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Stratasys, Inc. (SSYS)

Q1 2008 Earnings Call Transcript

May 1, 2008 8:30 am ET

Executives

Shane Glenn – Director of IR

Scott Crump – Chairman, President and CEO

Bob Gallagher – CFO

Analysts

Jeff Rosenberg – William Blair

Eric Martinuzzi – Craig-Hallum Capital

Troy Jensen – Piper Jaffray

Clint Morrison – Feltl & Co.

Andy Schopick – Nutmeg Securities

Ryan Thibodeaux – Maple Leaf Partners

Graeme Rein – Bares Capital

Jeff Evanson – Dougherty

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2008 Stratasys earnings conference call. My name is Akia, and I'll be your operator for today. At this time, all participants are in a listen-only mode. We'll conduct a question-and-answer session toward the end of the conference. (Operator instructions) I would now like to turn the presentation over to your host for today's call, Mr. Shane Glenn, Director of Investor Relations. Please proceed, sir.

Shane Glenn

Thank you, Akia. 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 the Chairman and CEO of Stratasys, Scott Crump, and Chief Financial Officer 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. We will begin with the Safe Harbor statement. All statements herein that are not historical facts or that include such words as expects, anticipates, projects, estimates, vision, planning, believes, or similar words are forward-looking statements that we deem to be covered by and to qualify for the Safe Harbor protection covered by the Private Securities Litigation Reform Act of 1995.

Our belief that we have the largest part-building service is based on the number of dedicated machines. Except for the historical information herein, the matters discussed in this news release are forward-looking statements that involve risks and uncertainties. These include the continued market acceptance and growth of our Dimension product line, our FDM 200mc, 360mc, 400mc, 900mc, Maxum, Titan, and Vantage product lines, the size of the 3D printing market. 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 and market new materials, such as ABS-Plus and ABS-M30, and the market acceptance of these and other materials, the impact of competitive products and pricing, the timely development and acceptance of new products and materials, the success of our recent R&D initiative to expand the direct digital manufacturing capabilities of our core FDM technology, the success of the our RedEye RPM and other paid parts services, and the other risks detailed from time to time in our SEC reports, including our quarterly reports filed on Form 10-Q, to be filed throughout 2008, and our annual report that is filed on 10-K for the year ended December 31, 2007.

The information discussed within this conference call includes financial results and forward-looking financial guidance in accordance with U.S. Generally Accepted Accounting Principles, or GAAP. In addition, non-GAAP financial guidance is included that exclude certain expenses. The non-GAAP financial measures are provided in an effort to give information that investors may deem relevant to the company's operations and comparative performance, primarily the identification and exclusion of expenses associated with stock-based compensation expense required under SFAS 123R.

We'd like to quickly confirm the date of our second quarter earnings release and conference call. Stratasys' second quarter results will be released on or before the morning of July 31, 2008, followed by a conference call on the day of the release. We will release the conference call time and details about two weeks prior to that date. Now I would like to turn the call over to our CEO, Scott Crump.

Scott Crump

Good morning, and thanks for joining us. We are pleased to announce our record first quarter financial results this morning, which includes the highest level of system units and revenue for any quarter in our company's history.

Revenue grew 16% for our proprietary products and services in the first quarter. Operating profit grew 24% and was our fastest quarterly growth over the past year. Our new products continue to outperform our expectations with approximately 80% of our system revenue in Q1 coming from products introduced since the start of 2007. This growth was led by the outstanding performance of our proprietary high-end system business, which grew by 29% over the last year, our fastest growing business during the period.

New direct digital manufacturing applications are partially responsible for this growth of our high-end systems. 3D printer revenue increased by 20% during the first quarter, driven by the successful introduction of our premium-priced Dimension 1200es line in February, as well as strong demand for our high-priced Dimension Elite.

Our margins improved significantly over last year, a result of strong sales of our new products. Our premium-priced 3D printers represented approximately 89% of printer sales during the first quarter. In addition, we continued to experience healthy growth of our consumable revenue, as our installed base of systems continues to expand.

Okay, I'll return later to discuss some of our strategic initiatives, but first I'd like to turn the call over to our CFO, Bob Gallagher, who will further highlight our first quarter results. Here's Bob.

Bob Gallagher

Thank you, Scott. Prior to discussing the details of our financial results, we would like to discuss the non-operating impairment charge incurred during the quarter, as well as discuss the relative impact of discontinuing our product distribution agreements. Given the current environment, we have been proactive in evaluating our cash and investments. As we reported in our 10-K, we finished 2007 with approximately $18.8 million in auction rate securities, but has reduced our exposure to $7.4 million subsequent to year end. Today we continue to hold $7.4 million in auction rate securities.

Approximately two-thirds, or $4.8 million, of our auction rate securities are AAA rated and insured by a highly rated insurance company. The remaining $2.6 million in auction rate securities is an investment in Jefferson County, Alabama that has seen its rating reduced to CCC from AAA. In order to help us determine the carrying value of these investments, we hired outside consultants to qualitatively and quantitatively evaluate our auction rate securities portfolio.

With the assistance of the outside consultants, we determined the $2.6 million investment in Jefferson County has incurred both a temporary and more permanent impairment. As a result, we took a Q1 pre-tax charge of approximately $390,000 against other expense. Net of tax, this represents first quarter charge of approximately $257,000, or just over $0.01 per share.

