Stratasys' CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: Stratasys, Inc. (SSYS)

Stratasys Ltd. (NASDAQ:SSYS)

Q4 2012 Results Earnings Call

March 4, 2013 8:30 AM ET

Executives

Shane Glenn - Director, Investor Relations

David Reis - Chief Executive Officer

Erez Simha - Chief Operations Officer, Israel Operations and CFO

Scott Crump - Chairman and Chief Innovation Officer, Stratasys

Analysts

Brian Drab - William Blair

Troy Jensen - Piper Jaffray

Paul Coster - J.P. Morgan

Jim Ricchiuti - Needham & Company

Steve Dyer - Craig-Hallum Capital

Hendi Susanto - Gabelli & Company

Andrea James - Dougherty & Company

Holden Lewis - BB&T Capital Markets

Operator

Good day, ladies and gentlemen. And welcome to the Q4 2012 Stratasys Earnings Conference Call. My name is [Su], and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Mr. Shane Glenn, Director of Investor Relations. Please go ahead, sir.

Shane Glenn

Thanks, [Su], and good morning, ladies and gentlemen. And welcome today’s conference call to discuss the Stratasys’ fourth quarter and fiscal year 2012 financial results. My name is Shane Glenn, and I will be moderating the call today. Thank you for joining us.

On slide two, you will find the details of the call today. On the call with us are David Reis, CEO; Erez Simha, CFO and COO of Israel; and Scott Crump, Chairman and Chief Innovation Officer of Stratasys.

I’ll remind you that access to today’s calls including the prepared slide presentation is available online at the web address provided in our press release. In addition, a replay of today’s call, including access to the slide presentation will be made available on the Investor section of our website later today.

On slide three, a reminder that certain information included and incorporated in this presentation maybe deemed to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934.

Forward-looking statements are often characterized by the use of forward-looking terminology such as may, will, expect, anticipate, estimate, continue, believe, should, intend, project or other similar words, but are not the only way these statements are identified.

These forward-looking statements may include, but are not limited to, statements relating to the company's objectives, plans and strategies, statements that contain projections of results of operations or financial condition and all statements other than statements of historical fact that address activities, events or developments that the company intends, expects, projects, believes or anticipates will or may occur in the future. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties.

The company has based these forward-looking statements on assumptions and assessments made by its management in light of their experience and the perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate.

Important factors that could cause actual results, developments and business decisions to differ materially from those anticipated in these forward-looking statements include, among other things, the company's ability to efficiently and successfully integrate the operations of Stratasys, Inc. and Objet Ltd. after their merger, the overall global economic environment, the impact of competition and new technologies, general market, political and economic conditions in the countries in which the company operates, projected capital expenditures and liquidity, changes in the company's strategy, government regulations and approvals, changes in customers' budgeting priorities, litigation and regulatory proceedings, and those factors referred to under Risk Factors, Information on the Company, Operating and Financial Review and Prospects, and generally in the company's annual report for 2012 to be filed on Form 20-F and in other reports that the company files with the U.S. Securities and Exchange Commission.

Readers are urged to carefully review and consider the various disclosures made in the company's SEC reports, which are designed to advise interested parties of the risks and factors that may affect its business, financial condition, results of operations and prospects.

Any forward-looking statements in this press release are made as of the date hereof, and the company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Now, I’d like to turn the call over to Scott Crump, Chairman and Chief Innovation Officer of Stratasys. Scott?

Scott Crump

So slide four, thank you, Shane. I’d like to welcome all of you to the first quarterly conference call of Stratasys Limited as a combined company. We are very pleased with our accomplishments in the fourth quarter, including our strong financial performance.

These are very exciting times with significant opportunities for long-term growth. Prior to closing the merger, our combined team spent five months developing a comprehensive integration plan to prepare for a success.

The fourth quarter was a very busy time for our company as we worked hard to close the game changing merger between Stratasys and Objet, while at the same time conducting business as usual within our extensive sales and marketing organization.

I’m happy to report that we pulled it off and we have established a world-class organization of employees and partners to lead the company forward.

Now, I'm also very pleased to introduce to you the new CEO of Stratasys, David Reis, who will lead our conference call today. Let’s go to slide five. Okay, David?

David Reis

Thank you, Scott, and good morning, everyone. I would like also to thank you for joining today’s call. As Scott mentioned, this is an exciting day for all of us and we are very pleased with the results we have released today.

Switching to slide six, in addition to our impressive financial results, we are excited about completing the merger of our two leading companies and the positive implication it has on our future.

We have initiated our integration plan for our worldwide sales and marketing organization, introduced exciting new product, and are planning for additional investments in products and channel development that we believe will expand application and drive future acceptance.

We are focused -- we have a focused strategy and are confident that our new combined organization would be a leader in this rapidly developing market and provide significant long-term value to our shareholders.

I will return later in the call to provide more detail on our strategy. But first, I would like to turn the call over to our CFO and COO of Israel Operations, Erez Simha, who will provide you detail on our financial results. Erez?

Erez Simha

Thank you, David. I’m switching to slide seven. We have provided you a significant amount of financial information in today’s press release and conference call presentation. In addition to the pro forma GAAP financial results we have included pro forma non-GAAP financial results, which we believe more accurately reflect the combined performance of our company.

Within these non-GAAP presentations we would like to make special note of the significant acquired intangible asset amortization expense that is excluded. This intangible asset is created by the merger of Stratasys Inc. and Objet Ltd. $462 million of intangible assets will be amortized over approximately 10 years on average and will have a significant impact on our GAAP results during that period.

