this is a quarter where we saw flat consumables whereas in Q3 we saw 20% consumable growth. There’s going to pressures on margins but I don’t think to the extent that you saw in Q4.

Operator

Your next question comes from Clint Morrison – Feltl and Company

Clint Morrison – Feltl and Company

Back to distribution, you talked about you’ve kind of got three types of distributors now. Can you give us some numbers, how many distributors you have in those categories? Specifically, I’m looking at uPrint only. Obviously those are new so how many new distributors have come on and maybe a little bit of color as to what the numbers of distributors look like a couple quarters out, what are you shooting for?

Shane Glenn

As Scott mentioned, we’re early in the process, only three weeks with the strategy of looking at uPrint only distributors. If you were to look at the makeup of the channel today once again you have that relatively small number of full line distributors less than 15 in North America, you have the bulk of our distributors are resellers are still in that full line Dimension which includes all the legacy 3D printers, the 768, the 1200 and the Elite plus the uPrint. A very small number of, once again, we’re just developing the uPrint only strategy so very small number of those.

Clint Morrison – Feltl and Company

Any expectation or target as to what you’re looking for in terms of uPrint only assuming that’s where the real distributor growth is going to be over the next year.

Scott Crump

Clearly that’s going to be an area that we focus on over the next year is developing that uPrint channel. We’re not prepared to discuss specific targets as to how many we want to sign up and how many locations we want to have today.

Clint Morrison – Feltl and Company

Do you have a total number of distributors at the moment?

Shane Glenn

We still have over 200 locations worldwide. Some of that is individual companies with multiple locations.

Scott Crump

The amount of resellers hasn’t change dramatically in 2008 over 2007.

Operator

Your next question comes from Jeff Evanson – Dougherty & Company

Jeff Evanson – Dougherty & Company

I’m wondering if you could talk with us about when the Fortus go to market strategy is going to change. Did that change in January or sometime in Q4?

Scott Crump

We started the process in Q4 on a highly confidential basis, signed up actually a slow process to get to 12 and now 15 total. Officially launched that January 1, 2009.

Jeff Evanson – Dougherty & Company

Could you talk about possibly the impact that the stronger US dollar had on your profit in Q4?

Scott Crump

The dollar actually we saw probably the most variation in the dollar that we saw probably in any quarter in the last five to 10 years we saw probably a 17% to 18% fluctuation in the Euro relative to the dollar going from very high, low, came back up again so there’s been dramatic fluctuations. Clearly you saw in our transactions that we took losses as it relates to that.

The stronger dollar does have an impact on our margins, however, with the fluctuations in the currency its going to require us to look at our Euro pricing not just on a semi annual basis but probably be valuating that on a quarter to quarter basis as we move forward so that we nominalize the impact that the exchange rates will have on our P&L as it goes forward.

Jeff Evanson – Dougherty & Company

How much do you think you can improve uPrint gross margins throughout 2009?

Scott Crump

Our uPrint gross margins, we just introduced the product I don’t think we’re going to see a dramatic change in the cost as we look forward into 2009 from what it is today.

Jeff Evanson – Dougherty & Company

Your volume component buys already have it?

Shane Glenn

You have to understand the way we launch; we start with high volume in order to get demo units out to our resellers. The demo units are an integral part to the process of doing benchmarks and samples and closing a sale. We start that process actually way back in the tail end of Q3 all like Q4 we saw that effect in our inventories. We were already both from a volume standpoint but also supply chain capacity at a very high capacity, higher then we’ve ever actually been at the Q4 point and we are today as well.

Operator

Your next question comes from Jim Ricchiuti – Needham & Company

Jim Ricchiuti – Needham & Company

With respect to SG&A I understand that there’ll be some unusual expenses in Q1 relating to the reseller meeting and some other expense. Going forward as we look out to Q2 can you give any sense as to what savings that you might be realizing from the shift in strategy with respect to the Fortus product line?

Bob Gallagher

As we model the Fortus line long term it’s modeled it’s going to give us great efficiency and we think it’s incremental to us on the operating income line as we move forward in 2010, 2011 and beyond. As we look at it in 2009 we’re going to make sure that we’re supporting our channel very strongly and we think that the change in strategy in 2009 will actually be neutral on an operating income line.

