Stratasys Ltd (SSYS) 2005 Q2 法說會逐字稿

Welcome to the Stratasys second-quarter earnings results conference call moderated today by Mr. Scott Crump, Chairman and Chief Executive Officer; Mr. Tom Stenoien, Chief Operating Officer; Bob Gallagher, Chief Financial Officer; and Shane Glenn, Director of Investor Relations.

At this time participants are in the listen-only mode. After the presentation a question-and-answer session will be conducted and instructions to participate will be given at that time. Please be aware that today's call is being recorded. (OPERATOR INSTRUCTIONS). I would now like to introduce you to your moderator, Shane Glenn.

Good morning and welcome to the Stratasys conference call to discuss second-quarter 2005 financial results. A quick reminder that today's conference call is being transmitted over the Web and can be accessed through our IR section of our website at www.Stratasys.com.

We will begin with the forward-looking statement. Except for the historical information herein, the matters discussed during this call are forward-looking statements and involve risks and uncertainties. These include the continued market acceptance and growth of our Dimension, Prodigy Plus, Maxum, Vantage and Titan productlines; the size of the 3D printing market; our ability to penetrate the 3D printing market and success in launching the Dimension SST and the market acceptance of this product; our ability to maintain the growth rates experienced in this and preceding quarters; our ability to introduce and market new materials such as polyphenol (ph) cell phone, PC-ABS and the market acceptance of these and other production grade materials; the impact of competitive products and pricing; the timely development and acceptance of new products and materials; our ability to effectively and profitably market and distribute the Eden line; and the other risks detailed from time to time in our SEC reports including Form 10-K for the year ended December 31, 2004 and Forms 10-Q filed throughout fiscal 2005.

We'd like to confirm the date of our third-quarter 2005 earnings release and conference call. Stratus' third-quarter results will be released on or before the morning of October 27th followed by conference call on the morning of October 27th. We'll release the conference call time and details about two weeks prior to that date. Now I'd like to turn the call over to our CEO, Scott Crump.

Good morning. Stratus has just announced the highest quarterly revenue, earnings and system shipments in the Company's history. Revenues rose 20% to a record $20.8 million for the second quarter of 2005 over the prior period in 2004. The increase was driven by strong growth in consumable revenue as well as record levels of dimension 3D printer and maintenance revenue. These portions of our business continue to exceed our expectations.

Overall we're pleased with our results year-to-date and we remain confident in our outlook for a strong growth for the remainder of 2005. The end-user demand for our systems remains strong which is reflected in our unit growth for the quarter. In addition, the reoccurring revenue components for our income statement continue to build steadily. Now I'd like to turn over the call to our CFO, Bob Gallagher, who will further highlight our second-quarter financial results. Here's Bob.

As Scott said, total revenue increased by 20% to 20.8 million for the second quarter of 2005 compared to 17.3 million for the same period last year. The Company shipped 351 systems during the second quarter of 2005 compared with 281 systems during the second quarter of 2004. Product revenue increased by 23% to 16.9 million for the second quarter compared to 13.7 million for the same period last year. The growth in product revenue was driven by a record level of Dimension 3D Printer shipments generated during the quarter as well as strong growth in our consumable business which expanded by 65% over the second quarter of last year.

Service revenue increased by 7% to $3.9 million for the second quarter compared to 3.6 million for the same period last year. The growth in service was driven by a record level of maintenance revenue generated during the quarter. The growth in maintenance revenue was largely offset by slower than expected sales within our paid parts business.

Despite the 20% revenue growth for the second quarter, our total system sales into the European market declined by 5% in the first six months over the same period last year, a result, we believe, from the current weak economic environment in Europe. Conversely, sales growth in our domestic and Asia-Pacific markets remained strong during the second quarter.

Despite the weak economic environment in Europe, total sales of our high-end systems, which rely more heavily on robust markets for capital equipment, grew during the second quarter. High-end system sales were driven by solid growth in our legacy FDM systems including Prodigy Plus and Maxum. However, our distributed product, the Eden Poly Jet system, generated the biggest increase which obviously carries a lower gross profit margin for us than our manufactured products.