Additionally, we recognized a temporary impairment charge, net of tax, of approximately $128,000 through other comprehensive income. We will continue to proactively evaluate all of our investments and the auction rate securities in particular. As we have previously outlined, we discontinued the distribution of Eden products at the beginning of 2007 and continued to recognize a nominal level of Eden-related revenue throughout the year.

In addition, as we have previously outlined, we discontinued the distribution of Arcam products at the beginning of 2008. These decisions have created certain issues when conducting year-over-year comparative analysis of our revenue growth and margins. In the first quarter of 2008, we recognized approximately $83,000 of sales related to these discontinued distribution agreements, compared to approximately $1 million in the same period last year.

Our gross margin on the revenue was negligible in both periods from distributed products. We have previously provided you the distributed product-related revenue by quarter for 2007, which includes some residual revenue we generated from the Eden-related products and services, as well as all product revenue from the Arcam distribution agreement. As a reminder, distributed product and service revenue for 2007 was as follows, Q1, $1 million; Q2, $540,000; Q3, $1 million; Q4, $1.4 million for a total of approximately $4 million. The overall gross margin on the revenue was essentially zero.

Total revenue increased by 12% to $30.7 million for the first quarter of 2008, compared to $27.3 million for the same period last year. Revenue from proprietary products and services, which excludes all distributed product-related revenue increased by 16% in the first quarter over the same period last year. The company shipped 577 systems during the first quarter versus 548 last year, an increase of 5% over last year. While the increase may seem small, it's because it's against a tough comparable quarter from last year.

As you might recall, last year's 548 systems in the first quarter was 36% increase over Q1 of 2006. Additionally, a relatively low growth rate of 3% for 3D printer units in Q1 2008, compared to previous periods has most likely been influenced by our recent strategy to advance the functionality of our printers and market those products at premium prices. This strategy has allowed us to maintain strong system revenue growth despite the lower unit growth sales.

We should emphasize that we remain committed to our long-term strategy of expanding the market by making 3D printers more affordable. The 1200 SST, Elite, and 768 SST, our three highest priced 3D printers, represented approximately 89% of our 3D printer unit volume during the first quarter.

First quarter product revenue as reported increased by 16% to $25.1 million when compared to $21.7 million for the same period last year. Distributed product-related revenue amounted to $83,000 in the first quarter versus $698,000 for the same period last year. Excluding distributed product-related revenue, total product revenue increased by 19%. Several factors drove our proprietary product revenue growth in the first quarter.

First, proprietary high-end system revenue increased by an impressive 29% when compared to last year, driven by the successful introduction of several new products. The performance of our high-end system business exceeded our expectations during the quarter.

Second, our 3D printer system revenue increased by 19%, driven by the success of our new products and the resulting increase in average printer prices compared to last year.

Third, our proprietary consumables grew by 14% during the first quarter when compared to last year, driven by an ongoing expansion of our installed base of proprietary systems, especially 3D printers. As we've observed in the past, consumable revenue was slightly impacted by the timing and inconsistent nature of distributed purchases.

First quarter service revenue, as reported was flat when compared to the same period last year. We recognized no distributed product-related service revenue during the first quarter compared to $323,000 in revenue for maintenance contracts we recognized during the same period last year. Excluding distributed product-related service revenue, total service revenue increased by 5%.

Maintenance revenue from contracts and proprietary systems increased by 19% during the first quarter when compared to last year. The increase in maintenance revenue over the prior year is due to the 2,169 systems we added to the installed base in 2007. Our paid parts revenue declined by 12% during the first quarter. The comparative first quarter in 2007 was an exceptionally strong quarter for paid parts, as the business grew 70% over the first quarter of 2006.

Despite consideration for the difficult comparison, the performance of paid parts in the first quarter of the year was disappointing. We remain optimistic about the future prospects of paid parts. It's worth noting that the disappointing paid parts performance has been overshadowed by the other strong performing components of our company.

Gross profit increased by 18% to $17.4 million for the first quarter of 2008 when compared to $14.7 million for the same period last year. Gross profit as a percentage of sales, increased to 56.5% from 53.8% for the same period last year. The gross margin percentage year over year benefited from better average prices for 3D printers, as well as the growth in our proprietary consumable products. In addition, the gross margin percentage year over year benefited from improved mix within our high-end system business, as the elimination of distributed products has been replaced by the increased sales in our proprietary high-end systems. As we have indicated previously, we maintained a negligible gross margin on the sale of our distributed product lines.

Operating profits increased by 24% to $5.5 million for the first quarter 2008, compared to $4.4 million for the same period last year. Stock-based compensation expense required under Statement of Financial Accounting Standards, or SFAS 123R, amounted to approximately $315,000 in the first quarter compared to $303,000 in the same period last year.

Operating expenses increased by 15% during the first quarter compared to last year. Our vision remains to move down the price elasticity curve and target opportunities that are developing within the direct digital manufacturing market. Both of these initiatives will require continuous product development and investment. As we have previously outlined, we plan to invest heavily in 2008 to address these future opportunities. Consequently, we expect operating expenses will continue to show material growth for the balance of 2008.

Total interest and other income for the first quarter decreased to $297,000 versus $370,000 last year. The decline was a result of the $390,000 impairment charge in auction rate securities I outlined earlier, partially offset by the increase in interest income due to higher cash balances. Despite the $390,000 impairment charge, pre-tax profit increased by an impressive 21% to $5.8 million for the first quarter of 2008 compared to $4.8 million for the same period last year.

