Stratasys' CEO Discusses Q1 2013 Results - Earnings Call Transcript

| About: Stratasys, Inc. (SSYS)

Stratasys (NASDAQ:SSYS)

Q1 2013 Results Earnings Call

May 13, 2013 8:30 a.m. 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

Cindy Shaw - DISCERN

Troy Jensen - Piper Jaffray

Paul Coster - J.P. Morgan

Jim Ricchiuti - Needham & Company

John Baliotti - Janney Capital Markets

Hendi Susanto - Gabelli & Company

Bobby Burleson - Cannacord

Andrea James - Dougherty & Company

Jim Bartlett - Bartlett Investors

Patrick [Wu] - Battle Road Research

Stephen Stone - Sidoti & Company

Operator

Good day, ladies and gentlemen. Welcome to the Q4 2012 Stratasys Earnings Conference Call, hosted by Shane Glenn, VP, investor relations. [Operator instructions.] I’ll now turn it over to. Shane. Please go ahead.

Shane Glenn

Thank you, operator. Good morning, everyone, and thank you for joining us to discuss our first quarter financial results. 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.

A remainder that access to today’s call, 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.

A reminder that certain information included or incorporated in this presentation may be 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 or operations or of 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 their 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 companies operate, 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 filed on Form 20-F and in other reports 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 presentation 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

Thank you, Shane. I’d like to welcome you to our first quarter conference call. In addition to our strong financial performance, we’re very pleased with our many other accomplishments in the quarter. I’m pleased with how our team has come together since completing our game-changing merger. The past five months have provided me with additional confirmation that we truly have a world-class organization that is well-positioned to lead the way within our rapidly growing industry.

I believe interest additive manufacturing solutions has never been higher on a global basis, and the game-changing combination between Stratasys and Objet is very well timed. I believe that we’ve only begun to meet our potential.

Now I’d like to turn the call over to our CEO, David Reis. David?

David Reis

Thank you, Scott, and good morning everyone. I would like 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. We generated record revenue and earnings during the first quarter, reflecting a continuation of the strong demand for our innovative products and services worldwide.

We are pleased to report that our plan to integrate and combined the sales and marketing organization as a result of the merger is proceeding as planned. The hard work of integration is being accomplished while we remain focused on our customers and core business.

In addition, we introduced an exciting new product in the first quarter, for the dental market, and have been investing in new marketing campaigns to raise brand awareness and drive future growth. And finally, following our strong first quarter, we remain confident in our growth plans for 2013.

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

Erez Simha

Thank you, David, and good morning everyone. We have provided you with a significant amount of financial information in today’s press release and conference call presentation. Our focus on today’s call will be on the non-GAAP financial results of the combined company, [Stratasys Ltd.], for the first quarter of 2013 and pro forma non-GAAP financial results for the first quarter of [2012].

This non-GAAP financial measure should be used in combination with our GAAP metrics to evaluate our performance. Note that when we refer to GAAP metrics in respect to the period of January 30, 2013, we are referring to pro forma GAAP numbers prepared in accordance with Article 11 of SEC article [unintelligible], which give [unintelligible] to the merger as though it had occurred on January 1 of the relevant year, with one-time merger-related costs excluded from the numbers. The non-GAAP to GAAP reconciliations are provided in a table contained in our slide presentation and press release.

Our first quarter results were impressive. We generated $98.2 million in non-GAAP revenue in the first quarter, an organic increase of 18% over the same period last year. GAAP revenue for the first quarter of 2013 was $97.2 million, which includes $1 million [unintelligible] expense on deferred revenue and intangible assets which resulted from our recent merger.

Our margins during the period benefited from our overall [unintelligible] and the relatively strong sales of our higher margin systems and consumables. Non-GAAP operating margin improved to 20.7% from 90.8% and non-GAAP net margin improved to 17.9% from 15.2%.

Non-GAAP net profit increased by an impressive 40% in the first quarter over the period to $70.6 million, or $0.43 per diluted share. GAAP net profit was a loss of $15.5 million in the first quarter, or $0.40 per share. Overall, we are pleased with our first quarter results, which were in line with our plan.