Gross profit increased by 16% to $12.2 million for the second quarter of 2005 compared to 10.5 million for the same period last year. Gross margin as a percentage of sales declined to 58.6% from 60.5% for the second quarter of last year. A mix of system sales that favored our lower margin products, including record sales of Dimension 3D Printers and the Eden Poly Jet systems, negatively impacted gross margin. In addition, gross margin was negatively impacted by the weaker than expected paid parts revenue which is typically one of our higher margin businesses.

Operating profit increased by 3% to $3.6 million for the second quarter of 2005 compared to 3.5 million for the same period last year. Operating expenses of $8.5 million for the second quarter were essentially in line with our expectations and compare to 7 million for the same period last year. Operating profit as a percentage of sales declined to 17.6% from 20.4% for the same period last year. Investments we are making in new products and channel development combined with a mix of system sales that favored our lower margin products offset the favorable margin impact of rapid growth in consumables and maintenance revenue during the quarter.

As we have articulated on previous conference calls, we expect operating expenses will continue to track materially ahead of comparable periods as we move through fiscal 2005. This is driven by higher R&D expenses as well as higher expenses associated with expanding our operations.

Interest and other income for the second quarter increased only slightly over last year. The significant increase in interest income resulted from our strong average cash balance during the second quarter. This was partially offset by an unfavorable foreign currency translation of $246,000. This compares to an unfavorable currency translation of 98,000 in the same quarter last year.

Effective at the end of the second quarter, we have increased our foreign currency hedging to reduce our income statement exposure to future currency fluctuations. Pretax income increased by 3% to $3.7 million for the second quarter versus 3.6 million for the same period last year. Income taxes amounted to 853,000 for the second quarter versus 1.2 million in the second quarter of 2004. The tax liability recognized for the second quarter of 2005 reflects an adjusted effective tax rate year-to-date of 34.25% compared with the 37% rate used in the first quarter.

In addition, we recognized a $325,000 income tax benefit in the second quarter for filing adjustments identified to our 2004 and 2003 tax positions. These discrete adjustments pertain to the methods used to compute our research activities or R&D credit and our extraterritorial income exclusion or EIE benefit in both 2004 and 2003.

Net income including discrete items grew 21% to $2.6 million or $0.27 per diluted share for the second quarter versus 2.4 million or $0.22 per share diluted for the same period last year. Our balance sheet continues to be very strong. Our financial strength is a competitive advantage and as a company we have decided to use our financial strength strategically to grow the business as we see opportunities. Although it represents a small part of our overall business, we maintain a leasing program for Dimension 3D Printers that is comparable to the leasing program that we successfully implemented in 2004. We currently have approximately only 150 to 160 machines under lease agreements.

Our cash and investment position amounted to 55.8 million at the end of the second quarter. The decrease in cash from the first quarter of the year is primarily reflected in changes in our operating assets. Accounts Receivable was $19.2 million at the end of the second quarter, an increase of 3.9 million from March 31, 2005, reflecting the higher sales volume in the quarter as well as some impact from our sales demo unit program where we provide resellers 180 day terms on demo unit sales.

Days sales outstanding decreased to approximately 81 days compared to 95 days for the second-quarter of last year. This DSO is calculated by eliminating the effect of our leasing program. Starting in fiscal 2004 we offered a special program where resellers could purchase two Dimension systems, one BST and one SST with extended 180-day payment terms. The voluntary program provides the resellers with a valuable selling tool and marketing tool to sell multiple systems.

The program has proven to be highly successful as Dimension orders have exceeded our expectations throughout the year. However the program results in the Company carrying substantial accounts receivable balances which elevates days sales outstanding during part of the fiscal year. As reflected in our 2004 year-end days sales outstanding, virtually all the demos sold last year under the extended payment terms programs were sold to end-users and paid for by the resellers.

Given the success of last year's Dimension demo program we offered a similar voluntary program at this year's annual reseller meeting in February. The initial order activity within our Dimension resellers including the demo program improved substantially over the previous year. And while we expect to experience a similar spike in DSO's outstanding during fiscal 2005 as a result of the program, we believe fiscal 2004 proved the program's value and manageability. Moreover, we believe this year's high level of participation reflects our resellers confidence in maintaining strong sales momentum throughout fiscal 2005.

