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Executives

Shane Glenn - Director of IR

Scott Crump - Chairman and CEO

Bob Gallagher - CFO

Analysts

Chad Bennett - Northland Securities

Brian Drab - William Blair

Chuck Murphy - Sidoti & Company

Steve Dyer - Craig-Hallum

Ryan Thibodeaux - Maple Leaf Partners

Jim Ricchiuti - Needham & Company

Andy Schopick - Nutmeg Securities

Graeme Rein - Bares Capital Management

Russell Lynde - Park West Asset Management

Presentation

Stratasys Inc. (SSYS) Q1 2010 Earnings Call April 28, 2010 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Stratasys earnings conference call. My name is Heather and I will be your operator for today. At this time, all participants are in listen-only mode. We will be conduct a question-and-answer session towards the end of this conference. (Operator Instructions)

I would now turn the presentation over to your host for today’s call, Mr. Shane Glenn, Director of Investor Relations at Stratasys. Please proceed.

Shane Glenn

Good morning and welcome to the Stratasys conference call to discuss first quarter financial results. Representing Stratasys’ executive management on the conference call today is Chairman and CEO Stratasys, Scott Crump and, CFO Bob Gallagher.

A quick reminder, that today's conference call is being transmitted over the Web and can be accessed through our Investor section of our Web site at www.stratasys.com. or directly by accessing the link provided in our press release.

We will begin with the Safe Harbor statement. All statements herein that are not historical facts or that includes such words as expects, anticipates, projects, estimates, vision, planning, could, plan, believes or similar words, constitute forward-looking statements covered by the Safe Harbor protection of the Private Securities Litigation Reform Act of 1995.

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

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

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

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

Information discussed within this conference call includes financial results that are in accordance with US generally accepted accounting principles or GAAP. In addition, non-GAAP financial measures are included that exclude certain expenses. The non-GAAP financial measures are provided in an effort to give information that the investors may deem relevant to the company’s operations and comparative performance, primarily the identification and exclusion of expenses associated with warrant charge, restructuring expenses and expenses associated with stock based compensation.

The company uses these non-GAAP financial measures for evaluating comparable financial performance against prior periods. The appropriate reconciliations between non-GAAP and GAAP financial measures are provided in a table at the end of our press release.

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

Scott Crump

Good morning and thank you for joining us to discuss our first quarter financial results. During the first quarter we entered into a game changing exclusive agreement with HP for the worldwide distribution of 3D printers. In addition to this historic development we are pleased to see a continued improvement in business conditions across our core markets.

Revenue for products and services increased by 21% over last year and when you exclude the one time non cash charge for the warrant our margin continued to expand year-over-year and quarter on quarter. The strong year-over-year performance was somewhat expected given the very weak comparison from last year however we are pleased to generate strong sequential growth considering the seasonal weakness that is typical for our first quarter.

Highlighting our first quarter results was a 140% increase in Fortus system sales over the last year. Fortus sales have rebounded that dramatically benefiting most from the economic recovery. In addition our RedEye and consumable revenue grew and impressive 25% and 22% respectively during the first quarter.

We believe the growth in these two businesses could be a positive leading indicator for the months ahead. As we begin the second quarter we are entering an exciting new phase of our agreement with HP as they launch into the distribution of our 3D printers. HP officially introduced its line of Stratasys manufactured DesignJet 3D printers last week and we’ve begun shipping these new products.

We believe this marks the major inflection point for our company’s history. I will return later to update you on some of our initiatives including our game changing agreement with HP but first I would like to turn the call over to our CFO Bob Gallagher who will further highlight our first quarter results. Here’s Bob.

Bob Gallagher

Thank you Scott. Total revenue as reported was $23 million for the first quarter 2010 which included a one time non cash charge against revenue of approximately $5 million. The one time charge resulted from the warrant granted to HP for 500,000 shares of Stratasys common stock.

As we disclosed in our January announcement the distribution agreement with HP included a one time warrant that vested upon the grant date in January. The proper accounting treatment for this non cash expense is a charge against revenue and amounts of approximately $5 million.

Total product and services revenue was $28 million for the first quarter, a 23% increase over the $23.1 million reported for the same period in 2009. The company ships 610 systems during the first quarter versus 590 last year.

Overall the positive momentum we began to observe in our businesses during the fourth quarter carried over into 2010 and we are cautiously optimistic that this trend can be sustained.

First quarter product revenue increased by 28% to $21.8 million when compared to $17 million for the same period last year. Three factors impacted our product revenue growth in the first quarter. First, revenue from Fortus 3D production systems increased by 140% when compared to the same period of last year.

