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Stratasys, Inc. (NASDAQ:SSYS)

Q2 2008 Earnings Call

July 31, 2008 8:30 am ET

Executives

Scott Crump - Chairman, President and Chief Executive Officer

Bob Gallagher - Chief Financial Officer

Shane Glenn - Director of Investor Relations

Analysts

Troy Jensen - Piper Jaffray

Jeff Rosenberg - William Blair

Graeme Rein - Bares Capital

Ryan Thibodeaux - Maple Leaf Partners

Eric Martinuzzi - Craig-Hallum

Andy Schopick - Nutmeg Securities

Clinton Morrison - Feltl and Company

Steve Denault - Northland Securities

Amit Thomas - Capital Investment

Corey Johnson - Kingsford

Operator

Welcome to the second quarter 2008 Stratasys earnings conference call. (Operator Instructions) I will now like to turn the presentation over to your host for today's call, Shane Glenn, Director of Investor Relations.

Shane Glenn

Welcome to the Stratasys conference call to discuss second quarter financial results. Representing Stratasys’ Executive Management on the conference call today is the Chairman and CEO of Stratasys, Scott Crump and CFO, Bob Gallagher.

A quick reminder that today’s conference call is being transmitted over the web and can be accessed through the investor section of our website at www.stratasys.com. We will begin with the Safe Harbor statements. All statements herein that are not historical facts or that include such words as expects, anticipates, projects, estimates, vision, planning, believes or similar words that 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 is that we have the largest part-building service based on the number of dedicated machines. Except for the historical information herein, the matters discussed in this news release our forward-looking statements that involve risks and uncertainties. These include the continued market acceptance and growth of our Dimension product line, 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 rate experienced in this and preceding quarters, our ability to introduce in the 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 on 10-K filed 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 the US Generally Accepted Accounting Principles or GAAP. In addition non-GAAP financial guidance’s include and 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 compared to the performance. Primarily the identification and exclusion of expenses associated with stock-based compensation required under SFAS 123R.

We'd like to confirm the date of our third quarter earnings release and conference call. Stratasys' third quarter results will be released on or before the morning of November 4 2008, followed by a conference call on the same 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

We are pleased to announce our record second quarter financial results. Revenue grew 13% for our proprietary products and services in the second quarter and net income was also up 13% over last year. Our high-end FDM system business grew by 33% over the same period last year driven by new products and positive impact of our direct digital manufacturing opportunities.

We announce the large order for multiple 900mc systems during the quarter, which was a direct result of our efforts to strategically expand into direct digital manufacturing. Our proprietary consumable revenue increased by 17% driven by our rolling installed base of systems as we announced the installation of our 10,000 system during the second quarter. Paid parts demonstrated improve performance as revenue increased 25% sequentially over the first quarter.

Okay I’ll return later to discuss some of our strategic initiatives but first I would like to turn the call over to our CFO, Bob Gallagher who will further highlight our second quarter results; here’s Bob.

Bob Gallagher

Prior to discussing the details of our financial results, we would like to outline the relative impact of discontinuing our product distribution agreements. As we have previously outlined, we have discontinued the distribution of Eden and Arcam products which created certain issue when conducting year-over-year comparative analysis of our revenue growth and margins.

In the second of 2008 we recognized approximately 105,000 of sales related to these discontinued distribution agreements compared to approximately 537,000 in the same period last year. Total revenue increased by 11% to $31.2 million for the second quarter of 2008, compared to $28.2 million for the same period last year. Revenue from proprietary products and services, which excludes all distributed product-related revenue increased by 13% in the second quarter over the same period last year.

The company shipped 540 systems during the second quarter versus 564 last year. The decline in unit resulted from lower 3D printer unit volume. The decline more than offset strong unit growth in our high-end system business. Scott will provide additional commentary later in the call which will address the reason impact of promoting our higher priced printers as well as the impact of the weakening domestic manufacturing environment.

The 1200 SST, Elite and 768 SST, are three highest priced 3D printers, representing approximately 72% of our 3D printer unit volume during the second quarter. Second quarter product revenue as reported increased by 12% to $24.8 million when compared to $22.2 million for the same period last year.

Several factors influenced our proprietary product revenue during the second quarter. First, proprietary high-end system revenue increased by an impressive 33% 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 declined by 4%, a function in the lower unit volumes for 3D printers, which more than offset higher average prices compared to last year.