In addition to the amortization of intangible assets, other costs excludes from our non-GAAP presentation include a significant cost associated share-based compensation expense, the expenses related to completing our merger and expenses associated with Object [therefore] to go public in 2012.

Our focus in today’s call will be on the pro forma non-GAAP financial results of the combined company Stratasys Ltd. However, these non-GAAP financial measures should be used in combination with our GAAP metrics to evaluate our performance.

Note that when we refer to GAAP metrics, we are referring to pro forma GAAP numbers prepared in accordance with Article 11 of SEC Article S-X, which numbers give effect to the merger as though it had occurred on January 1, 2011 of the relevant year. With one-time merger-related cost excluded from the report. The non-GAAP to GAAP reconciliations are provided in table reading our slide presentation and press release.

I’m switching to slide number eight, the merger between Stratasys Inc. and Objet Ltd. was completed in December 1, 2012, creating an industry leader within the additive manufacturing and 3D printing industry. The two companies that merged to create Stratasys Ltd. have a history of strong growth with financial model driven by selling a growth portfolio of system, consumables and services.

In 2012, the company generated $369 million in pro forma combined revenue, an impressive organic increase of 30% over the $277 million in pro forma combined revenue for fiscal 2011.

Pro forma non-GAAP gross margin improved by approximately 158 basis points in fiscal 2012 to 58%, driven by strong sales of our higher margin products and finally, pro forma non-GAAP net profit for 2012 grew by impressive 60% over 2011 to $59.6 million, or 49%. We would also like to highlight a strong $28.6 million in system backlog, recurring into fiscal 2013.

I’m switching to slide number nine, pro forma product revenue increased by 31% in 2012 over the prior year, driven by the strong growth of the company’s system and consumable revenue. System revenue increased by 32% in 2012, driven by demand for the company’s higher priced Fortus 3D Production Systems and broad portfolio of PolyJet 3D printers.

Within Fortus, DDM applications and the introduction of the Fortus 250mc were the primary contributors to growth. Within Polyjet, the growth was broad based as the channel continues to grow and mature.

Consumable revenue was consistently strong throughout 2012, including by 26% for the year, driven by an acceleration in customer usage, as well as the company growing install base of system. Our high-end FDM and Polyjet system sales were principal driver of consumable sales growth in 2012, given the product line relatively higher consumable utilization rates.

Pro forma service revenue increased by 21% in 2012 over the period, driven by 90% increase in maintenance revenue and a 24% increase in revenue within RedEye paid parts service. Maintenance revenue benefitted from our growing install base of systems, while RedEye benefited from strong demand for large and complex production parts.

Slide number 10, pro forma unit sales increased by 29% in fiscal 2012 over the prior year, driven by sales of the company’s Fortus systems, PolyJet 3D printers and (inaudible) uPrint and Mojo 3D printers. Stratasys has now sold 29,816 systems worldwide on a consolidated basis.

Slide number 11, pro forma non-GAAP gross margins improved to 58% in fiscal 2012 over the 56.5% for the same period last year. Pro forma non-GAAP product gross margin benefited during 2012 from the relatively strong growth in sales of the company’s higher margin systems and consumables.

Product gross margin also benefitted from the better overhead coverage provided by an increasing sales volume compared to prior year period as well as build-up of finished goods inventories to stock third-party distribution centers in Asia and Europe.

The stocking the third-party distribution centers, which remains as inventory on our balance sheet was done in anticipation of completing the measure and initiating a combined order procurement process, which is locally focused.

Pro forma non-GAAP service gross margin was low in 2012, due to higher new product introduction service rate of cost. We proactively initiated sales related to upgrade to certain systems to improve customer’s satisfaction.

Slide number 12, pro forma non-GAAP research and development expenses increased by 15% for fiscal 2012 over the last year, driven by new system and material development initiative.

Pro forma non-GAAP SG&A expenses increased by 32% for fiscal 2012. The increase was driven by changes in our product distribution strategy involving independent sales agents, which resulted in increased sales commission paid to that agents.

SG&A expenses were also impacted by significant expenses surrounding our new Mojo 3D printer lunch and increased expenses for strategic initiative to increase our market awareness. Pro forma non-GAAP operating income increased by 46% for fiscal 2012, driven by strong sales as discussed previously.

Slide 13. Our fourth quarter pro forma non-GAAP results were also impressive, especially when you consider the significant amount of resources committed during the period to complete our game changing merger and initiate an integration plan for our worldwide sales and marketing organization.

The company generated $96.4 million pro forma combined revenue in the fourth quarter and organically grew 23% over the same period last year. Pro forma non-GAAP net profit increased by 40% over the period to $16.3 or $0.40 per share.

Slide 14. Pro forma product revenue increased by 23% for the fourth quarter over the prior year and similar to fiscal year results was driven by strong growth of the company systems and consumables revenue. System revenue increased by 25% and consumable revenue increased by 17% for the fourth quarter.

Pro forma service revenue increased by 25% in fourth quarter over the prior year driven by 22% increase in maintenance revenue and a 33% increase in revenue within our RedEye paid parts services.

Similar to fiscal year, maintenance revenue benefitted from our growing install base of system while RedEye benefitted from strong demand for large and complex production parts.

Slide 15, pro forma unit sales increased by 70% in the fourth quarter over the prior year driven by sale of the company’s Fortus, PolyJet and Mojo systems.