It should be noted that the first quarter 2009 represented the start of the dramatic decline in Fortus System revenue and sales were significantly impacted by the economic downturn. Given the positive trends we are observing in 2010 and the favorable year-over-year comparisons we expect to generate strong positive growth in Fortus system sales during 2010.

The second item impacting our product revenue was a 22% increase in our consumable revenue compared to last year. This is a dramatic improvement compared to the 4% year-over-year growth we’ve experienced during the fourth quarter. We believe this growth may be a positive leading indicator for our businesses going forward.

The third item impacting our product revenue was a 10% increase in our 3D printer sales in the first quarter compared to last year. The relatively lower growth for 3D printers was expected given a tough quarter comparison. 3D printer sales during the first quarter of last year were bolstered by the introduction of a revolutionary new uPrint 3D printer while we did announce an extension of the uPrint platform in the first quarter of this year with the introduction of uPrint Plus.

The uPrint Plus rollout lacked the promotional impact of last year. Our higher price Dimension 3D printers continue to be our best sellers in the first quarter with our most affordable 3D printer the uPrint representing 41% of all 3D printer unit sales during the first quarter compared to 61% in quarter one last year.

We did begin to ship the HP design jet printers in the final week of the quarter but the impact on product revenue was immaterial. First quarter service revenue was looking at $6.2 million when compared to the same period last year. Revenue on our RedEye paid parts business increased by 25% in the first quarter compared to last year.

This represents the significant recovery for Red Eye which has been negatively impacted in recent by an aggressive pricing environment. The improvement in business conditions we’ve recognized over the past six months is beginning to have a positive impact on our RedEye business.

Our maintenance revenue declined by 12% in the first quarter compared to last year and reflects an extension in the warranting period we began to implement in early 2009 for most of our systems. In addition it should be noted that maintenance revenue is less susceptible to near term changes in the economic environment given that most of the revenue is generated from contracts signed in prior periods.

Including the one time non cash charge against revenue gross profit was $9.4 million. Excluding the one time warrant charge gross profit increased by 50% to $14.4 million for the first quarter 2010 when compared to the same period last year.

Excluding the one time charge gross profit as a percentage of sales increased to 51.5% when compared to 44.4% for the same period last year and 51% in the fourth quarter 2009. The gross profit percentage was positively impacted by the growth in total product and services revenue as well as favorable mix in product sales particularly our consumable and higher priced 3D printers.

In addition our margins in the first quarter benefited from the cost saving measures we implemented in early 2009 as well as our successful initiative to lower our manufacturing cost of our uPrint 3D printers.

We began last year with a goal of reducing the manufacturing costs of uPrint by 15% and we exceeded that goal. We will continue to drive initiatives whose goal is to lower the manufacturing costs of our products.

Including the one time non cash charge against revenue we incurred an operating loss of $762,000. Excluding this one time warrant charge and other discreet items we had an operating profit of $4.5 million in the first quarter 2010 compared to a loss of $578,000 for the same period last year.

Operating expenses declined by 9% to $10.2 million during the first quarter compared to last year. Operating expenses benefited from headcount reductions taking the first quarter last year which amounted to approximately $2.7 million in annualized savings for the company.

We will begin to anniversary the benefit of those reductions starting in Q2 of 2010. SG&A expense in the first quarter included $115,000 of stock based compensation expense net of tax compared to a $197,000 for the same period last year.

In other income the first quarter included a relatively large foreign currency loss of $359,000 compared to a $236,000 gain for the same period last year. The loss was a result of the significant appreciation in the dollar relative to the Europe during the period. Including the one time charge against revenue we incurred a pre tax loss of $880,000.

Excluding the warrant charge and other discreet items pre tax profit was $4.4 million for the first quarter 2010 compared to a loss of $42.000 for the same period last year. Total interest and other income for the first quarter declined to $215,000 from $286,000 last year.

This is due to a decline in interest rates and a more conservative investment portfolio. Excluding the warrant and other non GAAP items income tax expense amounted to $1.5 million in the first quarter for an effective rate of 34.2% compared to a tax credit of $46,000 for the same period last year.

We expect the tax rate in 2010 will average between 34% to 37% excluding any incentive stock option related impact. Including a one time charge against revenue we incurred a loss of $443,000. Non GAAP net income which excludes the warrant charge, certain discreet items and stock based compensation expense was $2.9 million or $0.14 per share for the first quarter 2009 compared to a $5,000 profit for the same period last year.

A table provided within our press release provided itemized details surrounding all non GAAP items incurred during both periods. We generated positive cash flow from operations of $2.7 million during the first quarter and we finished the period with approximately $72.1 million in cash and investments.