Non-GAAP product revenues in the first quarter of 2013 increased by $11.6 million, or 16%, as compared to pro forma combined product revenues in the first quarter of 2012. Our product revenue in the first quarter of 2013 was reduced by approximately $2 million, resulting from a unification of business practices surrounding the recognition of system warranty revenue and its associated warranty expense. The pro forma results provided for the first quarter of last year do not reflect this change in business practices.

[unintelligible] revenue increased by 15% in the first quarter over last year, driven by sales of higher priced systems. Application [unintelligible] growth includes [unintelligible] manufacturing and continuing adoption of PolyJet systems for complex prototyping applications.

As we indicated last quarter, our [channel cross-training] program includes the sales of demo units to our channel partner. The demo unit is an essential part of our plan in 2013 to achieve revenue synergies by combining the channels and promoting the complementary product line.

We were able to ship most of those demo units in the first quarter, which contributed approximately $6 million in revenue during the period. This was part of our plan, and we do not expect demo unit sales to be a material portion of our overall 2013 results.

Consumables revenue in the first quarter of 2013 increased by 18% as compared to pro forma combined consumables revenues in the first quarter of 2012, driven by an acceleration in customer usage and our growing installed base of systems. We believe that the continued strength in our production [series] and high-end design [series] system sales in our growing installed base of systems are positive indicators of consumable revenue growth in future periods.

Revenue from our service offering in the first quarter of 2013 increased by $3.6 million, or 31%, as compared to pro forma combined service revenues in the first quarter of 2012. The increase in service revenues was driven by an increase in revenue for maintenance contracts and service [unintelligible], reflecting our growing base of installed systems.

Revenue from our RedEye paid parts service in the first quarter of 2013 increased by 41% as compared to the first quarter of 2012, primarily due to the increased demand for large and complex production parts and the continued development of our service channel.

The number of system units shipped in the first quarter increased to 1,168 units, as compared to 1,115 units shipped in 2012 on a pro forma combined basis. We should note that the units shipped in 2012 benefited from units shipped surrounding our OEM agreement with HP, which was terminated effective December 31, 2012. Excluding the HP units, we shipped 877 units during the first quarter of last year.

Pro forma non-GAAP gross margin improved to 59% in the first quarter, over 56.7% for the same pro forma period last year. Pro forma non-GAAP product gross margin benefited during the quarter from the relatively strong growth in sales of the company’s higher-margin systems and consumables.

Non-GAAP net research and development expenses increased by 21% to $9.9 million for the first quarter of last year, driven by new system and material development initiatives. Non-GAAP SG&A expenses increased by 24% for the first quarter over last year, driven by higher sales commissions and increased marketing expenses.

As a result of the merger, we have begun to realize some tax synergies that will lower our effective tax rate compared to the pro forma rate for 2012. The effective non-GAAP tax rate decreased by approximately 9 percentage points in Q1 as compared to Q1 2012.

Non-GAAP operating income increased by 23% for the first quarter over last year pro forma results, driven by the strong growth in our relatively higher-margin products. Slide 13 provides you with an overview of the major growth drivers we have discussed for the period. The following slide provides you with a breakdown of our geographic [unintelligible]. Sales growth in the North American and Asia-Pacific regions continue to outpace the EMEA region.

I won’t be reviewing the specific reconciliations to GAAP from the non-GAAP measures we have discussed throughout our presentation today. This information is provided in a slide at the end of our presentation as well as in our press release.

Our cash and cash equivalents balance, including short term deposits and restricted cash, decreased by $13.1 million to $141.7 million at the end of the first quarter, as compared to $154.8 million at December 31, 2012.

This decrease is primarily due to the payment of nonrecurring merger-related expenses of $15 million, a planned increase in finished goods inventory, an increase in AR primarily due to significant order flow at the end of the quarter, and higher capital expenditures. DSO, at 67, remains very reasonable and comparable to the 61 days at the end of 2012.

In summary, we are very pleased with our first quarter results. We generated strong growth on a pro forma non-GAAP basis in both revenue and net income and experienced expansion in our gross margin, driven by sales of our higher-margin products. And finally, we are positioning the company for strong growth in the future for strategic investment in R&D and channel development.