Slide 16. Pro forma non-GAAP gross margin improved by -- improved to 57.8% in the fourth quarter over the 56.9% for the same period last year. Pro forma non-GAAP product gross margin benefitted during the quarter from the relatively strong growth in sales of the company’s higher margin system and consumable. Pro forma non-GAAP service gross margin was lower in the fourth quarter due to the factor we discussed earlier.

Slide 17. Pro forma non-GAAP research and development expenses increased by 25% for the fourth quarter over last year, driven by a new product initiative discussed earlier. Pro forma non-GAAP SG&A expenses increased by 29% for the fourth quarter over the last year driven by the higher sales commission and market development initiative. Pro forma non-GAAP operating income increased by 9% for the fourth quarter over last year, driven by the strong growth in sales.

Slide 18. Slide 18 provides you an overview of the major growth drivers we have discussed for that period.

Slide 19. The following slide provides you a breakdown of our geographic sales. Sales growth in North America and Asia-Pacific region continued to outpace the EMEA region.

We won’t be reviewing the specific item in slide 20, 21 and 22, which provide you reconciliation to GAAP for the non-GAAP measures we have discussed throughout our presentation today. This information is provided for your reference.

Slide 23. We increased our pro forma combined cash and cash equivalents and investments balance by approximately $28 million in 2012 over the prior year and finished the year with approximately $156 million. Inventory balances were $68 million at the end of fiscal 2012 which is up significantly for the $48.8 million at the end of 2011.

Inventory [balance] in last part of our plan strategy to transitioned our order procurement processes for the Stratasys Inc. product line to include two regional distribution centers, one located in Asia and one in Europe. Inventory was also higher in anticipation of future growth in sales. Accounts receivables was $64.7 million at the end of fiscal 2012 and days sales outstanding or DSO were 62 days.

Slide 24, revenue guidance of $430 million to $445 million for 2013, indicates growth of 20% to 24% over the $359 million pro forma revenue reported for fiscal 2012.

Market activity for the company’s product has increased substantially in recent months, driven in part by the significant attention that 3D printing has received from the trade and maintenance media. We expect this favorable environment will continue in 2013.

Revenue growth is expected to be relatively stronger in the second half of the year as we progress through our integration plan and revenue synergies from selling the combined product portfolio begin to end.

Guidance assumes that the merger integration plan will be a major focus in 2013, that the company will make significant investments to fund growth, including incremental sales, marketing and R&D expenses.

Non-GAAP earnings per share guidance of $1.80 to $1.85 per share represent growth of 21% to 31% over the $1.49 in pro forma non-GAAP earnings per share reported for fiscal 2012.

Our guidance assume relatively stable gross margin relative to the level of absorbing the pro forma non-GAAP fiscal 2013 as well as partial realization of some merger-related synergy, the most significant cost synergy in 2013 coming from income tax expense.

As a result of the merger, we begin to realize some step in synergy in the fourth quarter and we expect generalize additional synergies in the coming months that will lower our effective tax rate compared to rate for 2012. Our guidance also incorporates significantly higher investments to fund growth, which include incremental sales, marketing and R&D expenses.

Non-GAAP earnings guidance excludes the estimated impact of some additional merger-related expenses, the impact of share-based compensation expenses and the significant expense associated with amortization of the acquired intangibles. The reconciliation to GAAP is provided in the slide presentation and our press release.

Slide 25, our long-term operating model target includes annual revenue growth of at least 20%, non-GAAP operating income as a percent of sales of between 20% to 25%, and effective tax rate of between 15% to 20%, and non-GAAP net income as a percent of sales of between 16% to 21%.

I’m moving to slide 26, in summary, we are very pleased with our fourth quarter and full year financial results. We generated strong growth on a pro forma non-GAAP basis in both revenue and net income, and experience expansion in our gross margin driven by sales of our higher margin product.

And finally, we are positioning the company for strong growth in the future with strategic investments in R&D and channel development.

Now, I would like to turn the call back over to David Reis who will provide you with more detail Stratasys overview. David?

David Reis

Thank you, Erez. Moving on slide 29. I would like first to provide you a quick update on where we are standing with the merger between Stratasys and Objet. As you know, we completed the merger through an all stock transaction on December 1st bringing together two companies with complementary product lines, as well as shared commitment to innovation and excellence. So far everything is going according to plan.

The new Stratasys now offer customers a broad array of innovative 3D printing and direct digital manufacturing solutions from the single destination. We can deploy this comprehensive product portfolio across the large and more experience sales and marketing team.

Our market reach has extended and we are beginning to see opportunities for cross-selling of the complimentary product portfolio into the combined companies large install base of systems.

To begin developing the cross-selling opportunity, we completed the cross-training of 18 resellers in December that began the task of selling the combine product portfolio on January 1, 2013. We are currently accelerating the cross-training of additional resellers and expect to have the channel fully train within 18 months.

We are very excited about the long-term potential of this merger and we have initiated a detail plan for integration of our two companies. However, we do not underestimate the sizable costs we have at hand, the significant resources required to integrate our sales and marketing organizations.

The integration plan would be a major focus throughout 2013, which we believe will ultimately create significant value through the creation of stronger company. The financial guidance we have provided today is driven by a balance between driving near-term growth with a need to focus on initiatives that bring long-term shareholder value creation.