Inventories increased to $10.2 million at the end of the second quarter from $8.2 million at the end of the first quarter of the year. Principally to ensure adequate supplies of systems and consumables. In particular we have increased our inventories of both our Dimension 3D Printers and Eden products to meet a continuing demand. At the end of the quarter we also carried a higher-than-expected level of high-end systems that have been forecasted to be either sold into Europe or utilized in our paid parts business.

Net property and equipment increased to 10.9 million at the end of the second quarter compared to 10.5 million at the end of the first quarter this year principally reflecting strategic investments within our Company. We are pleased with our performance over the first six months of 2005; we are positioned to make strategic use of our strong financial position as reflected in our Dimension demo and leasing programs. Going forward we will focus on growing our existing businesses, investing in projects that will strengthen our leading position within the RP and 3D printing industries and reporting increased earnings and profitability.

Now I would like to hand it over to our Director of Investor Relations, Shane Glenn, to update our financial guidance.

Thank you, Bob. Stratasys has updated its fiscal 2005 financial guidance as follows -- the Company reconfirms expected revenue of 84 million to 89 million or 20% to 27% growth over fiscal 2004; operating margins are anticipated to be the range of 18.5% to 25.5% versus the previous target of 20% to 22%. The shift reflects the weaker performance in our paid parts business and a shift in product mix to our lower margin systems.

The tax rate, excluding discrete tax benefits, is expected to be 34% to 35% versus the previous estimate of 37% to 39%. The impact of the known discrete tax benefits will reduce the expected annual effective rate to 31% to 32%. The Company reconfirms its expected earnings of $1.07 to $1.12 per share or 26% to 32% growth over fiscal 2004 which includes the second-quarter discrete items outlined in our press release.

While we currently expect our business to remain strong throughout 2005 we attempt to provide guidance that incorporates our current growth expectations coupled with the limitations of predicting our operating environment over the next several quarters. Now I would like to turn it back to Scott Crump for closing comments.

Thank you, Shane. I think I'll pick up the handset here. Currently there are less than 15,000 rapid prototyping and 3D printing systems operating globally yet there is a growing universe of 5 million 3D mechanical CAD software stations being used by designers and engineers, more and more of whom are beginning to view rapid prototyping as a critical part of their design and engineering processes. We believe this creates an addressable market for at least 500,000 3D printers at the right price and we are confident in our early entrance and whole product solution approach to this market application -- that it will provide us a significant competitive advantage.

Our 3D printing business remains on track which is evidenced by the record level of Dimension 3D printer revenues generated during the second quarter. As Bob mentioned, the Dimension program, which provides resellers with two Dimension 3D Printers on extended payment terms is in its second very successful year. The program has proven to be a valuable selling tool for resellers as channel productivity has continued to improve.

We recently announced the launch of our second annual extreme redesign called the ultimate 3D printer challenge, a global design and 3D printer contest for high school and college students that will award scholarships to student designers. The program provides heightened visibility of our dimension 3D printers within the education market, one of our faster growing market applications within 3D printing. These programs have expanded awareness and improved reseller productivity. In the future we'll continue to introduce new and innovative 3D printers that will provide greater functionality for end users at more affordable price points.

Our paid parts business remains an emerging opportunity for strong Stratasys growth, but also maintains a growth pattern that is consistent with an early stage initiative. We are implementing several marketing programs that will -- or we believe that will drive incremental order volume through that business going forward. Our outlook for high-end productivity RP systems remains strong.

Despite the weak economic environment, as Bob mentioned, in Europe, we have begun to explore rapid manufacturing opportunities for our core FDM technology which we believe is a strong long-term platform. We also believe that our P-Class line will serve as a platform for developing this emerging application. We also believe that our rapid manufacturing applications will grow from about the 10% position of our high-end business currently to eventually 50%.

Based on the success of the Eden at 333, we added another Poly Jet system to our offering of rapid prototyping systems in North America during the first quarter. We now offer the Eden 260, a compact photopolymer jetting system manufactured by Objet Geometries. Given the strong growth of our distributed poly jet systems in the second quarter, we continue to be encouraged by this product's growth potential and the best of both worlds program as it sells along with the FDM system.