I would like now to turn the call over to our VP of investor relations, Shane Glenn, who will update you on our financial guidance. Shane?

Shane Glenn

Thank you, Erez. Non-GAAP revenue guidance of $430 million to $445 million for 2013 indicates growth of 20% to 24% from the $359 million in pro forma revenue reported for fiscal 2012.

The market environment for the company’s products has improved substantially in recent months, driven in part by the significant attention that 3D printing is receiving from the trade and mainstream media. We expect that this favorable environment will continue in 2013.

Revenue growth is expected to relatively stronger toward the second half of the year, as we progress through our integration plan and revenue synergies from selling the combined product portfolio begin to ramp. Guidance assumes that the merger integration plan will be a major focus in 2013, and 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 $1.95 per share represents growth of 21% to 31% over the $1.49 in pro forma non-GAAP earnings per share reported for fiscal 2012. Our guidance assumes relatively stable gross margins relative to the levels observed in the pro forma non-GAAP fiscal 2012 results as well as the partial realization of some merger-related synergies, the most significant cost synergy in 2013 coming from income tax expense.

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

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

Now I’d like to turn the call back over to David Reis, who will provide you with a more detailed strategic overview. David?

David Reis

Thank you, Shane. I will first provide you a quick update on where we stand on the merger integration process between Stratasys and Objet. As Scott mentioned in his opening remarks. We are very pleased with the progress we are making in bringing our teams together. The process is requiring us to invest a significant amount of time and resources across our entire organization and sales channel.

In addition to integrating our sales, marketing, and service teams, we’re in the process of cross-training our own employees, integrating our service and support functions, combining physical facilities outside the U.S., and integrating our IP, ERP, and CRM systems. At the same time, we held four channel partners meetings during the first quarter to keep our partners informed and focused on sales. As you can see, we have been very busy.

Despite this major undertaking, our plan to integrate the combined sales channel is ahead of schedule. We have now cross-trained 112 channel partners to sell the combined product portfolio. These partners represent approximately 80% of the company’s potential future revenue. As a result, we are now beginning to see opportunities with new customers as well as opportunities to cross-sell the complementary product portfolio into the company’s large installed base of systems.

In conjunction with our merger, we initiated a significant rebranding campaign in the first quarter. The campaign aimed to raise awareness of the new Stratasys and our value proposition with C-level executives and other decision makers. This included an ad campaign targeting readers of business and financial media in trade publications worldwide.

The goal of the campaign was to increase the brand awareness of Stratasys and our value proposition following the merger and included ads like the one you can see here. This is the first time Stratasys has done a branding campaign to media outlets of this magnitude. Our ultimate goal is to make Stratasys synonymous with 3D printing.

In support of this campaign, we also launched a combined post-merger web and social media strategy that includes and integrated website and social media channels. These efforts to raise brand awareness and improve upon the go-to-market capabilities of our channel should help us capitalize on the rapid, growing interest we are observing for additive manufacturing solutions worldwide. This interest has been driven in part by the mainstream media and their expanding coverage of our industry.

In addition to developing our channel and growing our brand awareness, we continue to invest aggressively in new product development. We invested approximately $10 million in R&D projects during the first quarter, a level we believe is unmatched within the industry. This investment will produce products that expand the functionality of existing platforms as well as products that address totally new applications.

The Objet30 OrthoDesk, introduced in March, is one example. The OrthoDesk is a 3D printer specially designed for smaller orthodontic labs and clinics. 3D dental applications are growing rapidly, given the many business advantages, including the ability to significantly shorten delivery time, increase production capacity, and ultimately eliminate bulky model storage.

The portability of the OrthoDesk printer makes 3D dental applications more practical for facilities of all sizes. We have identified the dental market as an attractive vertical that we will target through innovative products and channel development strategies.

In summary, we are pleased with our record first quarter results. We generated strong revenue growth while continuing to focus on the major task of merger integration. We continue to integrate our sales and marketing organization and we are ahead of schedule and cross-training our combined reseller channel and dealer network.