We continue to be pleased with the management of working capital. Inventory balances were $16.9 million at the end of the first quarter which is up when compared to the $14.6 at the end of the fourth quarter but down significantly from the $20.2 million at the end of the first quarter last year. The increase in inventories was planned in anticipation of HP’s new product launch during the second quarter as well as inventory for our new uPrint Plus and our new support removal system branded WaveWash.

Accounts receivable was $19.7 million at the end of the first quarter which is comparable to the $19.3 million at the end of the fourth quarter but down significantly when compared to the $23.7 million at the end of the first quarter last year. I am pleased to report day sales outstanding or DSOs were 63 days compared sequentially to 68 days at the end of the fourth quarter last year and compared to 90 days at the end of the first quarter of last year.

And now I would like to turn the call over to the Director of Investor Relations Shane Glenn for comments regarding our outlook.

Shane Glenn

Thank you Bob. We appreciate the need to provide financial guidance to our shareholders and investment community. We continue to observe an improvement in market conditions during the first quarter and we are optimistic about the coming periods. However continued uncertainty and the strength of the economics recovery as well as the many changes in our go to market product strategies over the past few months continue to make visibility difficult.

Based on those factors we will continue to now provide financial guidance for 2010. Now I would like to turn the call back over to Scott Crowe.

Scott Crump

Thank you Shane. We are optimistic that the first quarter represents an upturn for the economy and a return to a more favorable business environment for our company. In addition we believe the start of our second quarter represents the beginning of a revolutionary new period for our company.

In January we announced our exclusive agreement with HP for the distribution of our 3D printing products. Last week HP formally launched the DesignJet 3D printing series. The DesignJet 3D printer is engineered and manufactured by Stratasys and is based on our proprietary FDM technology.

HP is targeting the mechanical CAD and educational markets in five European countries with DesignJet series which starts at less than $17,500. The DesignJet series is comparable to our uPrint 3D printers that will continue to sell in markets not currently served by HP. For the countries served by HP Stratasys is no longer selling the uPrint line.

However we will continue to sell the Dimension line of 3D printers in all markets worldwide. In anticipation of HP’s announcement last week we began limited shipments of their new products in the final days of our first quarter. We are excited about entering this stage of our agreement with the HP. We believe their expansion into 3D printing with Stratasys products represents a major inflection point in our company and is further confirmation that a significant market opportunity exists.

Stratasys and HP believe that millions of product designers are now ready to bring their designs to light in 3D. We also believe that HP’s decision to answer the market with the products based on our proprietary FDM technology will provide a market boost offer all of our Stratasys products including Fortus and Dimension based on expanded awareness and HP’s endorsement of FDM.

Well another big development in the quarter was the introduction of our uPrint Plus 3D printer. The uPrint Plus is an extension of the uPrint platform which was introduced last year. The new system provides many new enhancements for our customers including the ability to print in 8 different colors. In addition the uPrint Plus has two resolution settings and 33% more build volume than basic uPrint enabling larger models.

It represents a higher margin system for Stratasys relative to the basic uPrint and has been well received within our market. We now offer two versions of the uPrint which are comparable to the HP new design jet line up. Coinciding with the introduction of HP’s new DesignJet 3D printers, both Stratasys and HP recently launched an ecofriendly automated support removal system.

The new platform will improve upon the whole product experience for customers by providing a hands free process to automatically dissolve support material. Sold under the WaveWash brand by Stratasys and DesignJet brand by HP the new system is office friendly and easy to use.

The product includes a compact liquid agitation tank and a new cleaning agent called Ecoworks. The cleaning agent is added to water creating a solution that dissolves the temporary support structure on the model. The waste water is at a pH level that meets household drain water requirements worldwide.

HP’s strategic input was instrumental in our development of this new support removal system and they fully appreciate the need to offer a product that is affordable, office friendly, easy to use and high only reliable. Well, we are pleased with the dramatic turnaround for our Fortus 3D production system business during the first quarter which grew an impressive 140% over last year.

Before the deep recession we were experiencing strong growth in our Fortus line reflecting our success in targeting new direct digital manufacturing or DDM applications. DDM is a new and progressive approach to manufacturing and during the economic downturn most manufacturers were more focused on survival and preserving cash instead of taking a calculated risk on new technologies and new processes. With the recent economic upturn our customers willingness to make investments in innovative new processes that save them time and money is returning.

Manufacturers have begun to recognize the value of our technology for end use part production including fixtures and assembly tools for manufacturing. In addition the capabilities of our technology allow for the production of complex geometries that would be impossible to produce through conventional processes.

We continue to see a strong pipeline of opportunities for Fortus line relative to last year which should translate into higher revenues going forward. But with the recent improvement in our business conditions we’ve observed an upturn in our RedEye business as well which grew an impressive 25% during the first quarter. In addition our consumable business continued to rebound in the first quarter expanding by 22% over last year.