Well, regardless of the application, as our products become more pervasive across multiple industries we expect to continue to increase consumable and maintenance contract revenues, a business that should provide substantial operating leverage going forward. In summary, we believe we are positioned for strong sales and profits throughout the rest of 2005 as we continue to innovate and expand our product continuum. At this point I'd like to -- we'd like to address what questions you might have.

(OPERATOR INSTRUCTIONS). David Cohen (ph), Midwood Capital.

Just one question. Scott, would you repeat that comment you made about some component of the business moving from 10% ideally up to 50% someday? I missed that.

Yes, let me back up a little bit. As the Wurther (ph) report indicates -- they're the industry experts -- they believe and have believed for quite a long period of time that the use of the additive technologies, which we're a leader in, will drive into the application of -- the use of rapid prototyping, this technology for the use of short run rapid manufacturing.

So for the last few years, three years, we've grown the sales of our primarily T-Class systems, but our productivity systems up from 0 to 3% to 5% to -- in the range of 10%. And we believe that going forward that will continue to grow to a number that's over 50%. We don't know when that is and the industry experts don't either. But others in the industry -- other vendors of systems will also show that they have those applications and, of course, this is incremental growth to our overall business plan.

Can you maybe comment on any changes you might be seeing or might expect to see in the competitive environment in the 3D printing space with one of your competitors having merged with another and obviously another competitor coming out with some new systems? You don't talk about what you feel about total system growth; you don't talk about rate of Dimension system growth which in some prior quarters you talked about. But what are you seeing with the rate of Dimension system growth?

As I've mentioned in the past, certainly the number one issue within 3D printing -- although it is a very, very strong engine for the Company -- is awareness. The awareness that a desktop, easy to use, low-priced $25,000 type system is available with a one button, pushbutton from McCAD to build RP right in the engineering office. Awareness is the single biggest issue. There really haven't been that many changes over the last year. Obviously we've adjusted our elastic business model, price point of the SST. 3D systems has come out with the distribution of an Israeli product called solid dimension; but that's been out there for actually a couple of years and it has real limited applications.

Then as you mentioned, the merger of Z Corp with another company, but beyond that there hasn't been very many other shifts. It has been primarily opening up new applications, new geographic areas. We are putting on our dimension university as we speak in China right now to train our existing and new resellers that we have there. Shane, maybe you can comment briefly on the merger that recently came out.

Yes, Dave. We're starting to obviously spend some time looking at that and analyzing what we think that means for us, but just to reiterate what Scott said, it is a big playing field here and there is a lot of room for a lot of players in the 3-D printing space. We can't really speak to the motivation of our competitors and why they do certain transactions. We suspect it may be -- part of the motivation there might be reaching critical mass, some distribution leverage opportunities.

If there is one competitive advantage that we certainly have in the 3-D printing space, in addition to the whole product offering that we have with the dimension 3-D printer, is we have an incredible channel put together for the distribution. I think that part of the motivation there could be to gain leverage from a distribution standpoint, and there might be some motivations there as far as liquidity for current investors in the Company, but once again, it is hard to speculate on all of the reasons why they would do a certain transaction.

Your dimension sales grew, I think, 73 or 74% last year. I don't know, we have never talked about what the base is. So just dealing in strict percentage terms, what kind of rate of growth is implicit in your forecast for dimension sales this year?

In terms of our guidance and the product mix, what we have been giving and historically as well as going forward in the future is just guidance on the overall revenue as opposed to the individual components within those.

We haven't itemized for competitive reasons.

Okay. Thanks, guys.

Andy Schopick, Nutmeg Securities.

I'd like to follow up the question on the recent merger with Z Corp in context, and just ask you if you could comment a little bit about the anticipated impact that you might see in your channels as this company which reportedly will have combined revenues of about 100 million begins to enter the market, particularly in the 3-D printer side of things.