We are observing heightened market interest for mainstream sources and we initiated a marketing campaign to raise brand awareness among decision makers and C-level executives. We continue to invest aggressively in the future through innovative product and channel development programs and we are looking to grow through strategic acquisitions. And last, we maintain a positive outlook for 2013 and continue to expect strong growth for the year.

In closing, I would like to say that 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 questions you might have. Operator, please open the call for questions. Thank you.

Question-and-Answer Session

Operator

[Operator instructions.] And your first question comes from the line of Cindy Shaw of DISCERN. Please proceed.

Cindy Shaw - DISCERN

First, on the gross margins, there was some nice expansion during the quarter. Do you think that’s sustainable throughout the year? And the second one, in terms of the cross-training and the demo units, it seems like there should be a bit of a sales cycle. And when would you expect to start seeing the revenue from the cross-training and new opportunities?

Erez Simha

As for the gross margin, we do believe that we are able to keep the current level of gross margin. You need to remember that the gross margin is a mix between the territories that we sell and the way we sell, and the mix between direct and indirect. But I think that the current level of gross margin in Q1 is sustainable for 2013.

And as for the demo, I must say that we here are very pleased to see the channel partner invest in [proper] tools to [unintelligible] future growth, which includes the purchase of demo systems. The fact that they are willing to commit shows the trust they have in our combined business model.

Demo sales is as complicated as a regular sale of a new printer to a new customer. It will help us to focus and [unintelligible]. I think at the beginning of H2, we already see some [gross] sales opportunity that obviously were not translated into revenue in Q1, but I guess they will be translated into revenue in H2.

Operator

Your next question comes from the line of Troy Jensen of Piper. Please proceed.

Troy Jensen - Piper Jaffray

Specifically on service gross margins, obviously when the deal closed, Objet had a lower corporate service gross margin, so I’m wondering, what’s going to prevent, or how long would it take, to get the service gross margin line back up to where Stratasys was pre-merger?

Erez Simha

We saw in Q1, [unintelligible] gross margin, compared to Q4. However, it was heavily impacted by the acceleration in cross-training that we did in the customer support. It requires a lot of resources, focus, to cross-train the partners. I think Q2, we will [unintelligible] a better gross margin, in service organization and of course in 2013.

Troy Jensen - Piper Jaffray

Where do you think service gross margins can get?

Erez Simha

It’s really, really difficult to say. I can say that the current level that we are at in Q1 is lower compared to the level of service gross margin we want to see. [unintelligible] impact and efficiency, the number of new products that we introduce to the market, and I think we can say now that Q2 will be better and probably [unintelligible] in 2013 will be better than Q1.

Troy Jensen - Piper Jaffray

And then David, can you talk about the 24 and the 30, and maybe how that’s done against your biggest competitor out there, with the ProJet 3500?

David Reis

I’m not sure. Can you repeat the question?

Troy Jensen - Piper Jaffray

Just the Objet 24 and 30, if you could just give an update on how those products have been received? And then I’m assuming your competition for that would be the [jetting] products from 3D Systems?

David Reis

We don’t quote exact number of units, but I can say that there was a very good acceptance for both the 24/30 and especially for the 30 Pro machine and we’re doing very well in the market.

Troy Jensen - Piper Jaffray

Of the integration [unintelligible], which one do you think is the biggest obstacle that us as investors need to watch?

David Reis

As mentioned earlier, we are ahead of plan in integration. It’s a very complex process, but we are doing, I think, good and better than expected. I don’t see any one significant element that you or anyone should be concerned about. I just can state that it’s a complex process. We are doing better than expected, and I’m very optimistic about the remainder of the year.

Operator

Your next question comes from the line of Paul Coster of JPMorgan. Please proceed.

Paul Coster - JPMorgan

David, the complexity of your integration contrasts with that of your nearest competitor, for whom it seems to be fairly straightforward, the integration of new companies. And your gross margins are significantly north of theirs, and yet your operating margins are not. Can you talk a little bit about what you think’s happening here, and whether this integration is going to, beyond 2013, yield significantly favorable margins?

Erez Simha

I will take the gross margin and I guess David will take the integration. And I do not refer to the other competitor. We have a different model, of go-to-market and the way we approach the market. It’s a combination of different territories and different [unintelligible] between direct and indirect that impact the gross margin. When you measure the net result, you look at the operating margin. Because part of the cost that we have of the distribution cost is on the opex, which I’m not sure is the case in other places.