Third, our proprietary consumables grew by 17% during the second quarter when compared to last year, driven by our ongoing expansion of our installed base of proprietary systems. The 17% growth in consumable revenue we reported for the second quarter excludes any consideration for the consumable cartridges included in the 1200es operate kit announced in February for customers who had a non-es version of the Dimension 1200. We sold approximately 260 operate kits during the quarter.

Second quarter’s service revenue as reported increased by 7% compared to the same period last year. We recognized no distributed product-related service revenue during the second quarter, compared to 376,000 in revenue for maintenance contracts we recognized during the same period last year. Excluding distributed product-related service revenue total proprietary service related revenue increased by 14%.

Maintenance revenue from contracts and proprietary systems increased by 17% during the second quarter when compared to last year. The increase in maintenance revenue over the prior years is due to the 2169 system we added to the installed base in 2007. Our paid-parts revenue increased by 5% during the second quarter versus last year, which was a significant improvement over the 12% decline in year-over-year revenue for paid-parts during the first quarter. We should note that the paid parts business was also up to 25% sequentially.

Gross profit increased by 11% to $17.3 million for the second quarter of 2008 when compared to $50.6 million for the same period last year. Gross profit as a percentage of sales remained at 55.3% compared to the same period last year. Operating profit increased by 16% or $5.8 million for the second quarter of 2008 compared to $5 million for the same period last year.

Stock-based compensation expense required under statement of Financial Accounting Standards or SFAS 123R amounted to approximately 320,000 in the second quarter compared to a 179,000 in the same period last year. Operating expenses increased by 9% during the second quarter compared to last year.

The increase in operating expenses was led by a 43% increase in R&D expense during the quarter. We expect more modest growth in R&D expenses in the second half of the 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.

While we remain committed to these plans we have recently initiated some cost reductions that should lessen the overall level of operating expenses we had previously expected. Total interest and other income for the second quarter decreased to 382,000 versus 525,000 last year. The decline was a result of lower interest rates and higher charges related to foreign currency exchange.

Pretax profit increased by 12% to $6.2 million for the second quarter of 2008 compared to $5.6 million from the same period last year. Excluding stock-based compensation expenses, pretax profit increased by 14% to $6.5 million for the second quarter of 2008 compared to $5.7 million for the same period last year.

Income tax, as reported amounted to $2.1 million, a rate of 34.1% compared to $1.9 million or 34.7% for the same period last year. Excluding the impact of stock-based compensation expenses, income tax expense amounted to $2.2 million or 33.2% for the second quarter versus $2 million or 34.4% for the same period last year.

Net income increased by 13% to $4.1 million for the second quarter of 2008 or $0.19 per share compared to $3.6 million or $0.17 per share for the same period last year. Excluding stock-based compensation expenses net income increased by 16% to $4.4 million or $0.20 per share for the second quarter of 2008, compared to $3.8 million or $0.18 per share for the same period last year.

Our diluted shares outstanding declined by 125,000 shares from the second quarter of last year, a result of our lower stock price and share repurchases. Our cash and investment position amounted to approximately $49 million at the end of the second 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 cash used for stock repurchases combined with higher working capital requirements.

Year-to-date we bought back approximately 221,000 shares for approximately $4 million for an average purchase price of $17.88. We have approximately $26 million remaining under current repurchase authorization.

Inventory balances were $18.5 million at the end of the second quarter, which is up from the $12.8 million at the end of fiscal 2007 and up from the $17.6 million at the end of the first quarter. We attribute at the growth in our first quarter to four main reasons: A buildup of Dimension units in anticipation to 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, particularly 900mc’s in the second quarter as we commercially ship in Q3; a last time buy for legacy system inventory; and an increase in consumer volume until you to meet future customer demand.

In the second quarter we still have the effects from all the above. In addition we expanded our inventory for 900mc’s as we are now in non-commercial production in the third quarter. We also made additional strategic buys of consumable raw materials in anticipation of future lead and price increases. Accounts receivable at the end of the second quarter was $34.4 million compared to $26.3 million at the end of fiscal 2007.

Day sales outstanding or DSOs was approximately 100 days at the end of the second quarter compared to 89 days at the end of the first quarter. Our receivables at June 30 were at very high level. Obviously, it had to do with the timing of collection, but also the fact that many of our sales come towards the end of the quarter. While I’m disappointed in the number at June 30; I’m happy to report our DSOs have trended down in July and were under 90 days as of July 31. As I look forward to the end of Q3 I expect our DSO’s will continue to be under 90 days.