We believe the strong growth in our consumable and RedEye paid parts revenue could be an indicator of our sustainable growth trend. We were encouraged by the positive trends during the first quarter and our optimism for the rest of the year is growing. However we remain cautious in our outlook and we will continue to control our expenses accordingly given the uncertainty that persists over the economic recovery.

We maintain a healthy balance sheet and we are well positioned to execute on all of our growth plans going forward. Most importantly as we begin the distribution phase of our agreement with HP, we believe that we are well positioned for a significant expansion in 3D printer sales in the future.

We now have the right solution with the right partner targeting a significantly under penetrated market with millions of CAD seats to serve with our 3D printer. Okay I will return with some closing comments but first I would like to, we would like to address any questions that you might have. So operator let’s open up the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Chad Bennett with Northland Securities. Please proceed.

Chad Bennett - Northland Securities

Just a couple of questions first of all may be I missed it. Did you give a backlog number?

Bob Gallagher

The only time that we give backlog is at the end of the year when we are required to do it, so no we did not.

Chad Bennett - Northland Securities

Okay. And then, Bob, I think you talked about hitting your target on uPrint gross margins and cost cutting there. So uPrint gross margins, I think remind us again what the target was there. I believe it was 25%, but maybe it was even higher, closer to 30%.

Bob Gallagher

What we said in the first quarter last year was to reduce the material cost by 15% and we exceeded that target.

Chad Bennett - Northland Securities

So you never gave a gross margin target though?

Bob Gallagher

No we only gave you how much we thought we could reduce the material cost of the product line.

Chad Bennett - Northland Securities

Okay. Okay. And then, now that you're actually shipping to HP and I think it's probably earlier than what most of us thought, can you give us a better sense of kind of what the ramp potentially would look like, or what the next steps are in kind of the channel fill or demand there through HP, at least over the next quarter or two?

Bob Gallagher

The comments that we made when we announced the HP agreement, we said that it wouldn’t have a material impact on the top or the bottom line in 2010 I think its important to remember that the launch is only in 5 countries and the launch is really only two products which are equivalent for the uPrint and the uPrint Plus. So as you look at our 2010 we have said and we continue to say that we don’t think the HP agreement is material to 2010.

Scott Crump

And we just hang on to that just to repeat the announcement was in January but the actual product launch was just last week.

Chad Bennett - Northland Securities

Right. Okay. And then, the last question for me, on the consumable side, obviously a nice return to growth there. Scott, can you talk about or Bob, for that matter can you talk about what markets or was it across all your product lines that you saw improved "utilizations" or can any type of further color there on what you're seeing?

Scott Crump

Well I think it was fairly uniform over both the high end Fortus as well as Dimension I think it’s thoroughly straightforward reflection of higher design, higher prototyping, greater business, that’s out there within our customer base.

Operator

(Operator Instructions) and your next question is from the line of Brian Drab with William Blair. Please proceed.

Brian Drab - William Blair

Good morning. Just wanted to start by asking about the first-quarter 2010 3D printer sales. Should we assume that the first quarter benefited at all from the introduction of the uPrint Plus in terms of channel fill.

I know you said it's nothing on the order of magnitude as we saw last year with the uPrint, but is this run-rate unit volume that we saw in the first quarter what you'd expect going into the second quarter or might we see a modest downtick related to the uPrint Plus introduction?

Bob Gallagher

I think you quantified it correctly is that we did a modest event as it related to the uPrint Plus part of that is an anticipation of the HP agreement too for the five countries that were being impacted, so there’s clearly some impact of the uPrint Plus but it was fairly nominal in Q1.

Brian Drab - William Blair

Okay. Then, I just want to go back to the HP ramp and, Bob, your comment that it shouldn't be material in 2010. And I understand the timing and I understand that you're only going to have sales through HP for eight months of the year and you said it's only in five countries.

But these are major European countries and eight months of sales in five major European countries, even if you only sell 10 units per country per month for the rest of the year, I mean, that could be significant. So it sounds like you're, I'm just trying to gauge what we're talking about here.

Just rough numbers, I think if you did for eight months, five countries, say 10 units per country, we're talking about something in the $5 million to $10 million range in revenue, aren't we?

Bob Gallagher

Yeah but you have to remember that those are and I am saying relative to without the agreement you have to remember that all those countries are countries that we were selling in for the uPrint and uPrint Plus, already.

So I am looking at it when I am talking about HP’s impact I am talking about it relative to what Stratasys thought we would do on our own within those countries. So I think what I look at is what incrementally is HP adding to us in 2010 and I continue the believe as they refine their marketing message in those five countries before they expand through additional rollover that it will not be material to 2010.