David Reis

Also, and I think I mentioned it in the last call, we really have a good mix of strategy of short term results and long term. And as you can see, we’re heavily investing in R&D and we don’t have plans to decrease this investment, which also has impact on the level of opex.

Paul Coster - JPMorgan

And is the investment primarily centered on the photopolymer jet technology or on the FDM? Can you just give us some sense of how it’s being chunked out?

David Reis

Again, I cannot go into detail, but the investment is across both platforms and new technology in the platforms which is going to hopefully become very dominant in the industry in the future. So it’s a very large amount of money, which is going to both platforms and new platforms and technologies.

Paul Coster - JPMorgan

Finally, your competitors have raised some funds to go about making acquisitions, and you’ve expressed an interest in acquisitions as well. To what extent is there a window here that kind of closes? What’s the pipeline of potential acquisitions? Are they very few and far between? Or are are there lots of them?

David Reis

I agree, we stated very clearly that part of our growth plans will include inorganic growth. We are constantly searching. We have a very clear method and infrastructure to evaluate potential acquisitions, and when these will be relevant, obviously we’re going to update the market.

Operator

Your next question comes from the line of Jim Ricchiuti from Needham & Co. Please proceed.

James Ricchiuti - Needham & Company

I was wondering if you might be able to provide a bit more color on the performance of the product lines, the FDM versus the PolyJet. Can you talk a little bit about the demand you’re seeing for both product lines in the market?

David Reis

As you know, we don’t give a breakdown of the product sales and revenue. I can just state that we see good demand, as we saw last year, for both product lines. And we’re very happy about it. I can’t specify if one is bigger than the other, but both product lines see good demand.

James Ricchiuti - Needham & Company

David, can you talk at all about the different segments without getting specific about FDM and PolyJet? Just in terms of what you’re seeing or DDM versus DeskJet Professional? Any color you could provide along those lines?

David Reis

We do see increased demand for our high-end products across both platforms. A significant number of units in the high-end FDM are being sold toward DDM apps, which we believe in the future will become an even more significant part of our business.

James Ricchiuti - Needham & Company

The paid parts business, the RedEye business, was very strong in the quarter. Can you talk a little bit about what you might be seeing there?

David Reis

I think first of all the increase in revenue, the growth in revenue, is driven by three factors. One of them is increased demand in the market for end-use parts, especially complex end-use parts from the industrial side of our business, combined with increased investment on our side in both the manufacturing infrastructure and the channel and marketing development.

James Ricchiuti - Needham & Company

Is that kind of growth sustainable as you go through the year?

David Reis

I think it will continue to grow. Again, if it’s sustainable at this rate, it’s difficult to say, but it definitely will continue to grow.

Operator

Your next question comes from the line of John Baliotti of Janney Capital Markets. Please proceed.

John Baliotti - Janney Capital Markets

Is there a way to characterize the R&D for the balance of the year in terms of is it balanced across products as well as material? Or is there any particular focus? Or is it pretty even?

David Reis

As I mentioned earlier, I think we have a balanced R&D plan between both product lines and materials. Obviously material is a significant part of our business, and we heavily invest in material development. But in general I can say that it is balanced.

John Baliotti - Janney Capital Markets

Is there any kind of typical timespan between the R&D concept point to when it actually shows up in the marketplace? Or is it too broad to characterize.

David Reis

It’s very, very broad. Basically you can look at it in two directions. One of them, you know, we first of all developed a technology platform, and as a result of it, only to rebuild products, which typically will have a shortened time to market. And when we talk about new platforms, it’s typically longer, and we’re talking about years.

Operator

Your next question comes from the line of Steve Dyer of Craig-Hallum. Please proceed.

Steve Dyer - Craig-Hallum Capital

You had mentioned about $6 million in demo revenue in the quarter. How many units was that? And then secondly, is that largely done at this point?

Erez Simha

We didn’t provide the number of units, and yet we believe that the majority of the service demos this year is done. We do not expect any significant demonstrate sales throughout the rest of the year.