Total revenue increased by 12% to $62 million for the six month period end of June 30, compared to $85.6 million for the same period last year. Revenue from proprietary products and services which excludes all distributive product related revenue increased by 14% in the six month period, over the same period of last year.

Net income increased by 16% to $7.9 million for the six months of 2008 or $0.37 per share compared to $6.8 million or $0.32 per share for the same period last year. Excluding stock-based compensation expenses net income increased by 80% to $8.4 million or $0.39 per share for the six months period of 2008 compared to $7.1 million or $0.34 for the same period last year.

I’d like to summarize by going through the key financial highlights for the quarter. Strong growth in our high-end system sales and proprietary consumables driven by our new products in expanding basement solved systems, weaker 3D printer system revenue driven by lower 3D printer unit volume. Solid profit growth and a similar outline projected strong year-over-year profit growth in the second half of 2008.

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

Shane Glenn

Stratasys provided the following information regarding its financial guidance for the fiscal year ending December 31, 2008. We adjusted revenue guidance to $125 million to $130 million, from our previous guidance of $130 million to $136 million. We adjusted non-GAAP earnings guidance, which excludes stock-based compensation expense required under SFAS 123R to $0.79 to $0.84 per share from our previous guidance of $.81 to $0.89 per share and we adjusted our GAAP earnings guidance to $0.75 to $0.80 per share from the previous guidance of $0.77 to $0.85 per share.

Stock-based compensation expenses required under SFAS 123R, estimated at $0.04 to $0.05 per share for the year. Our revenue adjustments reflect a reduction in 3D printer system revenue for fiscal 2008 compared to previous expectations. Net income per share adjustments reflect a lower revenue expectation offset partially by a reduction in operating expenses compared to previous expectations.

Our earnings growth projections remained very strong. Based on the low-end of our revised guidance we are projecting approximately 20% growth in pre-tax profit in the second half of the year. This is an acceleration from the growth rate we experienced in the first half.

We’re conducting a year-over-year comparative analysis and we would like to remind the callers of the approximate portion for share in tax credits we recognize in the second half for the fiscal 2007. Appropriate reconciliations between non-GAAP and GAAP financial measure are provided in a table at the end of the press release. We provide the non-GAAP financial estimates for those analyst 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

Our second quarter results reflect our ongoing success with our new high-end precision systems, the FDM 200mc, 360mc, 400mc and 900mc. Customers are valuing this system for their improved functionality in making parts for prototypes and concept models, but more importantly have succeeded in targeting new direct digital manufacturing application with our high-end systems which is driving incremental system sales.

This success was highlighted by the large quarter we announce in July, we were at FDM 900mc systems. The 900mc, our largest added fabrication system is used expressly by customers for direct digital manufacturing. We estimate that approximately one third of all the high-end system sold during the second quarter will be utilized for direct digital manufacturing and sub-frequency.

I hope you can appreciate we remain excited about the emerging applications within the direct digital manufacturing as the second quarter results show we are generating significant incremental business from these new applications. Our direction within the 3D printing business over the past two years has been a departure from our longer-term vision of driving adoption through greater affordability.

Our recent strategy has included the introduction of higher-priced 3D printers that provide customers with improved functionality. This has produced some unanticipated results as our resellers have focused their efforts on these new systems, resulting in a disproportionately higher level of sales of our full-featured 3D printers compared to the lower-priced units.

While the strong sales of the higher-priced 3D printers have positively impacted our average printer prices and margins, total 3D printer unit volume lagged our expectations during the second quarter. We believe this trend reflects the difficulty in selling a relatively new technology to customers that are contending with a weakening domestic manufacturing environment and are less inclined to make innovative investments. We believe the new initiatives planned for 3D printing over the coming quarters will contribute to improve performance for this business.

We remain confident in our longer-term vision within 3D printing and believe a significant under penetrated market remains right for expansion. We continue to observe positive trends within our paid parts business as we’ve made organizational changes and implemented improvements in our sales and marketing efforts.

In addition to a 25% sequential increase in revenue over the first quarter, total registrations for our RedEye website increased by 43% and the number of new first-time customer orders increased by 53% compared to last year.

We are pleased to announce the installation of our 10,000th system in June to Peugeot Citroen, which purchased a high-precision FDM 400mc for the automaker’s engineering facility. We’ve now sold more systems in the past three years than in the company’s prior fifteen-year history. This expanding base of systems is contributing to the growth of our proprietary consumable, as well as maintenance revenue, which both increased by 17% during the second quarter versus last year.