Scott Crump

To the percentage I think its realistic to view that those five countries is may be 15 historically about 15% of our business and what this does is it gives HP and the Stratasys HP relationship a way of learning about 3D of course HP knows huge amount two about the 2 Dimensional market but they were learning about the 3 Dimensional market and this gives them an excellent way to understand things like the Dimension University program and how best to sell as they further expand from there.

Brian Drab - William Blair

Okay. I'll just make one last comment, that I would think that HP would be disappointed in their results if they weren't able to sell 10 units a month in Spain or in France and incrementally to what you're selling already, which could I mean, maybe it's not material in terms of $5 million to $10 million, but it seems like you should see some revenue from that opportunity this year.

But I guess I'll just ask another question, just one last question on the price point. It looked like in HP's press release that they said that their product is going to be selling for around $17,000. And they have two products, so I imagine one of them is around that $17,000 range and one's a little higher. Is that correct?

Bob Gallagher

Those are the published prices that you out there from HP but I think you need to keep in mind there is a lot of different ways within the market place to help prices that are determined and ultimately for the end customer we don't think end customers is going to see ascertainable difference in the prices.

Operator

Your next question is from the line Chuck Murphy with Sidoti & Company please proceed.

Chuck Murphy - Sidoti & Company

Good morning, guys. Your unit shipments were up quite sharply sequentially, while the product revenue was up, but just not nearly as much. And I'm guessing that's due to product mix, but what I'm a little confused on is why the gross margin managed to be up in that case, if the product mix was tilted towards the lower-end products.

Bob Gallagher

I think part of that I need to add to that is to remind you that consumable revenue growth was up 22% over the last year. So consumable growth as everyone knows on the call is a major component to our gross margin

Chuck Murphy - Sidoti & Company

Okay. So attribute it mostly to consumables and maybe yes, okay. All right. And then my other question was just, do you guys expect Fortus to continue to ramp up sequentially or was the first quarter benefiting from some seasonality or a few kind of one-off orders?

Scott Crump

I think it depended upon a slowly growing a economy out of the recession but I definitely believe that we are going to see continued growth. If you go back to just before the deep recession, some quarters we are growing 27, 30 - 33 in quarter, 40% on year-over-year basis for the quarter.

I think the primary reason for the growth is dollars, capital dollars are freeing up and we are in a new or fairly new application which gives very good return on investment to the customer and we are unique. There is only a couple of companies in the world that can provide additive fabrication to this application of end used parts and fixtures and assembly tools. So I definitely believe that we are going to see continued strong growth.

Bob Gallagher

Just taking on behind Scott, obviously with beginning of the year, a lot of companies reset their capital budgets I think Q1 benefited from some pent up demand and whether that's continuing factor or not I think will remain to be seen.

We are cautiously optimistic but I don't think we are in a position to predict that is yes or no at this point of the year.

Chuck Murphy - Sidoti & Company

Got you. Right. And if I could just come back to my previous question before about the margins, could you say how much consumables were up sequentially?

Shane Glenn

We don't have that right here. We don't have that chart.

Operator

Your next comes from Steve Dyer with Craig-Hallum please proceed.

Steve Dyer - Craig-Hallum

Thanks, guys. Good morning. A lot of mine have been answered. I don't want to beat the HP thing to death, because it's been come at from every angle. But so, Bob, is your definition of materiality kind of 15% of sales, give or take, in these countries as being something material or worth talking about with respect to HP?

Bob Gallagher

When I defined materiality in my mind, I look at what I think they are adding incrementally to it within those countries and then I am looking at from Stratasys overall both from our quarters and dimension product line. So I am talking about revenue on gross basis for the company.

Steve Dyer - Craig-Hallum

Okay. And obviously you're not willing to give numbers on HP, but I'm just trying to get a sense for kind of going back to the question of how that ramps throughout the year. Are you going to see kind of a or is your expectation that you'll see sell-in here largely in kind of Q2 and then a lot will depend on sell-through? Or how would you expect that to hit your P&L throughout the year?

Bob Gallagher

Well we sell directly to HP and they take ownership at the dock. But in terms of the timing of sales you have to remember we just announced HP relationship last week as when they actually introduced the products. They are dealing with a lot of resellers who have never sold 3D printer before.

So there is a lot of moving parts to this and that, order to predict ramp at this point in time after they just announced it last week. It's too premature.

Scott Crump

And the good news there is that of all our active European resellers have expanded to not just sell the Stratasys product but also now our certified in their area to sell HP certified HP 3D printing which I see is a very good sign for stability in the sales force and should carry over as we expand into other region.