Excluding stock-based compensation expenses and the impairment charge recorded during the first quarter, pre-tax profit increased by an impressive 27% to $6.5 million for the first quarter of 2008 compared to a comparably calculated $5.1 million for the same period last year.

Income tax, as reported, amounted to $2 million for a rate of 34.5% compared to $1.6 million, or 34.2% for the same period last year. Excluding the impact of stock-based compensation expenses, income tax amounted to $2.2 million, or 33.6% for the first quarter, versus $1.7 million, or 34% for the same period last year.

Net income increased by 20% to $3.8 million for the first quarter of 2008 or $0.18 per share, compared to $3.2 million, or $0.15 per share for the same period last year. Excluding stock-based compensation expenses and the impairment charge recorded during the first quarter, net income increased by an impressive 28% to $4.3 million, or $0.20 per share for the first quarter of 2008, compared to a comparably calculated $3.4 million, or $0.16 per share for the same period last year.

Our diluted shares outstanding increased by approximately 256,000 from the first quarter of last year, a result of our higher stock price, as well as the exercising of employee stock options, offset partially by share repurchases. Our cash and investment position amounted to approximately $54 million at the end of the first quarter, compared to approximately $61 million at the end of fiscal 2007. The change in cash and investments from the end of fiscal 2007 is a result of the cash use for stock repurchases combined with higher working capital requirements.

During the first quarter, we bought back approximately 221,000 shares for $3,953,000 for an average purchase price of $17.88. We have approximately 26 million remaining on the current repurchase authorization. Inventory balances were $17.6 million at the end of the first quarter, which is up from the $12.8 million at the end of fiscal 2007. The increase is largely due to a buildup of Dimension units in anticipation of additional demand, in order to provide for differences in our forecast mix versus actual demand, an increase in inventory to support our new product introductions, a lifetime legacy buy for system inventory, and an increase in consumable inventory to meet future customer demand.

Net property and equipment was $26.8 million at the end of fiscal – at the end of the first quarter, compared to $26.6 million at the end of fiscal 2007. Accounts receivable at the end of the first quarter was $30.1 million, compared to $26.3 million at the end of fiscal 2007.

Day sales outstanding, or DSO, was approximately 89 days compared to 87 days at the end of the first quarter of last year. As we've observed in prior quarters, our DSOs will likely continue to be impacted by our successful programs for resellers that allow participants to purchase a limited number of 3D printers with extended 180-day payment terms. This follows a similar pattern we've now observed over the past four years.

The current level of participation for reseller is consistent with historical levels and we've made no significant changes to the program. We believe our past history has proven the program's value and manageability. I would like to reiterate what I believe are three of the key points to highlight during in the quarter. Strong growth, not only in our proprietary 3D system revenue, but 29% growth of our high-end system revenue, gross profit margins benefiting from favorable proprietary product mix and the discontinued distributed products, strong net income despite $267,000 or $0.01 per share charge related to auction rate securities. Now, I would like to turn it over to our Director of Investor Relations, Shane Glenn, to outline our financial guidance.

Shane Glenn

Thank you, Bob. Stratasys provides the following guidance for the fiscal year ended December 31, 2008 as follows. We're maintaining our revenue guidance of $130 million to $136 million for fiscal 2008. It's worth noting again that fiscal 2007 had approximately $4 million in revenue from products and services that we no longer distribute or offer. We are reiterating non-GAAP earnings guidance of $0.81 to $0.89 per share, which excludes the impact of stock-based compensation expense required under SFAS 123R.

Direct affiliation between this non-GAAP adjustment and our GAAP financial measures is provided in a table at the end of the press release. We are reiterating GAAP earnings guidance of $0.77 to $0.85 per share. We are providing the non-GAAP financial estimates for those analysts and shareholders that want to use that information in evaluating our performance.

Now, I would like to turn the call back over to Scott Crump.

Scott Crump

Thank you, Shane. We are very pleased with our strong first quarter financial performance, especially in the light of the prevailing concerns over a weakening global economy. The peers repeating the first quarter represented our highest level of system units and system revenue in the company's history.

In addition, our 24% growth in operating profit was the highest in four quarters. This performance is especially noteworthy when you consider operating profit in the first quarter of last year increased 57% and represented a difficult comparison for Q1 of this year. The first quarter performance was driven by the success of our new product introductions. Approximately 80% of our system revenue was generated from products introduced since the start of 2007.

In addition, our growth resulted from further expansion into the under-penetrated market for 3D printers. The standout performance of the quarter was our proprietary high-end system business, which grew by 29% over last year, our fastest growing business during the period.

The high-end system business benefited from strong demand for our new products, driven in part by new opportunities from customers using our systems for direct digital manufacturing applications, DDM, or in other words, the manufacture of end-use parts. These new DDM applications are incremental to our traditional applications for prototyping and concept modeling. An example of this market opportunity is represented by the market for fabrication and assembly tools. These are specialty tools and unique parts that are made for and used in the manufacturing processes of other products.

We estimate that companies that serve this market generate $8 billion in revenue in North America alone, which is related to these applications. We believe our FDM technology represents a cost effective alternative to a subset of this industry. Our introduction of the FDM 900mc last December directly targets the new opportunities in DDM. We began limited shipments of the 900mc during the first quarter and plan on reaching full production of the unit during the third quarter of this year. So, as you can see, we've a great start to the year with our high-end system business.