Slide 29. Our industry has received a lot of attention lately. I think it’s important for me to take a moment to review our market opportunity and the unique developments we’re observing within the industry and combine that with the discussion of the strategies we are implementing to exploit those opportunities. We are at the forefront of the significant change within manufacturing as companies are utilizing our products to change the way they conceive design and make things.

Slide 30. This opportunity starts with a rapid growth of 3D design and analysis tools that are becoming more functional and easier to use. There are approximately 14 million total CAD seats and more than 5 million 3D CAD seats currently worldwide. And we expect those numbers to continue to grow. However, despite this large addressable market, we estimate fewer than 50,000 professional 3D printers have been installed through the end of 2011 suggesting a significant market opportunity for us.

Slide 31. In targeting this opportunity, we have a strategy to expanding within the traditional 3D CAD market while focusing on providing our customer across multiple verticals with expanding number of applications. We believe we can achieve this by focusing on developing innovative new systems and materials and by investing in new avenues of distribution to drive adoption.

As we grow and expand our installed base of systems, we will benefit from business model which offers significant leverage potential to the sale of high-margin consumables. We believe we are in the early stage of multi-year growth opportunities.

Slide 32. We now employ three very distinct technology platforms. We offer advanced FDM technology, which is great solution for functional prototyping and application requiring high level of durability.

We also have PolyJet technology, which provides high resolution printing for applications that require high feature details. And we offer Solidscape technology which is great for sophisticated investment casting applications.

We offer customers the best of all worlds. Whether the customer needs multi-material capabilities or durable material, prototype or finished parts, Stratasys can meet the needs with the product or service.

Slide 33. A proprietary technology supports an impressive portfolio of high functional and complementary 3D printing and direct digital manufacturing systems. We can provide the right solution to customers to address the needs across the entire 3D design and manufacturing spectrum. From concept modeling to direct digital manufacturing, we expect to have a solution.

Slide 34. We serve a broad range of industries and have products ranging from entry level to high-end systems. Within the idea series, Stratasys offers several leading products starting with the modules which are used for conceptual and functional modelling. These products help give form to designers’ ideas quickly in the format that is highly accessible, affordable and easy to use.

Within the design series, we offer a product that’s helped companies refine and finalize their design before committing them to production. This includes high performance prototyping and functional testing as well as system which offers true to life designs for visual verification.

Within the production series, we offer products which produce finished parts or produce complex work patterns used in the investment casting process of finished parts. We now offer solution across the entire design and manufacturing spectrum from conceptual modelling to fit and form prototyping to functional prototyping and up to direct digital manufacturing.

Our portfolio products, we continue to expand given our focus on investing in technology and new products. For example, we recently introduced the Objet1000 at Euromold in November. The Objet1000 is a wide form of 3D printer that allows for rapid printing of industrial site parts that are highly complex and detailed.

The new system features a dual chamber that is more than 14 cubic feet in size, 10 times larger than the built volume of our next larger PolyJet system. The system is ideal for producing big scale models in industries that make large-end products such as automotive, aerospace, household application, defense systems and industrial equipment.

The new system is priced in the premium and offers the full functionality of the Connex machine with a choice of more than 120 different materials. The Objet1000 is a third major system platform introduced within the last six-month period for Stratasys, which include the Solidscape 3D and the Mojo product.

Slide 35. The value proposition for our customers is clear. For design application, we help to liberate creativity by allowing the designers to test multiple ideas before committing to one design. Our printers help designers get their products to market faster by shorten its design cycle and accelerating lead times. In addition, our printers help eliminate costly design errors by making sure the final product is true to the intent design.

Slide 36. A great example of how our products provide value in the design across -- design process is with Microsoft and the design of a new tablet to surface, which was refined and finalized by evaluating several 100 prototypes made in Stratasys’ 3D printer.

Slide 37. Manufacturing application, we gave manufacturers a more cost effective process to make usable path and process that allow for greater manufacturing flexibility and less customization.

Slide 38. One more innovative manufacturing application we have observed recently was on the runway of the fashion week in Paris. And the elaborate 3D printed skirts and cape created in collaboration with professor Neri Oxman from MIT was displaced at the show. The 3D printed skirts and cape were produced using Stratasys’ unique Objet Connex multi-material 3D technology which allows a variety of materials property to be printed in a single bill.

This allows both the hard and soft material to be incorporated within the design crucial to the movement and texture of the piece. The prints are quite amazing and I encourage you to review them by accessing the video provided on our investor relation website.

Slide 39. Growing our marketing and sell capabilities as well as our combined network of resellers would be crucial or critical to future growth. We currently partner with approximately 250 resellers and sales agents worldwide, supported by 42 direct channel managers in more than 70 countries.

We believe we have the best salary in the industry but we will continue to invest aggressively in channel development of the coming quarters. We’ve identified three areas of focus for the development of the specific channel strategies which includes dental education and the DDM markets. We believe those markets are significantly underdeveloped for certain additive manufacturing application and require unique channel strategies to fully exploit it.

Slide 40. In summary, I would like to emphasize a tremendous strategic opportunities for our customers, our channel partners and for our employees around the world. The merge of Stratasys and Objet have placed the company in the leadership position within a market that is developing rapidly.

Going forward, our strategy will identify new application for our proprietary 3D printing technologies while expanding beyond the tradition of CAD market to various critical markets and applications. Drive farther market adoption through lower capacity entry level system, leverage our global reselling network to extend our customer base and farther penetrate existing customers, maintain and extend our technology lead and grow through complementary acquisitions.