It’s going to have reductions obviously in our sales and marketing expenses as we don’t have the direct feed on the street. Conversely that’s going to be offset by some compression on the gross margins as we’re giving a portion of the gross margin to that distributor as they’ve made that investment in feet on the street.

Jim Ricchiuti – Needham & Company

You gave a little bit of color on the international domestic sales, apple to apples domestic what was the increase in the business domestically?

Bob Gallagher

In the quarter we actually saw strong domestic business then apple to apples basis it was over a 30% growth in the quarter.

Operator

Your next question comes from Ryan Thibodeaux - Maple Leaf Partners

Ryan Thibodeaux - Maple Leaf Partners

Considering the magnitude that the uPrint had on the quarter as far as unit shipments and the presumed impact it’s going to have moving forward, can you finally just give us a Dimension shipment number for the quarter. I know you said 5% year over year but that’s not really helpful when we have no base number. As a one time, can you give us the number so we can have a better idea modeling going forward?

Bob Gallagher

We don’t break out the Dimension as a unit breakdown.

Ryan Thibodeaux - Maple Leaf Partners

The last three calls you’ve given us number of 70% for the three highest priced Dimensions as a percent of total Dimensions can you give that number for Q4?

Shane Glenn

What we said was the 30% of the units were uPrint and most of that is going to be the higher priced systems.

Bob Gallagher

The higher priced systems represented 55% whereas in last year it was 76%. That’s the shift that you’re seeing in our 3D printer business with the uPrint being 30% of the overall volume in the quarter.

Ryan Thibodeaux - Maple Leaf Partners

55% versus the 76% last quarter.

Bob Gallagher

76% in Q4 2007.

Ryan Thibodeaux - Maple Leaf Partners

So I get the definition right the three highest price could you name those just so I make sure I have it correct.

Bob Gallagher

768 SST, 1200 SST, and the Elite.

Ryan Thibodeaux - Maple Leaf Partners

The balance then which is around 30% as well would be the 1200 and 768 BSTs.

Bob Gallagher

That would actually be 55% for the three that I mentioned, 30% for the uPrint would leave 15% for the other two units.

Operator

Your last question comes from Jeff Evanson – Dougherty & Company

Jeff Evanson – Dougherty & Company

What I’d like now is on the guidance you mentioned the tough economy but how much is the go to market strategy transition and the uPrint impacting the visibility that you have into ’09. I would assume that’s part of the equation.

Shane Glenn

When we stated our reasons for our position for guidance that certainly fits into that. We obviously have a lot of things going on with uPrint, you have to go back to 2002 to find product introduction that is on the same scale as uPrint. Obviously a big shift in the go to market strategy with the high end systems then on top of that you layer what’s going on in this irrational market environment and it is what it is as it relates to the visibility that we’re seeing right now in ’09.

Jeff Evanson – Dougherty & Company

When do you think you will be able to give us some guidance? I would have thought the reseller show would have helped out to a certain extent on that front.

Scott Crump

It did and it didn’t. We saw a lot of excitement as it related to the uPrint but I don’t know that we can translate that as to what it’s going to be for the year in the market in this economy. As we all know, the buyers have a crisis of confidence right now. As we see an opportunity have more clarity we won’t hesitate to give guidance at the point in time where we feel we have more clarity in order to be able to give meaningful guidance.

Jeff Evanson – Dougherty & Company

About a month to go we shouldn’t expect it on the Q1 call.

Scott Crump

That would be safe to assume.

Operator

That concludes the question and answer session for today’s call. I would now like to turn the call back over to Mr. Crump for closing remarks.

Scott Crump

Although the world is feeling the impact of an unprecedented slowdown in manufacturing worldwide our financial position is strong. We are solidly profitable with significant reoccurring revenue components which maintain strong contribution margins. We will remain committed to our long term goal of providing products and services that help our customers reduce costs and accelerate their new products to market.

We maintain a flexible business model as we’ve reduced our fixed costs associated with the selling and distribution of our Fortus 3D production systems in North America. We have positive momentum in our RedEye parts and our Fortus production system businesses and we have introduced a revolutionary new product in uPrint the world’s first personal 3D printer. We are very well positioned for the future.

I’d like to thank you for your interest in Stratasys and we look forward to speaking with you again in April.

Operator

Thank you for your participation in today’s conference. This concludes the presentation you may now disconnect.

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Source: Stratasys, Inc. Q4 2008 Earnings Call Transcript
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