Well, in general, the scanner company that was merged with is not in our space. They are not anywhere near the design engineering space that we sell into. So I don't initially agree with the synergy there. There may be some interesting synergy from a stock market standpoint or something like that, but their primary expertise at Z Corp is focused on the education market, as you know, and ours is education and the commercial. But beyond that I'm not sure it's really that appropriate for us to be commenting. Z Corp can certainly comment.

Okay. Bob, a couple of quick questions for you.

And if I could tag onto Scott's comments; a quick scan of some of their Web information indicates that they -- contacts only has five distributors in the U.S., so it's not going to dramatically expand their presence.

Well, I would anticipate that they'll open additional channels.

Absolutely. But one of the things that we'd like to highlight is that we spent millions of dollars and three and four years of efforts to develop the channel that we have and we still continue to believe that that's a competitive advantage for us.

Okay. Did you report the number of sales demo units that were shipped? I think you've given that in prior quarters.

Andy, I think last year we had mentioned a range of demo units that was around the 175 to 185 range. We did indicate in the first quarter that we had increased that substantially following our reseller meeting in the first quarter. And just to anticipate one of your questions, because we did look into this prior to the conference call this morning, a majority of those demo units that were sold in the first quarter have already been passed on to end-users and resellers are reordering demo units at variable rates.

And that's per plan.

Yes, that's per plan. As we've said in the past on past calls, we kind of anticipate resellers to have a demo unit, keep it for six to 12 months, rotate it out and then be prepared to buy an additional demo unit for a selling tool after that time. So if over 50% of those that we initially sold in the first quarter have already been passed on, I think that we're on track to what we've seen in the past.

Well, that's the good news. I just wondered whether you could be more specific in terms of the actual units shipped.

No, we're not going to provide that number.

Last question for Bob. Provision for bad debt, given that receivables are increasing and payment terms are being extended pursuant to the sales promotion program, I'm surprised that there was no increase in the provision for bad debt and at some point there's generally a formulaic approach that companies take to the receivable balances outstanding and as they grow. I would anticipate that there's going to be some adjustment to this number before the year's over. Any comment about how you go about establishing any change or increase in the provision?

Yes, we have a two-tier methodology on establishing our allowance for bad debts. And one, as you guessed, is a formula driven, looking at the aging of the receivables and making provisions against that. In addition to that, we look at individual accounts once they reach a certain point and we evaluate with them individually to determine whether we think additional reserve is required beyond the provision generated by the formula.

If you look at the provision, obviously it hasn't grown substantially from what you looked at previously, but we also had write-offs within the quarter direct that -- in the receivables. So in the quarter we had about a charge of 248,000 of bad debt charges in the quarter. So we have increased in the quarter the overall expense.

Okay, I was just looking at the allowance that I see on the balance sheet which was unchanged from prior quarter.

Sure, but if you look at the allowance and if you make specific write-offs, obviously I could have left it on the books and had the allowance higher. The net effect is that we are looking at both the formula-driven method about establishing our allowance as well as specific identification.

Thank you.

Megan O'Callahan (ph), SG&A Capital.

This is Glenn for Megan. Can you guys just give us a little more color on the operating margin guidance? It's a little bit worse than I would have thought. You touched on it a little bit in the remarks, but can you just give us a little more granularity on what's creating the gross and operating margin pressure? And then also, I think you guys just touched on it briefly on Europe being a little bit weaker. How much of your business comes from Europe and what do you guys expect for Q3 as a whole? Is there seasonality with your European exposure or what are you guys expecting for Q3?

Taking the first part of that question in terms of operating margins is we're seeing a little bit of a change in our product mix. Clearly we're having significant growth in our Dimension which is a little bit lower margin than some of our high-end systems. And if you look within our high-end systems, we're seeing a little bit of a shift to our Eden. And in addition, the other thing that we commented about was our paid parts business which is one of our higher margin businesses -- was down from what we anticipated it would be. Year-over-year it's still a good business.

Looking at Europe, Europe does have a seasonality to it in the second half, particularly the third quarter for Europe tends to be a weaker quarter. We expect some recovery in the second half, but at this point that's probably the number one question that we have within the second that.

Is what Q3 will be?

No, what -- Europe in general in the second half -- what that will provide for sales. That's the biggest question mark we have because it's relying so much on the European economy.