I will return with some closing comments, but first I’d like to address any questions that you might have. Let’s open up the call for questions.

Question and Answer Session

Operator

(Operator Instructions) and our first question comes from the line of Troy Jensen with Piper Jaffray.

Troy Jensen - Piper Jaffray

A couple of quick questions here; Bob, I’m still going to focus on margins for a little bit, to start off with can you talk about, service gross margins were up substantially in the quarter, 65% from 53% in the prior quarter. I‘d just like an explanation to what drove that?

Bob Gallagher

Yes, there’s two factors it within that Troy. One, last year contributed had service margin in there from maintenance on object systems, which really had no margin whatsoever for us and secondarily the other improvement we have is the number of visit that we are making on our own customers per se has been down. All the other products have been extremely strong and there’s been a less requirement to make visit out there under our maintenance contracts with them. So, those two factors together are very positive for the quarter.

Troy Jensen - Piper Jaffray

Do you think 65% is a sustainable margin in your services business?

Bob Gallagher

I think this quarter was a little bit of an anomaly, but the trend is going to be positive for the remainder of the year relative to what we’ve seen historically.

Troy Jensen - Piper Jaffray

Okay fine and then if you switch to the product side here, your last year product margins were 56.3, this year its 52.8, you had great growth in high end systems and consumables and paid products and all of those are higher margin businesses and so can you just explain what’s driving the gross profit margin declines on the product side given the strength in the high end sales?

Bob Gallagher

We’ve talked it. We have a big variation of our margins from product-to-product, even within the high end systems, there’s a dramatic difference whether you’re buying in what I would call an three product of 360mc versus buying a high end of the 400mc. Also we’re still selling some of our legacy systems advantages going through there. What we saw within the mix, within the high end systems, is probably a mix that favored some of the lower margin products even within the high end systems. So it’s really a mix issue as it relates to Q2. I would suspect that as we go forward we would see improvement on that relative to the mix.

Troy Jensen - Piper Jaffray

Well how about with the 900mc and 400mc; are those at or above corporate average or are they just volumes still pretty lower or are they below currently?

Bob Gallagher

The 400 has a lot of different variations. The 400; it’s very upgradeable, there’s different modules people can put on and from a manufacturing cost stand point, it’s not a dramatic change for us. So even within the 400 itself depending on which model they are buying, there can be a dramatic difference in the 400c. At the very low end it would probably be slightly below the corporate average; you could certainly be well above the corporate average depending on that. So we just saw a mix in the quarter on the high end of it that favored some of the lower margin products within that what I would consider more introductory products for some of the people.

Troy Jensen - Piper Jaffray

Last question I’ll ask you. Bob you had mentioned and I think Scott you too about the cost reduction initiatives and some of the realignments in certain business segments; could you just expand a little bit on what you’re doing at the low end of the cost?

Bob Gallagher

Well obviously we’re looking at our discretionary spending as we move forward through the rest of the year. I made the comment specifically as it relates to research and development. In addition we did a small staff reduction effective yesterday internally here.

Operator

Our next question comes from the line of Jeff Rosenberg with William Blair. Please proceed.

Jeff Rosenberg – William Blair

Bob did you say what the percentage change was in units for 3D printers?

Bob Gallagher

No, I said that the revenue for 3D printer systems was down 4% quarter-over-quarter.

Jeff Rosenberg – William Blair

Okay. You’ve given us the unit number before, right.

Bob Gallagher

Yes, we said that it was a average fair price; units were down by 9%

Jeff Rosenberg – William Blair

And then also a number that I think you gave last quarter was the percentage of premium units in the mix. I mean that was pretty high already; I guess I’m wondering did it go even higher into 90s or how did that look?

Bob Gallagher

I did mention that number was 72%, so it was relatively similar to what we’ve seen.

Jeff Rosenberg – William Blair

Okay but you still feel like if you look at it sequentially or however it might be, there was more weakness at the low end of the 3D printers as oppose to incremental weakness kind of across the board if you well in demand for 3D printers.

Bob Gallagher

Yes, I think we saw a weakening in the domestic manufacturing environment and if I look at it relative to the marketplace, the weakness I think our high end systems were 72% of the mix in Q2 and I think last year they were also 72% of the mix, so the mix is comparable to last year.

Jeff Rosenberg – William Blair

Okay and then I think a quarter ago the feeling was that certainly your channel was aware of the economic weakness and concerned about it, but it wasn’t effecting their business. Can you talk about when during the quarter you started to recognize that; towards the very end of the quarter when you normally see a push or was it something that really we saw the weakness throughout the second quarter?