We plan to execute this strategy while maintaining a very attractive business model, which has a significant leverage potential as we grow our business. Me and all of us at Stratasys are passionate believers in the value and power of 3D printing and we are here to lead the development of this industry.

We would like now to address any question you might have. Operator, please open the line for calls.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Brian Drab [William Blair]. Please go ahead.

Brian Drab - William Blair

Good morning. And welcome to the company, David and Erez and congratulations on completion of the merger. So first question I had is just, I think people are going to be trying to discern what the growth was at the legacy Stratasys business in the quarter and what the growth was at Objet and it’s hard to discern from what you released. So maybe if I could just start with that question, what was organic growth from the legacy Stratasys business and the legacy Objet business in the fourth quarter?

Erez Simha

Brian, we are not providing standalone pro formas of the company. We believe that the merger has combined certain functions of the two companies as of December. And we needed to provide a clear picture of our company. And looking forward in 2013, there is really no meaning to differentiate between the Object legacy and the Stratasys legacy. We manage it here as one product line and one business and we don’t even evaluate it as two businesses, as standalone.

Brian Drab - William Blair

Okay. I can understand the need to talk about the company that way going forward. I was hoping that we could just get a sense -- since everyone’s estimates and models for the quarter were largely focused on the Stratasys business. It would have been interesting to get idea for the health of that standalone business one last time but I understand.

Then one specific question then about the sub-segments within maintenance. I thought it was interesting that the Stratasys business year-to-date as of September had only grown at a mid single digit rate in that maintenance segment. But for the full year, it looks like maintenance revenue was up 19%. And I am just wondering if you could -- for the combined entity -- I am wondering if you could provide any insight into the momentum in Object’s maintenance business which appears to have been up well over 30% for the full year 2012.

Erez Simha

Yeah. Brian, for sure. And actually, Objet was growing faster the last three years. And service revenue that we got was completely related to the growth in the install base. So when you look at the service revenue Object as standalone, which you don’t have it, you could expect that Objet could grow faster than ever as combined company. The growth that you’re seeing in 2012 is mainly related to the fast growth of their install base of Objet for the last two years.

Brian Drab - William Blair

Okay. Back in line. Thank you.

Erez Simha

Thanks Brian.

Operator

Thank you. And your next question is from Troy Jensen [Piper Jaffray]. Please go ahead.

Troy Jensen - Piper Jaffray

Congratulations on a nice quarter, gentlemen.

David Reis

Thanks Troy.

Troy Jensen - Piper Jaffray

Hey, I’ve got two quick questions here. So backlog to me looked pretty interesting. It was $28.6 million. I went back and looked at the K for last year. I think it was Stratasys’ standalone. It was $12.5 million exiting 2011. So curious to know if you guys view $28.6 million of backlog as excessively high number and maybe not excessively but just a high number, and what was Objet’s traditional backlog coming into the quarter?

Erez Simha

Troy, the backlog level of $28.6 million were obviously high, give us the level of confidence entering in 2013. In Q1, also the full year of 2013 when we get our guidance on topline. And yeah, we consider $28.6 million as a high amount of the backlog.

Troy Jensen - Piper Jaffray

To that point, Erez, was there -- I mean was there just orders came in late in the quarter, you could turn around quick. Is there a lot of Objet1000 in that backlog? Can you just touch to why it was so high this quarter?

Erez Simha

There are no Objet1000 at all in the backlog. It’s mainly out of the -- we had to ship post end of the year orders that we got. And we have to ship in Q1 and possibly small amount in Q2 and orders that we didn’t have the time to ship towards the end of the year that we’re receiving actually on the last few days of the quarter.

Troy Jensen - Piper Jaffray

Okay. And then one for David, how about -- David, with the integration in front of you, what components or is there a certain area that you think is like the most risky thing to integrate or one that only keeps you up at night the most?

David Reis

First of all, like we said in the presentation, I feel it’s so far so good. We spent a substantial long time in planning this integration, maybe too much time unfortunately. So we are well prepared and we know we have plans for all the different avenues of integration.

At this point of time, I don’t have any kind of specific areas that I’m more concerned about. In general, it’s obvious -- and I cannot underestimate the challenge. It’s a major challenge, so far so good. I must also add that both employees, channel partners, resellers and other partners are extremely enthusiastic and excited about it. And so -- I don’t have I can’t give you specific areas of concern. It’s a complex operation.

Troy Jensen - Piper Jaffray

All right. Well put. Good luck this year, gentlemen.

David Reis

Thanks, Troy.

Scott Crump

Thanks, Troy.

Erez Simha

Thank you, Troy.

Operator

Thank you. And your next question comes from Paul Coster [J.P. Morgan].

Paul Coster - J.P. Morgan

Yeah. Thanks for taking my question. I’m more interested in the future than the past of course, whether you are referring to revenue that you’ve already reported or what you are seeing in the pipeline in backlog. Can you give us some breakdown of where your sales are going in terms of industry verticals, where the fastest growth is and also what the application mix is between idea, design and production?

Erez Simha

Paul, it is Erez. Hi. I think just looking at 2013, we cannot specify a specific vertical or applications that drive the growth. I think that we are growing in all service lines, in all segments. And in 2013, it’s naturally really difficult to grow in such numbers through one vertical or one application which is specifically growing. However, I think that looking into 2013, part of the growth will come from our ability and focus -- our ability to focus on verticals that we were not focused in 2012 as result of the merger.