3D printer revenue increased by 19% during the first quarter, driven by the successful introduction of our premium priced Dimension 1200es line in February, as well as the relatively strong demand for our higher priced Dimension Elite. We are especially pleased with our 3D printer growth given the difficult comparison created by the record performance in the first quarter last year.

It's worth noting that 3D printer units and revenue increased 40% and 59%, respectively, in the first quarter of 2007. We are pleasantly surprised that our premium 3D printers and 1200 SST, the Elite, and 768 SST represented approximately 89% of the 3D printer units sold during the first quarter. This was a major factor in our margin expansion during the quarter, as the higher priced – the higher printer prices, combined with relatively stable printer costs.

The success of the new 1200es and subsequent product mix trends demonstrate an opportunity to expand the 3D printer market by improving system functionality and performance. These growth opportunities supplement our longer-term strategy of growing the market by making the systems more affordable using the price elastic business model. These new systems provide the dual value of improving functionality to our customers while expanding product awareness and education.

So, like the high-end system business, 3D printing is off to a great start here in 2008. Although total paid parts order volume increased by 26% in the first quarter, total revenue declined by 12% compared to last year. It's worth noting that the first quarter of 2007 was an exceptionally strong quarter for our paid parts business, as we generated several large orders.

We continue to evaluate and improve upon our sales and marketing efforts. Leads are up, registrations are up, and traffic to our web site RedEyeRPM.com continues to trend up, as we've seen a number of first time orders increase by approximately 30% during April. The new ABSplus material offered on the Dimension Elite and 1200es line has improved the functionality of our 3D printers and has been well received by our customers.

Our proprietary consumables business grew a respectable 14% during the first quarter. Quarter-over-quarter consumable growth can be impacted by timing and shipment of reseller purchases, but the growth trend remains strong. We expect our growth in consumable revenue will accelerate from the first quarter levels as we move through the balance of 2008. Although we've observed some signs of weakness in the domestic market, overall, we continue to experience strong global demand for our products. It's worth noting that international sales for proprietary products and services increased 23% during the first quarter versus 10% domestically.

The trends are similar to the conditions that leading CAD software companies have reported, suggesting the market for 3D products remain under-penetrated and ripe for growth. We were encouraged by the recent positive commentary from AutoDesk that 3D products are key growth drivers for their businesses and that 3D penetration of their customer base remains under 15%. We continue to believe that 3D printers will become an essential output device for these users and believe that the current installed base of 3D CAD users is under-penetrated.

In addition, we believe that incremental growth of 3D CAD would most certainly be a positive leading indicator for our business. Following the first quarter performance, we remain confident in our ability to achieve our goals for 2008 and look forward to a very successful full year. I'll return with some closing comments, but first we'd like to address any questions that you might have. Operator, let's open up the call to questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question is a question from the line of Jeff Rosenberg of William Blair. Please proceed.

Jeff Rosenberg– William Blair

Morning.

Scott Crump

Morning, Jeff.

Jeff Rosenberg– William Blair

I guess I wanted to ask, as we look into the second quarter and we think about the 3D printer business, is there any difficulty in terms of sequential comparison because of the pent up demand you had from orders you weren't able to fulfill in the fourth quarter that if I assume you were able to meet in the first quarter, for the Elites and then also the initial shipments of the 1200es?

Scott Crump

Alright. I don't think so, Jeff. Again, we don't give – we give guidance on the year overall. We expect good strong growth in the 3D printers over the course of the year. But I don't think Q2 is going to be any different than what we're seeing for the remainder of the year in terms of anticipation of the growth. There's nothing that allows me to give you any clear guidance one way or the other on that quarter.

Jeff Rosenberg– William Blair

Yes. I was just wondering, maybe just directly talking about this quarter, whether you saw any specific benefit from the other things I talked about, the Elites and the es that was notable there?

Scott Crump

We saw some positive impact from that, but we'll see some residual positive impact in that in Q2 also.

Jeff Rosenberg– William Blair

Okay. And, then, I'll just ask you one follow-up on your comments about the – seeing some effects on some economic weakness. I assume based upon the data you gave, you're talking about geography, but is there any difference that you see by product line? Do you think it has – you've seen it more or less in 3D printers versus the Stratasys equipment?

Scott Crump

No. I don't think it's specific to product. I'm actually not sure that it's all specific in the domestic market to geography other than the old automotive center of Detroit that obviously, the new automotive is everywhere around the world, including as far as away as Shanghai. So, I don't know to reiterate. I don't believe that there's anything specific to product.

Jeff Rosenberg– William Blair

Okay, thanks.

Scott Crump

Thanks, Jeff.

Operator

Ladies and gentlemen, to ensure everyone can ask a question, please limit your question to one and one follow up. And your next question comes from the line of Eric Martinuzzi of Craig-Hallum. Please proceed.

Eric Martinuzzi – Craig-Hallum

Thank you. Terrific quarter, guys.

Scott Crump

Thank you, Eric.

Eric Martinuzzi – Craig-Hallum

If there was one area though that we could have had an even better result on the quarter from it would have been that paid parts contribution. You gave us some numbers there and I think I understand all of them except the revenue decline number because you talked about orders being up or traffic trends being up 30% and I guess the volume number of 26%. Is that, when you say volume, is that number of parts ordered or cubic inches of materials consumed? Help me understand this 12% decline in paid parts.