Bob Gallagher

As I think we’ve said before, we have a hockey stick within the quarter; there is a push in the month of June usually and we didn’t really see part of the weakness until the actual order was placed and running through our customers. It was late in the quarter that we were seeing the weakness and that’s why we didn’t say anything about the weakness when we were doing our first quarter conference call.

Jeff Rosenberg – William Blair

Okay and I guess from that perspective I was curious about then the DSOs increasing, because it did seem to suggest that you had at least your normal sort of quarter end pushes there, because that came where the high-end systems were, that was where the push was there?

Bob Gallagher

A little bit, but clearly our DSOs was way too high as of June 30, and that’s why I made the comments within the call to say that as we look at our receivable, at July 31, our DSOs are under 90 days as of the end of July, yesterday.

Jeff Rosenberg – William Blair

Okay, and then the last question is just another follow-up on the expenses. So, given what you're saying should we think in terms of on an absolute basis, the operating expenses going down into well maybe not the fourth quarter because I know there is usually a seasonal ramp, but as we think about that the third quarter do you see an absolute reduction in OpEx from versus Q2?

Bob Gallagher

We don’t give quarterly guidance. Obviously as I indicated we made some step reductions effective as of yesterday and early on we’ve implemented expense controls as soon as we saw the weakening happening. So, we’re doing things to control and that’s why I think our earnings guidance relative to the decline in revenue that we put in our guidance would indicate we’re going to control our expense level, but I don’t want to comment on the individual quarters.

Operator

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

Graeme Rein – Bares Capital

Hi Scott; could you talk a little bit more about the 3D printers. What might have caused that slowdown? Are there competitive pressures or there are just people putting off buying decisions. Do you think it’s a pricing issue? Can you just kind of talk a little bit more about how you’re thinking about addressing that slowdown?

Scott Crump

Well, we definitely saw a little bit of a softening of buying in the US primarily which is another way of saying that we saw some orders that are firm orders, but not necessarily by June 30, so a little bit of a pushing from Q2 into Q3. Beyond that Bob did you make any other observations?

Bob Gallagher

Well as we continue to talk within the channel, the channel still remains very optimistic, but what they’ve seen is a push up in some of the decisions from some of the customer base. Relative to competition, we think we’re continuing the have our market share and not losing the market share to anybody else at this standpoint.

Graeme Rein – Bares Capital

Okay and what about the pricing strategy. Does it make sense to rollout a lower end unit at some point?

Scott Crump

Well, essentially we believe that our final strategy is a good one. We do have within that strategy strong actions for this year as well as 2009 and on into 2010. So I think the vision is solid and I think the strategy is solid and really working more to work with the reseller locations and expanding the reseller locations globally.

Graeme Rein – Bares Capital

Okay and then I would imagine the higher end, the 900mc, the units used for DDM would use more of the proprietary consumable; do you have any data on what one of those units might consume in a year -- I know in the past you’ve talked about 3000 to 5000 as a good parameter for each unit; do you have any data on what a high-end system running sort of 24/7 would look like.

Scott Crump

Yes, to repeat 3000 to 5000 on the average for the company per unit per year out in the field, but products like the 400mc which not only operate a longer duration usually going towards 20 hours a day, 6 days a week, those are running in the $20,000 per system per year. The 900 is operating at a little bit higher rate than that, but I think if you use a number like that, 20,000 per machine per year, it would be close, but those machines are just now getting out on the field, so that’s just started to ramp up.

Graeme Rein – Bares Capital

Right okay and then the last question; I think you have $26 million left on the buyback at the end of the first quarter; when do you kind of plan on getting more aggressive in that regard?

Bob Gallagher

Obviously we can’t comment on about when we’ll be in the market and when we’re not, so I have to differ on that question.

Operator

Our next question comes from the line of Ryan Thibo with Maple Leaf. Please proceed.

Ryan Thibodeaux – Maple Leaf Partners

Bob, firstly can you give us the cash flow from operations number for the quarter?

Bob Gallagher

Yes, our cash flow from operations for the six months with high investments in inventory and the high receivable balance was about a negative $5 million.

Ryan Thibodeaux – Maple Leaf Partners

That’s for the six months.

Bob Gallagher

Yes.

Ryan Thibodeaux – Maple Leaf Partners

So, like three for the quarter. Okay and the clarification on -- I think the question was asked on Dimension units of revenue; did you say that revenue was down 4% quarter-over-quarter or year-over-year.