Steve Dyer - Craig-Hallum

Okay. And then, with respect to R&D costs, they bumped up a little bit relative to where they were a couple of quarters ago. Is this kind of a new run rate to think of in terms of that line?

Bob Gallagher

During the quarter we introduced uPrint Plus, we introduced both our version the spot removal system the WaveWash as well as the DesignJet version of that. So we had significant efforts within the R&D area but yes with the HP relationship and the quality we are putting a heavy emphasis on R&D within the 2010.

Steve Dyer - Craig-Hallum

And then I think, Bob, you said cash from operations was $2.7 million. Did you have any CapEx of anything worth talking about in the quarter?

Bob Gallagher

CapEx was somewhere in the $800,000 range.

Operator

Your next question from the line of Ryan Thibodeaux with Maple Leaf Partners.

Ryan Thibodeaux - Maple Leaf Partners

Good morning. Just to go back to the HP deal, just trying to get a sense of the scope. Originally in January in the 8-K you guys said that you thought that HP in five years could be shipping 50,000 units a year. That's kind of how you got to the numbers of the $500 million in revenue for Stratasys. What I'm trying to understand better is how, if the entire industry shipped an average of 3,300 units, according to the Wohlers data, over the last five years, how is it that HP's going to grow the market by 13 times over the next five years, shipping a product that's priced higher than the uPrint is priced now?

Scott Crump

I think it's a good question. If you look at the application which is currently mechanical so future is in the area of architectural and if you look at the application and I call it three dimensional blueprint, so rather than two dimensional plotter which they dominate, we call it three dimensional plotter.

When you look at their rapid growth as they entered that market their growth was at or the market overall was at even a higher rate and you can see that in almost S curves of, when the tornado, if you get into crossing the chasm of the tornado the current amount volume let say for Stratasys at 2000 units per year is nothing, it's only on the beginning stages of the, or say five or six years into the S curves.

When it starts to take hold the potential here with millions of existing CAD seats solid mechanical CAD seat, the opportunity is for over 500,000 3D Printers and if you have any awareness, in our case if you have the endorsement on the technology high reliability so I am getting to whole product offering, if you can satisfy that the customer as HP has proven time and time again and is proving in this market with this budgets, with these customers, I believe it’s more than possible.

I believe myself it’s inevitable and I have been tracking it for about 18 years through company that used to dominate the 2D plotter called Calcomp and of course HP that does dominate it. And that's the basis for our vision being a half billion dollar revenue company.

Ryan Thibodeaux - Maple Leaf Partners

But that's essentially the same thesis that you guys had five years ago. Right?

Scott Crump

Well, with one huge difference we got the muscle and the awareness endorsement of a company HP that knows these customers, they can do talk down and selling that we have not been able to do to sell to these exact same customers for the exact same application. So yes we are very consistent with our vision.

Ryan Thibodeaux - Maple Leaf Partners

Okay. Well, if that's the case, what's your capacity right now to build these uPrint units? How many can you build in a year?

Scott Crump

The question is what is our extended capacity. It is little capacity, you have to include huge overheads which we don't have right. So we believe that we can expand through 6000 units and with more work to get to over 10,000 and part of that is kind of include as we grow beyond 10,000 units per year with the help of HP's worldwide supply chain which we are currently using.

Bob Gallagher

I think you have to remember from a manufacturing standpoint we are really a final assembly in cash and we bring a lot of sub components here so ramping up is relatively easy.

Ryan Thibodeaux - Maple Leaf Partners

But presumably you'd have to have a great deal of CapEx and additional labor to assemble them. Right?

Scott Crump

Well no because of most of the CapEx is in the Printers really with our manufactures are suppliers. We have certain amount of hours touch labor and burn in and assembly. So what you see is probably true for the consumable side but for the unit shipments side it really lies within our supplier to make motors that are suppliers, yes, they have to have a lot of CapEx painting equipment that are suppliers yes metal bending but not here at Stratasys.

Shane Glenn

And Ryan one of the things you mentioned ability to get to those kind of numbers when and you refer to uPrint specifically in the price point there I mean we have a plan and we believe HP is going be involved with that that looks at introducing, we are not going to, it's still we will introduce additional products overtime. We still hold by our thesis that, the market is price elastic and as we continue to make the products more affordable, more easy to use, more office friendly that’s one of those patches are pretty critical and liability are really critical to expanding the market. The same thing we are going to get to those kind of numbers with the part that we had today I think is that will be pretty shortsighted in the vision.

Operator

Your next question comes from the line of Jim Ricchiuti with Needham & Company.