Bob Gallagher

Yes, Eric. One other things that we saw in the first quarter of '07 is we had, and I apologize, I don't have the exact number for you, but we had several very large orders that came into that quarter. So when you look at a typical order, average order, may be being in the $1,000 to $5,000 range. We had several orders that were six figures, a number of orders that were six figures in Q1 of last year. So, obviously, that doesn't impact, when you look at your number of order comparison year over year, one order is $100,000 is the same as a $5,000 order. So when you look at Q1 of '08, we saw a nice increase in the number of orders, but because of those several large orders that we had in Q1 of last year, the order or the dollar value actually declined year over year.

Eric Martinuzzi – Craig-Hallum

Okay. So, your comment, that 26% volume is number of orders, not numbers of parts.

Bob Gallagher

That is correct. Having said all that, yes, we are still disappointed with the performance in the quarter and hope to see some improvement there.

Scott Crump

Long-term, though, I think we still feel very positive about the paid parts business and we're going after a segment of the graphic prototyping that's over $300 million.

Eric Martinuzzi – Craig-Hallum

Okay. And so you continue to invest in machines and in personnel in paid parts at your expected – at your plan rate?

Scott Crump

That is correct. That is correct.

Bob Gallagher

We just added a new individual, a new marketing individual in the first quarter. We're looking at some – doing some things differently there from sales and marketing effort. And we've taken a look at some of those things. Those have been laid out for us, and we're still pretty excited about the business.

Eric Martinuzzi – Craig-Hallum

Thank you.

Operator

And your next question is from the line of Troy Jensen of Piper Jaffray. Please proceed.

Troy Jensen – Piper Jaffray

Congrats on the nice quarter, gentlemen.

Scott Crump

Thanks, Troy.

Troy Jensen – Piper Jaffray

Hi, so, Scott, I would like to talk to you about the DDM comments. I guess I'm most interested if the strength you're seeing on the DDM side is coming from your relationship with this Fortune 100, or is there more out there?

Scott Crump

The Fortune 500?

Troy Jensen – Piper Jaffray

Yes, exactly.

Scott Crump

Yes, we've got a great relationship with our Fortune 500 partner, but to your question, we see quite a lot of other opportunities similar in DDM, which is specifically fixtures and assembly and jigs that come off of our systems that are directly used on the manufacturing lines. And we see those opportunities worldwide. And we're going after them both from a strategic standpoint and a tactical standpoint with our new line of the 200mc, primarily 400mc, and as we get into the second and third quarters with the new 900mc. And the 900mc, so far from an order standpoint, we see the majority of those orders coming in for or dedicated to the DDM application.

Troy Jensen – Piper Jaffray

Got it. Well, specific with the relationship with the Fortune 500 and others, (inaudible) R&D, I thought when you originally announced it was a three-year deal, so to speak, or a three-year time frame. So could you just update us on where you are with that relationship?

Bob Gallagher

Yes. During the quarter, we offset approximately $280,000 of our R&D spending from that contract. We're really moving in to a phase now where we are going to deliver some commercial units that were included under the contract. And there may be some additional R&D dollars that are yet to be determined within that contract. But we are really moving more into the commercial phase with our Fortune 500 customer.

Troy Jensen – Piper Jaffray

Got it. Keep up the good work, guys.

Scott Crump

Thanks.

Bob Gallagher

Thanks, Troy.

Operator

Your next question comes from the line of Clint Morrison of Feltl & Co. Please proceed.

Clint Morrison – Feltl & Co.

Hey, guys; good quarter.

Scott Crump

Thanks, Clint.

Clint Morrison – Feltl & Co.

On the inventory build up, I think you said something about sort of a legacy buy on some systems or something. Can you tell us what that was and how much of that increase was accounted for?

Bob Gallagher

Yes. There are several factors moving in our inventory and legacy systems being a part of it. There's some lifetime buys that we did probably to the tune of about $0.5 million within their inventory related to our high-end systems, where parts were going to no longer be available. So, we needed to buy the parts both to fill what we believe is a trailing demand throughout 2008 for those products, as well as to be able to serve our installed base on maintenance contracts going forward.

Clint Morrison – Feltl & Co.

Okay. And then just one other question on the paid parts. Can you give us a sense of what your utilization of that is? You've obviously been investing in it and increasing capacity. I'm just wondering what your peak has been and for this quarter what was your utilization of your facility and capacity?

Bob Gallagher

Capacity – in that business – if you measure capacity for the quarter, clearly we had significant excess capacity because we wanted to continue to grow that business, we really evaluate capacity on a day-to-day basis. The reason that we do that is because we don't want to be turning away any business on a given day. And we don't think capacity is a really true measure of that business in its infancy stages that we still consider it to be.

Scott Crump

So, if you did want to put a number to it, you would have to use a range. I would say it's on a typical day from 50% utilization worldwide to 100%. And you have to almost look at it by the minute or by the hour because it can literally fluctuate from 80% to 100% over like a one or two hour period of time.

Bob Gallagher

Yes. And if you evaluate it on the historical, looking over the whole quarter basis you're probably looking at somewhere around a 50% level.

Clint Morrison – Feltl & Co.

Okay. And maybe the other way to ask is how many machines do you have on the floor supporting that facility?

Scott Crump

Let's see, we've over 110 systems, about 13 or 14 of those in Europe and 2 in Australia.