Bob Gallagher

Quarter-over-quarter for system revenue.

Ryan Thibodeaux – Maple Leaf Partners

Okay and then so that’s more like a 20% year-over-year number.

Bob Gallagher

I don’t have the year-over-year number in front of me.

Ryan Thibodeaux – Maple Leaf Partners

Okay and then the units were down 9%, that’s quarter-over-quarter also.

Bob Gallagher

Yes.

Scott Crump

That’s versus last year.

Ryan Thibodeaux – Maple Leaf Partners

That’s right.

Bob Gallagher

Excuse me, it’s over the second quarter of 2007; year-over-year.

Ryan Thibodeaux – Maple Leaf Partners

Okay, so 9% year-over-year and then the 4% revenue was quarter-over-quarter.

Bob Gallagher

No I’m sorry, that was year-over-year also. Shane clarified it for me. I misunderstood the question.

Ryan Thibodeaux – Maple Leaf Partners

So, both figures are year-over-year?

Bob Gallagher

Yes.

Ryan Thibodeaux – Maple Leaf Partners

Okay. Were any of the five FDM 9000, were those shipped in Q2 or was that just the order placed in Q2? So would that include revenue is the question?

Bob Gallagher

Some of those units did ship in Q2.

Ryan Thibodeaux – Maple Leaf Partners

All five or just some of them?

Bob Gallagher

No, there’s ones remaining to ship in Q3.

Scott Crump

Essentially we came up with a backlog and we’re in commercial production currently and we’re on schedule with that 900mc.

Ryan Thibodeaux – Maple Leaf Partners

Okay were there any inventory write-downs or adjustments in the quarter?

Bob Gallagher

There’s always a certain amount of inventory write-down in adjustments, but they were at fairly normal levels for us.

Ryan Thibodeaux – Maple Leaf Partners

So that didn’t impact the gross margin on products at all?

Bob Gallagher

No.

Ryan Thibodeaux – Maple Leaf Partners

Okay, its looks like there’s kind of as you talked about last quarter to seeing some slowness in the sell through on the order dimension units; did you guys have a strategy going forward; are you going to get more aggressive on price; are you going to try to move those out to a different channel or are you just going to kind of let them sit there and see how they sell through?

Bob Gallagher

Well, as I said before our short-term, mid-term, long-term final strategy is a good one and it remains unchanged. We planned to continue our success with evolving down the price elasticity curve on the mid-term and long-term with our vision and you it’s really more about awareness than it is about pricing and we have products as you know that our priced down below $19,000; so it’s more about awareness and having enough reseller locations globally and then making sure we’re getting penetration with each location, so that’s really more of where our focus is on the short-term.

Ryan Thibodeaux – Maple Leaf Partners

Okay, and lastly you made a comment about one of the reasons for the inventory build up is you’re doing some increased buying for your consumables and I think you had a comment about costs there; are you seeing increased raw materials costs for consumables and to what degree is that impacting your purchases?

Bob Gallagher

Our consumables is an extremely high margin piece of our business but we had an opportunity within the quarter what we saw and what we considered good pricing. Our consumables have an extremely long shale play to them. So we took advantage of the opportunity and nothing more than that. It’s a safety precaution more than anything else.

Ryan Thibodeaux – Maple Leaf Partners

Are prices going higher for you?

Bob Gallagher

They’re going slightly higher, but when you look at the relative margin that we get on the consumable, it’s not a significant factor on the overall margin piece of our business.

Operator

Our next question comes from the line of Eric Martinuzzi with Craig-Hallum. Please proceed.

Eric Martinuzzi - Craig-Hallum

Yes, I have a question about the macro commentary that you give. It seems like we’re at odds with our selves, the high-end being up 33% and then just supporting that with the weakening environment from manufacturing commentary; that was explaining the 3D printer decline. Could you elaborate on that please?

Scott Crump

Eric, the economy actually the way we see it is, it is impacting our high-end system business particularly for the RP applications and the prototype applications and we’re seeing slower growth there, probably with a single digits invested there for our RP applications. What’s happening here is on the high-end we’re making up for that with the new DDM applications and rapid manufacturing opportunities that we’re seeing with these new products. So we do not understand; it is kind of counter intuitive, but we’re really beginning to see significant opportunities in this DDM area.