David Reis

We recognize that there is a great opportunity for us. It’s David. Hi. We mentioned it few times in the past that we are in only initial stage of attempting to cross sell a product, which are really complementary in nature to a very large combined install base. Now, this will take time but it’s definitely a growth engine in the coming few quarters.

Paul Coster - J.P. Morgan

So the easiest growth path is to sell more to your existing customers rather than find new customers?

David Reis

No. I think the growth strategy is -- it has a few pillars. One of them is to continue what we did before, extending within the CAD market to traditional, let’s call it, traditional customers of Stratasys. Another pillar is to try and sell our complementary offering to our customers that we already sold previously.

And like Erez said, the third pillar is extending with specific go-to market strategies to few verticals that I mentioned in my presentation, which are the education, the requisition of manufacturing in terms of less medical markets.

Paul Coster - J.P. Morgan

Got it. Thank you. And then looking into 2013 guidance, do you anticipate a significant shift in mix? For instance, will consumables grow in 2013 or do you still think we are at the sort of leading edge of system sales?

Erez Simha

We assume that we will grow from product consumable and service. In 2013, there is no one product type of product and product of sales type that will grow faster than the others. So we think that we will still generate revenue from the installed base in a growing phase and we will grow through the hardware sales.

Paul Coster - J.P. Morgan

Excellent. Thank you very much. I’ll hop back on the queue.

Erez Simha

Thanks, Paul.

Operator

(Operator Instructions) And your next question is from the line of Jim Ricchiuti [Needham & Company]. Please go ahead.

Jim Ricchiuti - Needham & Company

Thank you. Question I had is -- Reis, maybe you can address it. You talked about stable gross margins in 2013. I’m just trying to get a sense as to, where you see the margins going in the service business which was maybe you can elaborate on the decline in 32.5% for Q4. Does that improve and what happens, how should we think about product gross margins?

Erez Simha

First, Jim, related to the service in 2013, we expect a higher gross margin compared to Q4. Q4 was -- I think we had issued a new product implementation, introduction and we have -- we incurred some costs for ongoing field upgrades that we did to improve satisfaction.

I think that overall gross margin, not only service but product and service. In 2013, we should assume that the gross margin will be more or less the same as it did in 2012, although we would see a little bit higher gross margin in service, which had minor impact on the overall gross margin.

Jim Ricchiuti - Needham & Company

Okay. And R&D expense, as we think about that for the full year, somewhere in the 9% area of revenues, or could that be a little higher just given the investments you’re making?

Erez Simha

We didn’t provide any guidance for the percentage of R&D out of sales and we did say that we are going to invest heavily in R&D in the channels in order to support the growth in 2013. And you should assume higher operating expense in 2013 compared to 2012.

Jim Ricchiuti - Needham & Company

Okay. And one final question and I will jump back in the queue. When you talk about revenue growth being relatively stronger in the second half of the year, and I look at the range of revenues that you're giving for the full year. If we just look at the low end of the range, I think in the past, if we think of both standalone Stratasys and standalone Objet, it looks like you're getting somewhere around 53% to 55% of your revenues in the second half of the year. When you talk about relative to second half of the year, the upside to the high end of that range, is that how we should think about the potential for a stronger component of the revenues in the back half?

Erez Simha

Jim, what we want to say is actually that in the second half of the year in terms of revenue, we will be stronger compared to the first half. It needs to be notably divided 50:50, and this is also part of our ongoing effort to finalize the cross selling in the channel, which I think that we will be able to see the results in H2. Because anything that we look at the upside that will come in the second part of the year. But we want to say that the revenue will not be divided equally between the two half of the year.

Jim Ricchiuti - Needham & Company

Okay, which has been the case all along. Okay. Thank you.

Operator

Thank you. And your next question comes from the line of Steve Dyer [Craig-Hallum Capital]. Please go ahead.

Steve Dyer - Craig-Hallum Capital

Thanks. Good morning, gentlemen.

Erez Simha

Good morning, Steve.

Steve Dyer - Craig-Hallum Capital

Just a follow up on the earlier backlog question. Can you remind me how backlog has defined, that number?

Erez Simha

The backlog has same feel, which we have in hand and that was not shipped yet to the customer.

Steve Dyer - Craig-Hallum Capital

And that’s generally shipped sort of in the subsequent quarter or is that not a safe assumption?

Erez Simha

Most of it. Most of it is shipped on the following quarter.

Steve Dyer - Craig-Hallum Capital

Okay. Question on the addressable market. You talked about kind of $5 plus million 3D CAD seats, and I think you had said, either David or Erez, 50,000-ish professional systems shipped sort of since the inception of the industry, I think is what I heard. Can you help me reconcile that with sort of the 29,000 combined last year? Are you just assuming that some subsection of that is professional?

David Reis

Let me elaborate on the numbers. The 29,000 printers, the total number of printers that were sold by Stratasys, the combined new Stratasys between Objet and Stratasys Inc. since inception, okay. The 50,000 is a number, which we estimate was sold totally in the market in the professional market since the kind of inception of our industry.

Steve Dyer - Craig-Hallum Capital

Okay. That’s helpful. Thank you. One last question and I’ll hop back in line. CapEx expectations for ’13?

Erez Simha

Again, we didn’t provide any CapEx expectation for 2013. I think that there will be, the CapEx investment in 2013 in order to support the growth will be higher compared to 2011. But it will be around the line in the infrastructure or the facility realty system and preparing ourselves for additional production capabilities and to support the demand for 2014 and ‘15.