Jim Ricchiuti - Needham & Company

Good morning. Maybe we could just shift gears a little bit. And I was hoping you might expand a little bit more about the strength you're seeing in Fortus. Whether you could talk about utilization rates or maybe some color on the end markets where you're seeing strength? Or perhaps, I assume you guys have a pretty good idea of where this equipment is going in terms of existing versus new customers.

Scott Crump

The applications vary across eight different market sectors, still for Fortus, they still predominantly for rapid prototyping, however as we have indicated in the past approximately 40% of our customers are using our system for DDM which would be less end use part for manufacturing of the end use part as well as fixtures and assemblies tools in the manufacturing process. And if they are using it I assume that 40% of the customers are using them in some capacity, so it goes across fairly wide set of applications and most of the countries that we selling to as well.

Shane Glenn

It's pretty broad based Jim. We kind of remember we also sell through distribution so we do have one degree removed from the end customer particularly with the consumable and often times with the system sales but it's pretty broad based.

Scott Crump

If you want to get a lot of details, I don’t think we want turn the call into like a technology allocation. There is a number of very fascinating real application on our website, take a look at that as well.

Jim Ricchiuti - Needham & Company

Well, I'm just thinking more in terms of the strength you saw this quarter. And I know you've been building out your indirect channel in North America. Did that perhaps contribute to some of the strength? And just some color where you’re seeing strength in Fortus are you geographically across your regions?

Bob Gallagher

I think you hit on just the point I was trying to bring up, in Q1 last year we really changed our distribution model within North America to go to from a direct sale into an indirect channel. We clearly lost some momentum in Q1, 2010, selling Fortus in North America.

The channels now been added for 12 plus months and the channel is much better educated within the Fortus systems and some of that movement of shifting gears was why you saw the 140% quarter-over-quarter growth. So probably North America was a strong point when you look at year-over-year.

Jim Ricchiuti - Needham & Company

Okay. And, Bob, from the standpoint of looking out over Q2 and the balance of the year, the changes you made in the channel were less disruptive I guess beginning of Q2, Q3?

Bob Gallagher

I would say probably Q3

Operator

Your next question from line of Andy Schopick with Nutmeg Securities.

Andy Schopick - Nutmeg Securities

Thank you and good morning. I just want to come back to HP. Bob, you can run through these very quickly with me. Will HP, for purposes of financial reporting, be grouped as domestic or international revenue?

Bob Gallagher

We will group them as international.

Andy Schopick - Nutmeg Securities

Okay. Also, for purposes of materiality, will you be breaking out HP separately when they become a 10% customer in terms of revenue contribution?

Bob Gallagher

That's something we were required to do, yes.

Andy Schopick - Nutmeg Securities

Okay. Can you provide us with any indication as to the impact on shipments in this quarter? I'm assuming there was just some stocking type of shipments that were impacted revenue this quarter? Was it more or less than 50 units? Can you give any indication?

Bob Gallagher

Yes, it was clearly immaterial to the quarter, non material.

Andy Schopick - Nutmeg Securities

Okay. Other than that, you don't want to be any more specific?

Bob Gallagher

No.

Andy Schopick - Nutmeg Securities

Okay. And will HP be giving you rolling monthly or quarterly forecasts to which you will build it’s ship to them? And how are you sorting this out right now in terms of trying to smooth this process?

Bob Gallagher

Yes, we work with HP very closely, we work with rolling forecast, the near term the forecast, the more committed the forecast is but in order to make sure that we are managing our relationship as well as our capacity, we are really looking out over the course of the year.

Operator

Your next question is from Graeme Rein of Bares Capital Management.

Graeme Rein - Bares Capital Management

Good morning. Scott, could you just talk about the RedEye business briefly? Are you seeing any competitive changes there? Do you have any sort of comments on the strength there?

Scott Crump

Yes, for most countries and for RedEye primarily US, there is more business, there is more project, there is more acceleration of design and engineering projects which is taking a lot of the pressure that we saw year ago to date where the small amount on top in order to survive would take an order pretty much on any basis and we were not at that time and going forward we are not.

So I think there is more business, there is less pressure, so we normally have more revenue opportunity but at more normal margins and I would expect that to be the case going forward within the US market for the kind of parts that we produce.

Graeme Rein - Bares Capital Management

Okay. And are you converting any of those RedEye customers into systems sales? Or do you even have visibility into that?

Scott Crump

It's a good question. Many times we will sell up a system and where a customer might need 10 systems they have one that many times can create even more business at that site for RedEye.

In fact we tracked some customers where they have done that cycle lets say three or four machines and then each year actually also ordering more from RedEye. I am viewing at really more I think we can say be 30% or 40% of business, where we have machines, customers want to get some help on their peak and valley.