Clint Morrison – Feltl & Co.

Okay. Good, thank you.

Scott Crump

Thanks, Clint.

Operator

And your next question comes from the line of Andy Schopick of Nutmeg Securities. Please proceed.

Andy Schopick – Nutmeg Securities

Thank you, and good morning. Bob, a couple of quick ones for you, then I would just like to come back to Scott. One question was already answered on the R&D reimbursement. Can you give us the capitalized software and associated amortization in the quarter?

Bob Gallagher

Sure, Andy. There was about $427,000 of capitalized software and about $336,000 of amortization.

Andy Schopick – Nutmeg Securities

Just on the software, not the depreciation as well.

Bob Gallagher

Just on the software.

Andy Schopick – Nutmeg Securities

Yes. And also Bob, any general commentary about the aging of the receivables? Is there any issue there that you see developing? Can you just give us some color on the aging?

Bob Gallagher

Obviously, in this economy, we watch our accounts receivable closely. During the quarter, we took approximately $80,000 of bad debt. We had a small increase in our allowance. We monitor that closely, we watch all our resellers. We put that as a risk factor historically in our 10-K and it continues to be a risk factor, and I think we're doing everything we can to monitor it. And as we see problems, we add to our allowance as we deem appropriate. So, it's a risk factor within our business, but we think we've taken the appropriate reserves.

Andy Schopick – Nutmeg Securities

Okay. Scott, a question for you about Japan and China. The company has become more aggressive in terms of developing a direct sales presence there. I know you had that large Marubeni order in early of '07, I think it was around $6 million. Did that all ship in calendar '07, and how are you progressing in the development of your presence in Japan and China?

Scott Crump

Well, both Japan and China are progressing very well. To answer your question in Japan, we did ship during 2007, the entire order.

Bob Gallagher

No, I think there was a small minority of the order would still residue into 2008.

Scott Crump

Into Q1? Okay. And we're continuing to train and grow our channel as well as in China.

Andy Schopick – Nutmeg Securities

Is there any follow-on business you have from Marubeni that you hope to achieve for '08?

Scott Crump

Well, sure. I mean, it's an ongoing growing business. We have really two focuses. We focus on the high end, actually with a separate group within Marubeni. They're doing quite well. And there's actually a separate group and a growing group within Japan within Marubeni's channel for the Dimension 3D printer. So, yes, quotas continue to rise and business continues to rise. That's true in most of the sections of the world. I would say we are fairly aggressive on that.

Andy Schopick – Nutmeg Securities

Okay, thank you.

Operator

Your next question comes from the line of Ryan Thibodeaux of Maple Leaf Partners. Please proceed.

Ryan Thibodeaux – Maple Leaf Partners

Good morning, guys. I just want to go back –

Scott Crump

Good morning, Ryan.

Ryan Thibodeaux – Maple Leaf Partners

Good morning. To go back to the inventory again, not to belabor the point, I just want to understand it better. Inventories increased 80% year over year, $4 million quarter over quarter. You said about $0.5 million of that was for legacy parts. And, Bob, on the call last quarter, you explicitly said that you did not want to build up any finished units for Dimension. I'm just curious if you guys are reassessing that and you are doing that now? If you could just add a little more color to that.

Bob Gallagher

Yes, Ryan. I think what I said is on the Dimension units in the last quarter, I don't think that's a good long-term strategy given the disappointment in Q4. Obviously, I made the comment that we did build additional units of the Dimension. I do believe that that's not a good long-term strategy. Obviously at Q1, we departed from what I think is prudent on a long-term basis and did have additional Dimension units.

Ryan Thibodeaux – Maple Leaf Partners

Okay. And were those, would you say the ratio to the inventory build is the same as the ratio to the – as far as new systems versus – is it a buildup of the old systems that aren't really selling as fast as they once were, or is it new systems that you're building in anticipation?

Bob Gallagher

No, no. It's not. The underlying question there is, do we have any problem within our finished goods inventory, and absolutely not. Everything that we have in our finished goods units at the end of Q1 are the things that will sell out in Q2.

Ryan Thibodeaux – Maple Leaf Partners

Okay. And, then, could you say what the cash flow from operations was in the quarter?

Bob Gallagher

Unfortunately, I don't have that number in front of me, I'm sorry.

Ryan Thibodeaux – Maple Leaf Partners

Okay. And, then, lastly, I think you said that Dimension revenue was up 19%, consumables was up 14%, and that the other was up 29%. Can you break out those actual numbers because I'm having some problems getting to the 25.1 total?

Shane Glenn

Yes. We don't, as you probably know, we don't give out the specific dollar values of our various businesses for competitive reasons.

Ryan Thibodeaux – Maple Leaf Partners

Okay. Could you – I guess you can't. Okay. All right, thank you.

Scott Crump

Thanks.

Operator

Your next question comes from the line of Graeme Rein of Bares Capital. Please proceed.

Graeme Rein – Bares Capital

Good morning, guys.

Scott Crump

Good morning.

Graeme Rein – Bares Capital

Scott, you talked about how you expect consumables to accelerate through the rest of the year. Is that – is your comment coming from information you get from resellers or is it just this idea of consumables lagging shipments? Or is there some other data that you have that gives you that confidence?

Bob Gallagher

One other things that we said on previous calls are we sell through distributors and our resellers, and particularly our distributors sometimes will do large orders, and the timing of those large orders can impact quarter-over-quarter comparison. That will give us the confidence is looking at what we saw in terms of those large orders in Q1, or the lack of revenue related to some of those large orders. And we know from historical trends that those will be there throughout the year.