Steve Dyer - Craig-Hallum Capital

And then piggybacking on an earlier question about RedEye, growth there obviously very, very strong. Are you building out additional capacity there? Have you seen enough in terms of demand to suggest that there’s maybe a step function change there? Or is it sort of a one-off this quarter?

David Reis

First of all, our plan for the year is talking about continuous investment in RedEye, both in infrastructure, which means facilities and it’s not only in the U.S., it’s including our partners worldwide, and a significant investment in marketing and channel development. Again, so your question is if this rate of growth is sustainable. It’s very difficult to say, but as I said earlier, we do expect RedEye to continue to grow, and to grow in a substantial way.

Steve Dyer - Craig-Hallum Capital

You spoke last quarter about rolling out a couple of distribution centers. Is that fully in effect? Any early thoughts there?

Erez Simha

It is up and running, as of the beginning of the year. We have local inventory in the regions and we act locally from each one of the regions that we have.

Operator

Your next question comes from the line of Hendi Susanto of Gabelli & Company. Please proceed.

Hendi Susanto - Gabelli & Company

I would like to understand the service gross margin better, between historical and current gross margin. If I look at pro forma service gross margin, it was significantly higher, at 43% in 2011. Would you share what drove that high service gross margin in 2011 compared to 2012 and 2013? And the reason for my question is I would like to see where your gross margin expansion opportunity is going forward and whether Stratasys can reach the high service gross margins seen in 2011.

Erez Simha

As I’ve said before, in Q1 the service gross margin was really impacted by the acceleration in cross-training that we had in the customer support organization. I don’t think it reflects the gross margin we do expect in 2013. And we cannot specify any number of the gross margin. It’s really difficult to predict. I can say that Q2 will be higher compared to to Q1, and 2013 will probably be higher compared to Q1 also.

And again, it really depends on the level of activity and new product introduction that we have, unexpected issues that we have or we do not have in the field. And what you have to compare is really the trend year over year not just the third quarter compared to 2011 or 2012.

Hendi Susanto - Gabelli & Company

And then my follow up question, the first quarter tax rate of 15% is at the low end of your 2013 guidance. Do you have updates on how we should expect progression in the combined tax rate? And I’m wondering also whether there was positive impact of R&D credit as a one-time benefit in the first quarter?

Erez Simha

Yes, there was a one-time effect of R&D credit that was signed by Obama at the beginning of 2013. And it is reflected in our tax rate in Q1. You should take the mid range. We gave a mid range of, I think, 15-20%, and you should assume mid range for 2013.

Operator

[Operator instructions.] Your next question comes from the line of Bobby Burleson of Cannacord. Please proceed.

Bobby Burleson - Cannacord

What is it that gives you the visibility for the inflection in growth in the back half of the year given the short lead time nature of this business?

David Reis

First of all, in general, I think all of us share the increase interest in our industry, which is coming from many, many verticals and potential buyers, combined with the fact that we see good demand for our products from the end of Q4 to the beginning of Q1 and through Q2, combined with the fact that we are ahead of our plan in integrating and cross-training our channel and our own people.

Combining all those together gives me a very optimistic outlook for the remainder of the year. Actually, there’s no guarantees, but it seems positive, and we are standing behind our guidance as represented last quarter.

Bobby Burleson - Cannacord

With the higher materials pricing for the PolyJet material versus the FDM, is there an inflection we can expect for gross margins or the materials components of your sales in terms of mix at some point as your installed base of Objet systems grows as a percentage of total printer mix?

David Reis

I think I’ll refer to an earlier answer. You know, we expect gross margin to be in line with what you saw in Q4 and through the continuation of the year. Going forward, I would be cautious to predict. I’ll keep it the way I represented it.

Operator

Your next question comes from the line of Andrea James from Dougherty & Company. Please proceed.

Andrea James - Dougherty & Company

How important is it, do you think, strategically, for you guys to get into metals, maybe sand, metal, and glass, to maintain sort of a lead in the space in general?

David Reis

First of all, currently we don’t provide metal assistance. I strongly believe that as a result of the merger of Objet with Stratasys, the combined company has a very strong portfolio of products which, as we’ve said many times, are for the most part complementary. And they answer a lot, or a high percentage of, the required applications from our customer base and installed base.