Steve Dyer - Craig-Hallum Capital

Okay. All right. Thank you, guys.

David Reis

Thank you.

Operator

Thank you. And your next question comes from the line of Hendi Susanto [Gabelli & Company]. Please go ahead.

Hendi Susanto - Gabelli & Company

Can you hear me all? Good morning.

David Reis

Good morning, Hendi.

Erez Simha

Good morning.

Hendi Susanto - Gabelli & Company

Okay. First question, would you help us understand how Stratasys achieved the targeted effective corporate tax rate of 15% to 20%? I’m thinking that you have a low tax rate in Israel, but at the same time the majority of sales, up to 50% of revenues come from North America and how long will it take you to get there?

Erez Simha

Yeah. The effective tax rate which you are talking about on the long-term model is a mix between the effective tax rate in the U.S. The effective tax rate in Israel and the effective tax rate around the world as well in the countries we have the activities.

I think looking at 2013, we should take into consideration that it will be close to the higher part of the range of the long-term model. And I guess it will take us two to three years to build down to the lower range of effective tax rate of the company.

Hendi Susanto - Gabelli & Company

Okay. And then second question, would you be able to share how much of your revenues come from medical surgical?

Erez Simha

Well, we did not -- we do not go by such accounts.

Hendi Susanto - Gabelli & Company

Okay. Thank you.

David Reis

Thank you, Hendi.

Operator

Thank you. And your next question comes from the line of Andrea James [Dougherty & Company]. Please go ahead.

Andrea James - Dougherty & Company

Hi. Thanks for taking my questions. I guess I wanted to see what the inflection point was in your sense of where the bigger expansion opportunities are? Is it moving toward more lower cost systems, or maybe moving up to value chain a little bit into just different verticals, or I’m just curious what you -- where you see those things intersecting?

David Reis

I think that we are lucky to the extent that we see our growth going in more than one direction. On one hand, we are going to expand our offering and reach. Let’s call it, in the high-end of the market in DDM applications by providing a production, better production printers and materials which suite this segment of the markets. In parallel to it, we will increase our penetration in the low end. We are introducing less expensive low-end easy to use office-friendly printers. And in parallel to those, let’s call them two main kind of growth directions.

As I mentioned earlier, we are going to expand and focus even more in the coming years on vertical applications, which require special solutions either from hardware or a material standpoint and one example is dental markets and other example is DDM direct digital manufacturing markets.

Andrea James - Dougherty & Company

And then as you focus your R&D versus acquisition strategy, how do they play into what you just said and how each one gets you there?

David Reis

In terms of time, we need to consider and balance between trying, making it on our own or the acquisition find complementary technologies that’s will help us to achieve the goals I mentioned earlier. It’s an ongoing process and which we are doing on regular basis.

Andrea James - Dougherty & Company

Okay. Thank you. And one final one, just on your 29,000 cumulative sales, how do you look at your attrition rate or could you give us a sense of your own installed base?

David Reis

It’s very difficult to say what the active installed base within these 29,000 printers, very difficult to say. I cannot give an answer on this issue.

Andrea James - Dougherty & Company

Okay. Thank you.

Erez Simha

Thanks, Andrea.

David Reis

Okay.

Operator

Thank you. And your next question comes from Holden Lewis [BB&T Capital Markets]

Holden Lewis - BB&T Capital Markets

Thank you. Good morning.

David Reis

Good morning.

Holden Lewis - BB&T Capital Markets

I wanted to ask in terms of the sales channels and the cross-selling, how do you seed those sales channels with machines or do you seed them with machines? Is this a case where you're going to have to seed all the Objet guys, the Stratasys’ machines and vice versa? And does that have any impact on your revenue stream that might be sort of a short-term benefit? How do we sort of view that process?

David Reis

Again, when you look in our historical combined customer base, you see more than a few is in a certain percentage of customers that when the companies were separated, they elected to buy those technologies. And the reason is it had to do with the complementary nature of the technologies in the different stage of the different technologies to the different stages of the design and production.

The advantage which is coming out of the merger is that suddenly that those installed base customer names are open in front of the company, in front of the channel and the products are available for the resellers. So the assumption here is that there is a need for those products and some of the customers will elect to buy the other complementary product when it’s going to be offered to them. And again, as I said we have quite a lot of example of customers who did it before.

Holden Lewis - BB&T Capital Markets

Right. I guess what I was curious about is the resellers themselves. Do you need to sell units into the resellers, that they have both Objet and Stratasys products to demo? How does that work?

David Reis

Sure. Some of the resellers that we would like to sell the complementary products and to most of them, they will probably buy demo machines in order to demo the new equipment. The answer is yeah.

Holden Lewis - BB&T Capital Markets

Okay. And does that benefit the revenue guidance that you provided in '13? And the reason I'm asking, obviously is that, as they do that, it seems like that would be sort of a one-time tailwind that sort of on the back end, on the backside of that, you wouldn't have that benefit anymore.

Erez Simha

Yeah. Finally, we see it now absolutely insignificant to the 2013 guidance that we gave.

Holden Lewis - BB&T Capital Markets

Okay. Got it. Thank you. And then, lastly, can you just give a sense of what the D&A that you expect in '13 is likely to be?

Erez Simha

Again, we didn’t provide any guidance here. Are you asking about GAAP, non-GAAP in terms of those included?

Holden Lewis - BB&T Capital Markets

Yeah. Just the total D&A number.