Bob Gallagher

One of the things about the early adopters within the DDM, is it’s a lot of the people are people who are already aware of our technology. So, we don’t have the awareness fear whatsoever in selling at least in the beginning applications and the DDM longer term are going have to create more awareness. With the early adopters, the people are well aware of DDM and are much quicker to adopt.

Eric Martinuzzi - Craig-Hallum

Okay does the guidance assume these same issue that we saw in Q2 hold true, in another words continued strong growth on the high-end through the end of the year as well as I guess I would say negative comps for the 3D printers through the end of the year?

Bob Gallagher

Our guidance includes in there that we’re going to have a continued strength in the high end relative to our previous expectations and that we’re going to see a weakness in our 3D printing relative to our previous expectations.

Eric Martinuzzi - Craig-Hallum

Okay and I know you guys you typically do a channel meeting or a reseller conference every year; I don’t you had one of those in 2008; is there a plan to have one of those in 2009 and when would that be?

Scott Crump

We did have norms meeting earlier in the year in ’08 where we introduced the Dimension 1200es. Right now there is nothing on the calendar for the next meeting, but we absolutely will have a meeting most likely in the first part of ’09 similar to what we’ve done in past year.

Operator

The next question comes from the line of Andy Schopick with Nutmeg Securities. Please proceed.

Andy Schopick – Nutmeg Securities

Bob I want to ask you a couple of point questions that I normally ask and then come back to Scott. Can you give us international as a percent of revenue?

Bob Gallagher

International was about 47% of revenue.

Andy Schopick – Nutmeg Securities

Are you seeing any material change in the overall business outlook between domestic and international in terms of what these growth curves looks like here this year?

Bob Gallagher

Yes. Well in our growth curve internationally overall on a proprietary system basis we saw about 17% growth internationally and about 6% domestically…

Andy Schopick – Nutmeg Securities

Year-over-year?

Bob Gallagher

Yes.

Andy Schopick – Nutmeg Securities

Okay and can I ask you on the capitalized software again and the amortization in the quarter.

Bob Gallagher

Yes, that capitalized software for the quarter was 520,000 and the software amortization for the quarter was 338,000.

Andy Schopick – Nutmeg Securities

Okay, also consumables; have you folks ever given us the percentage of product revenue from consumables. You give us growth rates without kind of these base numbers, but I’d like to know whether or not consumables are over or under 20% of product sales at this time?

Scott Crump

Andy we haven’t broken that out.

Andy Schopick – Nutmeg Securities

Okay Scott let me come back to you on a general business question. The primary verticals that the company sells into are the automotive, the aerospace academic education in consumer; could you kind of rank those in order of relative importance in terms of the contribution to the company’s overall business at this time?

Scott Crump

Sure, there’s eight verticals including to what you said medical. I’d say, the consumer or some would say it’s the consumer and business machines and then probably next would be automotive globally, followed by probably aerospace, medical, education especially this quarter that’s usually their buying budgets in the education high schools and colleges. I would say that’s probably the ranking.

Andy Schopick – Nutmeg Securities

Okay and the last question is; has the total R&D reimbursement associated with the development of the 900mc now been received and was there any reimbursement in the quarter Bob?

Bob Gallagher

Yes that’s all been received and there’s no R&D offset in the second quarter.

Andy Schopick – Nutmeg Securities

None at all?

Robert Gallagher

None.

Operator

Our next question comes from the line of Clint Morrison, with Feltl and Company. Please proceed.

Clinton Morrison - Feltl and Company

Hey Bob, just following up on that last one; roughly what was the R&D reimbursement that came in the last couple of quarters? Trying to get a hand on how much this jump was, that reimbursement going away?

Bob Gallagher

I don’t have the first quarter number in front me. In 2007 though, the reimbursement was 194,000, so if you’re looking at year-over-year that gives you the comparison I think you need.

Clinton Morrison - Feltl and Company

197 in Q2?

Bob Gallagher

Q2 2007 194...

Clinton Morrison - Feltl and Company

194 okay and there was some sort of a trad-in credit that you guys had announced in this last quarter; can you give us a sense as to how many people took advantage of, that?

Bob Gallagher

Yes, we did trade-in. Some customers took it, but it was less than 4% and the unit volume was on a trade-in basis, so it’s more out there. We’ve used it to knock on additional doors, but not a significant portion of our overall unit volume.

Clinton Morrison - Feltl and Company

Okay and you mentioned upgrade kits, I think those 260 or something; how much did those sell for and what kind of margins did those support?