However, we always evaluate new opportunities and technologies and if we feel that metal should be part of our arsenal, we will do the right move. At this point in time, we’re happy with what we have, and we are concentrating on it. As I said, cross-training our channels and providing what we can provide with our three main technologies.

Andrea James - Dougherty & Company

And how is it going with the whole dual headquarters thing? Do you guys feel like you’re having a lot of cross meetings? I’m just wondering if you could just give some color on how that’s going.

David Reis

I think I said in the script that we are extremely busy integrating the two companies. The dual headquarters, with modern telecommunication, is not an obstacle. It’s even maybe a benefit. But we’re definitely being kept very busy at this time, and it will continue for the rest of the year.

Operator

Your next question comes from the line of Jim Bartlett of Bartlett Investors. Please proceed.

Jim Bartlett - Bartlett Investors

Could you expand on your C-level branding, what you’re doing there, as well as what was the level of backlog at the end of the quarter?

David Reis

The campaign to C-level executives and high-level decision makers in our potential customer base aims to shift a little bit the way we are selling historically, which was kind of more a push mode, to a more pull mode. And the idea was increase awareness in top level executives around the world on the existence and the potential of 3D printing in the hope that they will drive demand downwards within the organization. This is the idea behind it.

It was done via a very strong campaign in the leading financial publications, including newspapers such as The Wall Street Journal, Financial Times, and magazines like The Economist and Fortune. And again, although you cannot see, typically, an immediate effect, besides a jump in web inquiries, I think that long term it will have substantial impact on the way we sell and our revenue potential.

And with respect to the question regarding the backlog, we do not disclose our backlog level during the year. We do it once a year at the end of the year, and we’re going to do the same this year.

Operator

Your next question comes from the line of Patrick [Wu] of Battle Road Research. Please proceed.

Patrick [Wu] - Battle Road Research

Wanted to get a better sense from you guys in terms of verticals. Are there any particular pockets of strength that you guys saw during the quarter? Or was it pretty much balanced throughout the quarter?

David Reis

In general, our sales were a reasonably good balance between our different product lines, price points. I can’t give any indication on it. Relatively good balance.

Patrick [Wu] - Battle Road Research

I’m speaking particularly to the different end markets, actually.

David Reis

Okay, sorry. Also here, I think we followed our historical pattern, from the point of view of percentage sales to different industries. We did not see any significant change here.

Patrick [Wu] - Battle Road Research

To expand that point, you guys spoke a little bit more on new products down the pipeline. Just wondering, are there any focus areas that you guys are looking at? Are you guys going to continue developing more printers for maybe the medical and dental areas. Any color from that standpoint would be great.

David Reis

Unfortunately I cannot give too much detail. It’s kind of confidential information. I can give you just a general direction. The R&D plan has a few main kind of arms. One of them is continued investment in developing our high-end machines with an emphasis on DDM applications. Another arm is continuing to develop desktop printers, which are suitable for office use toward the desktop applications. And we do have additional investments we just started in different verticals that we consider to be lucrative, with high potential for revenue.

Operator

Your next question comes from the line of Stephen Stone with Sidoti & Company.

Stephen Stone - Sidoti & Company

Can you just provide some color on growth opportunities, the market opportunities? Where are you seeing increased adoption. I’m guessing it’s mostly from the high end. Anything on the lower end here?

David Reis

Again, I agree with your first statement. We see increased demand in the high end. Nevertheless, there’s also a lot of activity and excitement in the low end, the very low end of the market, and we are very active in both sides.

Stephen Stone - Sidoti & Company

Andy kind of product introductions lowering products on the lower end? How competitive is the Mojo versus some of the lower end and lower priced products?

David Reis

The Mojo is a good product, a competitive product in the high end of the low end section. I cannot disclose any future introductions. Obviously, as I said earlier, we are working in all directions.

Operator

I would now like to turn the call over to David Reis for the closing remarks.

David Reis

I would like to thank you, everyone, for joining us on this call. We look forward to speaking with you again next quarter. Thank you very much and goodbye.

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