Scott Crump

And the full year of 2007 was very, very strong.

Graeme Rein – Bares Capital

Okay. And then –

Bob Gallagher

The important factor there is we're not seeing – we believe that we've a captured consumable base for our customers and we don't see anybody getting into our installed base.

Graeme Rein – Bares Capital

Okay. That's helpful. And then just a follow up. At this point to hear about the impairment charges there, possibility that there might be further write-downs or impairments in the coming quarters?

Bob Gallagher

Yes, I think we've been really proactive, as proactive in that as pretty much any company has been out there. Obviously, it's a very volatile market today. We've taken the charges that we think were prudent within the quarter, but it's a situation that changes day to day. There's opportunity on that both upside and downside as you move forward.

Graeme Rein – Bares Capital

Okay. Thanks a lot.

Operator

(Operator instructions) And your next question comes from the line of Jeff Evanson of Dougherty. Please proceed.

Jeff Evanson – Dougherty

Good morning, gentlemen. Thanks for taking my questions.

Bob Gallagher

Hi, Jeff.

Scott Crump

Hi, Jeff.

Jeff Evanson – Dougherty

Could you guys give us the geographic mix in the quarter and maybe speak to the growth you're seeing in major regional markets?

Bob Gallagher

Jeff, geographically, similar to the fourth quarter, about half of our business was in North America and about half outside. And as Scott mentioned in his comments, we saw 23% growth internationally and 10% domestically. Traditionally, our international business has been about half European and half in the Asian market. In the quarter, we saw strong growth in both of those regions, but in particular we saw it within Europe.

Jeff Evanson – Dougherty

And what is leading to that strength in Europe? Is it also the higher-end products?

Bob Gallagher

Yes, it's definitely both product lines.

Jeff Evanson – Dougherty

Okay, great. And then could you speak to the success you're having with the 1200 series upgrade kits?

Scott Crump

Jeff, we really haven't – we had a few – we shipped a few of those in the first quarter, but we expect to see a bigger piece of those begin to ship in the second quarter. So I would say the impact in Q1 was relatively small, and that's not because there's not the interest. It's just that the plan was to begin seeing higher shipments of those in Q2, starting with Q2.

Jeff Evanson – Dougherty

So are we talking tens of units or hundreds of units?

Scott Crump

Well, we're certainly trying to do hundreds as a goal. It's really an interesting, actually new – it's the first time ever for our Dimension product where we were able to offer this upgrade enhancement, which really makes sense mid-term and long-term as a low cost way of enhancing our both reputation as well as machine performance. And the ABSplus part quality, both for referrals as well as repeat orders. It's actually first time that the company has done this. But to your question, we certainly are aggressively going after hundreds of units.

Jeff Evanson – Dougherty

I mean are you disappointed, Scott, by the speed of the uptick there? I thought it was a pretty compelling offering.

Scott Crump

No, no, no. Just things take time if you're selling in Istanbul and if you're selling in Seoul, Korea, and then you've got to also fulfill in – no, I would say we're tracking per plan, and the plan has always been a Q1 launch and to get – well, the plan has been to get the vast majority booked by the end of June.

Bob Gallagher

Yes. You've got to remember, Jeff, that we introduced that product probably in the middle of February. So, there's only six weeks of the first quarter where there was even knowledge of the program. And it takes time for the knowledge to get out there in the marketplace and then for orders to come back. So, we're not disappointed with it at all.

Scott Crump

Right. And we've very optimistic that we will be able to achieve the vast majority of the units.

Jeff Evanson – Dougherty

All right. I'll be patient. Thanks.

Bob Gallagher

Thanks, Jeff.

Scott Crump

Thanks, Jeff.

Operator

Your next question is a follow-up from the line of Jeff Rosenberg of William Blair. Please proceed.

Jeff Rosenberg – William Blair

Hi, Bob, can you quantify any currency benefit you saw in the international sales?

Bob Gallagher

We don't split out currencies separately. Obviously, with the weak dollar and strong euro, it was a positive impact. But you also have to remember that we've a sales and service operation within Germany. In addition to that, we had some of our receivables throughout the year which – or throughout the quarter, so we had a negative impact. So, clearly, it's a positive impact, but not something that we separately quantify.

Jeff Rosenberg – William Blair

Okay. And, then, on the higher-end systems, do you have the unit growth there offhand?

Bob Gallagher

Unfortunately, I don't. I said that our overall unit growth was about 5%, and it was 3% on 3D printers.

Shane Glenn

Yes. Jeff, the reason we don't talk about, we don't highlight that as often is because we don't want you to draw a whole lot from that number, because when you look at the various price points that we've in the high end that range from anywhere from 50 grand up to over $300,000, when you start analyzing by – from a unit perspective, it can show some distortion. And relative to – we think the revenue growth rate is a little bit more important when you look at the high-end systems.

Jeff Rosenberg – William Blair

Okay, fair enough. But I guess maybe, overall, I mean, what should we think about has been your increase in ASP, or I guess maybe we should just focus on that at the low end in terms of the skew towards the Elites there, but –

Shane Glenn

Yes, that's the right answer.

Jeff Rosenberg – William Blair

Okay, all right, thanks.

Scott Crump

Thanks, Jeff.