Bob Gallagher

The upgrade kit is for people who had bought a Dimension 1200 SST prior to the introduction of the EX, the extra strength version. At a retail level the end customer was buying those for $5,000 which included the kit and approximately ten schools that are consumables and obviously we share that revenue stream with the resellers, because the resellers are doing the upgrade, a few themselves.

Scott Crump

Ultimately we think that this will give us increased usage with this improved performance of the machine and hope that it will generate repeat business and positive deferrals; that was that the basis for putting those out there.

Clinton Morrison - Feltl and Company

So, do sales like that positively impact margins or negatively?

Bob Gallagher

It’s neutral, it’s 5 in a year.

Clinton Morrison - Feltl and Company

Okay and then finally kind of on a competitive standpoint, the low end system weakness, did you see any competition or you think the V-Flash availability is having any impact on you at all Scott.

Scott Crump

In Q2 the V-Flash was essentially invisible. We do believe that they’re still working on that product to make it a product; however as a competitor we’re viewing it as a serious product, but we believe it had no influence on it.

Bob Gallagher

We believe, we’re maintaining our market share out there.

Operator

Our next question comes from the line of Steve Denault with Northland Securities. Please proceed.

Steve Denault - Northland Securities

Just a follow-up to the question that was asked both the end-markets, the verticals served. You ranked them in terms of importance; can you rank them in terms of growth trajectory or slowdown?

Scott Crump

No. In every quarter for the history of the company, it has a fairly high variation. I think we typically from a strategic standpoint look at it on a year-to-year basis to get some real meaning out of it and then in that respect as we said in the conference call of the last two quarter that the education sector has probably given us the highest growth or percentage growth area, but it really does vary quite a lot. In the automotive area for instance, we’re seeing that shift over a four-year maybe five-year period for less sales in the three area, but then are disproportionately higher amount of sales in places like Germany and as far away as Shanghai, China.

Operator

And next question comes from the line of [Amit Thomas] with Capital Investment. Please proceed.

Amit Thomas - Capital Investment

Most of my questions have been answered and Bob you may have mentioned this in your opening comments, but can you give us an update on the ARCs?

Bob Gallagher

Sure. We ended the 1237 with about $17 million in ARCs, we ended the first quarter with a little under $7 million in ARCs and we ended Q2 with under $5 million in ARCs. We have two auction rate certificates left: one is Lorain County, Ohio, which is AA rated; the other one what I would call our problem child is Jefferson County, Alabama, which has got a CCC rating as it did at the end of Q1.

Just to remind people, we took a $390,000 charge Q1 related to that as well as evaluation reserve through the equity session of approximately 190,000. We’ve continued to monitor that and there’s a lot of information that’s flowing back and forth, but nothing definitive at this point in time, so we made no change in evaluation on it this quarter and the positive news within the quarter is that we have reduced our exposure by being paid off on some of our others ARC’s at $0.100 on the dollar.

Operator

Our next question comes from the line of Corey Johnson with Kingsford. Please proceed.

Corey Johnson - Kingsford

Regarding the incentives you’ve got, the trading incentives, when does that program end and what are your intentions going forward regarding incentives?

Scott Crump

Well, trade-ins we view as more of a tactical measure and we’ve been viewing those types of tactics off and on for 12 years in the company, so I think it’s really more of a third quarter tactical as opposed to some long-term strategy.

Bob Gallagher

And I think you need to look at it -- as I said it was less than 4% of our volume in the quarter on the 3D printers with related to discounts.

Corey Johnson - Kingsford

So, back to my question, does that program end at the end of the quarter or does it continue?

Bob Gallagher

We continue to look at our marketing strategy as it relates to the success of that program and are still evaluating that.

Corey Johnson – Kingsford

So that means it’s still going on?

Bob Gallagher

It is as of today.

Operator

There no further questions. I would now like to turn the call over to Scott Crump for closing remarks.

Scott Crump

Okay. We’re pleased with our second quarter results but we’ve adjusted our projections for the balance of 2008 based on the recent short-term trends. We continue to project strong profit growth for the balance of the year.

We have a great team, very good products and a growing market; we’re observing a strong growth for high-end system sales as our customers embrace new DDM applications and we remain excited about our numerous opportunities globally for our paid parts business. Certainly we remain excited about our end initiatives within 3D printing. Our 3D printing vision remains intact.

I would like to thank you for your interest in Stratasys and we look forward to speaking with you again in November.

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Source: Stratasys, Inc. Q2 2008 Earnings Call Transcript
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