Erez Simha

You have a slide that reconciles between the GAAP and non-GAAP in 2012. And you should assume that 2013, would at least the number in 2012.

Holden Lewis - BB&T Capital Markets

Okay. Thank you.

Operator

Thank you. And your next question comes from Jim Ricchiuti [Needham & Company]. Your line is open. Please go ahead.

Jim Ricchiuti - Needham & Company

Thank you. David, the merger closed I guess about six months beyond when you initially were thinking. To what extent are you able to recapture some of the lost time in terms of realizing some of the integration synergies this year, and just a follow-up with respect to the reseller channel?

David Reis

First of all, it was a substantial delay. The good news is that, when we ramped it up again I think all the different partners and stakeholders, from employee to channel partners jumped on the wagon very, very fast. So basically, if you’re trying to get my estimate, we basically have kind of a delay or shift of between a quarter, maybe a little bit more than a quarter in our integration plan. We originally were planning to close on October 1st. We closed on December 1st, so this gap was not closed. Again, it’s been pushed into ‘13.

Jim Ricchiuti - Needham & Company

Okay. And with respect to the reseller channel, about 18 months from now you expect to have it fully complete. Where would you anticipate you'd be by Q4 of this year in terms of the reseller channel? What percent of the reseller channel do you think would have access and be fully trained on both product lines from both standalone companies?

David Reis

Let me -- maybe, I will answer it this way. Even if the training would be kind of on a linear progress, the potential revenue or the resellers which are going to be trained through the year or the potential revenues are going to be faster than the number of resellers because obviously, we’re going to start with the resellers in certain order. And therefore, if you’re asking by end of the year, what percentage of resellers are going to be trained. I’m not sure but revenues potentially could be generated by those resellers who are going to be larger in percentage of the number of resellers that were trained.

Jim Ricchiuti - Needham & Company

Sure. So, in other words, you obviously are going after the resellers that are going to account for a bigger part of the revenues. I mean, is it kind of a -- should we think of it in terms of an 80/20 rule by the end of this year?

David Reis

Let’s look at 80/20, but what you said is correct. And obviously, we will try and train the guys that can provide faster revenue in the early stage of the process.

Jim Ricchiuti - Needham & Company

Okay. Thanks a lot.

Operator

Thank you. And your next question is from Paul Coster [J.P. Morgan]. Please go ahead.

Paul Coster - J.P. Morgan

Yeah. Thanks. David, I wonder if you'd be kind enough to share with us your win rate in the photopolymer jet set, or if you can't share the actual statistic, directionally where you're headed. Is it improving with the new materials you've got onboard, or is it stable or whatever?

David Reis

We’re not disclosing our win rates, Paul. It’s not something that we are sharing.

Paul Coster - J.P. Morgan

Got it. And then the other question I had was the product cadence. Actually, no, a broader question than that which is, 2013 is obviously an integration year. What would you describe 2014 as likely to be? Is it execution and growth year? Do you see acceleration then?

David Reis

Paul, I think it’s really too early to discuss 2013, '14. Let me introduce to you -- in the case we have two quarters in 2013 and together to discuss 2014.

Paul Coster - J.P. Morgan

Okay. Maybe a more specific question. The product cadence, the rates of new product introduction, how do you think that will evolve over the next 18 months or so?

David Reis

I think we said earlier, we’re not decreasing in anyway our R&D expenditure.

Erez Simha

They are opposite.

David Reis

They are opposite. And therefore, I don’t expect limitation of introducing products in R&D timetable as I don’t foresee that the overall rate of their bringing new products to the market should change.

Paul Coster - J.P. Morgan

All right. Thank you very much.

David Reis

Thank you, Paul.

Operator

Thank you. And your next question is from Brian Drab [William Blair].

Brian Drab - William Blair

All right. One of the recent questions just brought another question to mind for me. Just wondering if you could talk a little bit more about the potential for the channel combination resulting in a one-time benefit to sales. And I'm just looking at the total number of resellers that you have now and that's about 260. And even if you say, assume maybe 20% of those buy some demo units in the first quarter and assume maybe that's $100,000 a reseller that could result in a $5 million, $6 million benefit in the quarter, based on those assumptions.

I don't know if those assumptions are way off or not. I'm hoping you could comment on it. But the combined company did about $83 million in revenue in first quarter of 2012, and that $5 million or $6 million would result in 5 or 6 points above or even more than that of revenue growth year-over-year. So, I'm just wondering if you could comment on any of those assumptions and let me know if you still think that it's immaterial. When you said it's immaterial, is it immaterial for the full year or the quarter and where am I off in those assumptions?

Erez Simha

Bryan, I think it’s the plan that we had today on the table doesn’t’ necessarily introduce those surveys through demo. I’m assuming that they have to buy. We had other plans and other alternative but not necessarily the demo. And we will not offer the demo to all, as I said the one who has the potential to ramp up the business and contribute fast to shares of the combined company. Mainly the guidance that you gave for 2013, do not include any significant amount of demo machines. And if this would not be the case in Q1, Q2, we would obviously disclose it.

Brian Drab - William Blair

Okay. Thanks.

Operator

Thank you. I would now like to hand the call back to David Reis for closing remarks.

David Reis

Ladies and gentlemen, thank you for joining us for the call. We look forward to speaking with you next quarter. Good bye and thank you very much.

Operator

Thank you for joining today’s conference. This concludes the presentation. You may now disconnect. Good day.

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