Operator

And you have a follow-up from the line of Andy Schopick of Nutmeg Securities. Please proceed.

Andy Schopick – Nutmeg Securities

One thing I would like to ask you about the consumables part of the business, because I just did a calculation, it looks to be like you've shipped cumulatively over 7,600 units beginning from 2003. And one would intuitively expect to see more of an accelerator to the consumables business. Are the units installed? Are they using consumables to the degree that you have expected over the years because certainly that cumulative installed base is growing nicely?

Shane Glenn

Yes, Andy, one thing you got to remember when you analyze the cumulative installed base is you've got to take into effect the machines that are falling out of that installed base. And –

Scott Crump

Over 20 years.

Andy Schopick – Nutmeg Securities

No, I'm just talking about since 2003, when the Dimension began shipping. So, I'm looking at the cumulative shipments that I've added up since the end of 2003. I think it was something like 690 in that year, or it was less than that, but I forgot that number. I don't have it in front of me right now, but –

Scott Crump

Andy, I don't think you can measure it by the day. I don't think you can measure it even by the month. You can measure and get some good trending over the year. And I believe it's still as we've seen historically about $3,000 to $5,000 per unit per year.

Andy Schopick – Nutmeg Securities

Okay.

Bob Gallagher

We haven't – one of the things that gets skewed quarter to quarter is the fact that we do sell our consumables through the reselling distributor channels. We said we were going to have some impact from those large distributed orders. We're expecting a higher expansion in the acceleration of that 14% rate that we mentioned for the rest of the quarter. So, we would agree with your comment that it would be something that we expect to see an acceleration on in the rest of the year.

Andy Schopick – Nutmeg Securities

Yes, I guess I would just observe that I would expect it to be a little bit more smooth in terms of that growth and that it would be more of an incremental steady a growth than what we –?

Scott Crump

I think it is at the user level, but since we're going selling in what 71 countries all exclusively through resellers, most of those resellers are not buying on a daily basis. In fact, they are a small, not big, but small stocking distributor in these various countries. So, you usually see those, and during many times at the end of the quarter, more on a quarterly basis. So, it becomes a little bit more lumpy at the – from the reseller. But I agree with you, it should be fairly consistent on a user – at the user level.

Andy Schopick – Nutmeg Securities

Because this clearly has been one of the appeals to the Stratasys story. And I think people are expecting to see that play out in a somewhat more dynamic manner.

Bob Gallagher

As do we, and that's why we made the comment that we expect higher growth rate throughout the rest of the year.

Andy Schopick – Nutmeg Securities

Thank you.

Operator

And your last question is from the line of Ryan Thibodeaux of Maple Leaf Partners. Please proceed.

Ryan Thibodeaux – Maple Leaf Partners

Hi, thanks. I just had one more follow-up question I forgot to ask you earlier. On the Dimension unit growth of 3% in the quarter, I understand that's up against a big 40% growth number last year and 50% something number in '06. Where do you see that trending over the course of the next several quarters? I mean, do you expect to get back to the double-digit growth rates or do you expect the price mix to – the price mix versus unit growth dynamics stabilize where it is now?

Bob Gallagher

Well, Ryan, I think we don't want to comment on that specific issue because it's going to be subject to what our plans are in the 3D printing business. As we've stated time and again, we think that the market is price-elastic and the demand is price-elastic and then that requires a certain pricing strategy, a more aggressive attractive pricing strategy. And so we don't want to comment exactly what we think are going to happen with units over the next several quarters near term because I think that could also suggest what we're thinking about doing in that business. And, secondly, I think, longer-term –

Scott Crump

Yes, definitely, longer term, we still believe that there's an opportunity for over 500,000 of the 3D printers. And to get there, you'll see some rise in prices, but you'll also see from Stratasys, over time, a lowering of prices running the price-elastic business model. We firmly believe that, even dedicated the cover for our annual report based on that. Stratasys is a lot about going after that price-elastic business model at the pace that the customer can accept it.

Ryan Thibodeaux – Maple Leaf Partners

Is that something you would do on current products or would that be a new product initiative?

Scott Crump

Oh, no, new products. And the reason for new products is we're able to engineer and through operations drive costs down significantly. We've been now seven years successful at that. And, then, as we achieve the lower cost on the products, then release them so that there's not a subsidy or, in other words, not a razor blade business model for a long time.

Ryan Thibodeaux – Maple Leaf Partners

Is there a target price reduction that you guys work to?

Scott Crump

No, other than you can go back in history and look at what was done in the 2D plotters and what was done in the 2D printers. We're basically following those, but not specifically.

Ryan Thibodeaux – Maple Leaf Partners

All right. Thanks for your time.

Operator

I would now like to turn the presentation back over to Mr. Scott Crump for closing remarks.

Scott Crump

Okay. Well, in closing, we believe that we are in the early stages of a tremendous growth opportunity. In addition to the proven growth opportunity within 3D printing, our high-end system business is showing signs of strong growth, driven by new opportunities with direct digital manufacturing. We look to maintain the positive momentum in our core businesses and expect the strong growth in our high margin consumables will continue to grow with our installed base. In addition, we are excited about other new product offerings and strategic initiatives that could provide incremental growth opportunities. So I would like to thank you for your interest in Stratasys and we look forward to speaking with you again in July.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect and have a great day.

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Source: Stratasys, Inc. Q1 2008 Earnings Call Transcript
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