So we can't help over their valley but on the peak they will place orders to RedEye and we cover them for that week or that month and it's way of not only getting business for RedEye but certainly as we grow more rapid prototyping system business as well as DDM system business.

Operator

Your next question comes from the line of Russell Lynde with Park West Asset Management.

Russell Lynde - Park West Asset Management

Hey, good morning. Couple questions. Was HP a 10% customer in this quarter?

Bob Gallagher

No.

Russell Lynde - Park West Asset Management

And you mentioned that 15% or the countries that HP represents is 15% of your sales?

Scott Crump

I think historically you could take those five countries and say depending on the quarter, 15 or 20% but not necessarily HP.

Bob Gallagher

Scoot said 15% I think the number is closer to the 20% range. And that's for all our products which would include our orders our Dimension as well our uPrint plus products.

Russell Lynde - Park West Asset Management

Okay. So do you expect HP to be material in any quarter this year? I know it's not for the year, but in any quarter?

Bob Gallagher

My comments go back to it being, we will find out where they just announced a product last week, we got new resellers who have never sold 3D printers before selling 3D Printers.

My comments as to materiality relate to what I said would be incremental sale that we got within those countries and if it's material within those quarter, we will report it as such.

Russell Lynde - Park West Asset Management

I guess just philosophically why wouldn't you just tell us what the HP sales are? Is there a competitive reason because clearly we all want to know about the relationship.

Scott Crump

Great, with HP as we work with HP and they are not all that interesting in sharing it.

Russell Lynde - Park West Asset Management

Okay. So HP has asked you not to share that information?

Bob Gallagher

We are under non disclosure with them, we may mutually change that but if we do you will get information from HP because they control, they are selling the 3D Printer and they control that, we don't.

Russell Lynde - Park West Asset Management

Okay. And then, can you just take us through how the accounting works? Do you book or is it a receivable and what are the terms when you sell to HP?

Bob Gallagher

Yes, when we shift units to HP they take ownership of those units and just like any other distributor or reseller that we have, we have receivable terms as it relates to that. And it will requested in our day sales outstanding along with the rest of our resellers.

Russell Lynde - Park West Asset Management

Okay. And so do you expect that to be a use of cash as you ramp that relationship? Do you expect day sales to go up as you ramp that relationship?

Bob Gallagher

Usually when you growing receivables over the period of time you see that as a use of working capital, what we have been able to do most recently is reduce our day sales outstanding as evidence in the current quarter going from 90 last year down to in the 60s. So we will continue to manage that component of our working capital as well as our inventory.

Operator

Next follow up from Andy Schopick with Nutmeg Securities.

Andy Schopick - Nutmeg Securities

Yes. One follow-up on the HP relationship. Has a decision been made yet when you will roll out into additional countries or regions and the timeframe for which you will do that beyond the five initial countries right now in Europe?

Scott Crump

No, I think that could occur at any time by mutual agreement but again remember they just launched the product last week. We gone through the last two or three months of pretty extensive education but focus really on those areas, those five countries and to repeat although HP is a proven leader and the 2D Plotter market, 3D printing is a new initiative for them and introducing in these five countries will allow them to refine their sales and marketing approach before they expand into other countries. We have heard of some demands now that the product is out but there is no decision to your question.

Andy Schopick - Nutmeg Securities

Has HP been able to forward any leads to you that you've been able to ship directly or through your other resellers in that context of what you just said?

Scott Crump

We are hoping to leverage but remember in four days or five days since a launch it can't be operate that quick right.

Andy Schopick - Nutmeg Securities

Well, HP's not formally launched in other countries beyond the five that's been rolled out, are they able to forward or would they forward to you any interest that they might be seeing that they simply cannot address right now through the existing relationship.

Bob Gallagher

Andy right now HP doesn't have mechanism today after just announcing the product last week. They don't have any mechanism to get any type of that information back to us, as you can appreciate given the size of HP relative to us that mechanism, this isn't in place today. From a contractual obligation, any expansion into other countries would be by mutual agreement during this year.

Operator

As there are no further question in queue at this time. I would like to turn call back over to Scott Crump for closing remarks.

Scott Crump

Okay, well in closing, we believe that we are off to a great start in 2010. The economic recovery appears to have gained momentum and we begun to deliver on our distribution agreement with HP. I'd like to thank all of our employees and strategy partners that have made this HP agreement possible. We have an exceptionally strong balance sheet and we remain committed to our long-term goals and objectives.

We remain confident in our ability to provide long-term value to our customers, channel partners and shareholders and I'd like to thank you for your interest in Stratasys. We look forward to speak with you again next quarter. Good bye.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: Stratasys Inc. Q1 2010 Earnings Call Transcript
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