How much of your business comes from Europe?

Typically in any given quarter it would be 20% to 25% of our business. Again, as Bob has highlighted, it was extremely weak for our high-end systems in Europe. We're already seeing some increased interest particularly in Germany for our high-end systems. And I think that it will improve in the second half and management will be making lots of visits to our distributors in that territory to attempt to ensure that that happens.

We've also added resellers in several key countries and we expect to see some growth from our Dimension productline in those countries once the resellers get up and get established.

I'd like to tag onto that -- you may recall during -- a few years ago when we had a fairly deep recession in capital equipment we actually had good strong growth in our low-end, low-priced 3D printers which more than likely will happen in Europe. But it's the big question.

Thanks a lot.

Troy Jensen, Piper Jaffray.

Congrats on the nice quarter, gentlemen. A couple quick questions. Can you talk about Objet consumable usage? If that business is doing better than expected, can you just let us know what those users typically use on the consumable side?

Objet users, Troy, use a lot of materials. It tends to be a system at the higher end -- our other system. So it is a machine because it's a very reliable machine and users tend to run it very, very hard. It uses up a lot of consumables.

Any way you can quantify it? Is it up by 20,000 per year, north of that, or any other flavor would be helpful.

I don't think we want to quantify that right now, Troy.

And one of the things, when you look at it from our perspective, the consumables on the Eden is also a distributed product so it's hard to make an apples-to-apples comparison versus something that we manufacture directly ourselves.

Okay. Any sense why paid parts is weak? I remember fourth quarter you thought it was around seasonality, but why in the second quarter would that be (multiple speakers) unexpected?

It's a good question. It's a merging -- really a startup. I've been involved with quite a few startups and it has the normal interesting -- looks like a startup. We have probably five different interesting initiatives, four here and one in Europe, and we don't have -- the definition of a startup is where you don't have a precise business model. You think you do but you don't really have a precise business model nor exact drivers, but we're getting closer and closer to knowing exactly what the drivers are, what the exact marketing is and it's an exciting area with very, very good strong growth potential.

Two of the biggest interesting areas that I see in it is the ability to help our system customers that run projects that are peak and valley projects by definition in R&D. And when they have a peak we cover their peak demand via the e-commerce and via FedEx. And the second area is by knowing the actual usage per any given 12-month period, we can also do profitable prospecting of that paid parts business into the sale of systems. That's kind of our overall growth situation with paid parts.

Two quick questions, one for Bob, one for Tom. Tom, you mentioned five distributors or contacts. Do any of those five overlap with yours?

No.

Okay. Short and sweet. And for Bob, gross margin guidance, can you give us any directional comments here? Do you think gross margins have bottomed here and will move (technical difficulty)? Any thoughts would be helpful.

No, I think while we appreciate you'd like to break each line down within the financial segments, I think we need to stick to our guidance down at the operating income level as opposed to the margin level.

Keep up the good work.

Clint Morrison, Feltl & Company.

Great quarter. Sort of getting back to the mix and the numbers and, I think you said it, did we see unit growth in the high-end quarter-over-quarter?

Yes.

Okay. But obviously the growth came at the lower end is I think what I was hearing. Europe, I think you indicated you gave a 5% down kind of a number. Was that units or dollars?

That was the dollars for our system sales.

Okay. So that was the dollars. Let's see, bouncing around -- tax rate, just to confirm, I think you gave guidance that it's 34 to 35 for the upcoming quarters and 31 to 32 for the year.

Right, and the differential between those two is the discrete items of the $325,000 benefit that we recognized within the current quarter.

Okay. And on the promotion you did for the -- on the Dimension units, and I recognize you don't want to give out numbers, but in terms of you've got a lot of orders in Q1 relative to last year, did we in the second quarter ship a comparable percentage or more of that kind of bold first-quarter orders this year than last year?

Clint, are you just talking about Dimension units in the second quarter?

Correct. We had obviously big orders in the first quarter, a lot of that ships through and gets recognized in the second quarter. I'm just wondering if we shipped and recognized a higher percentage this year because we probably had a little better visibility than we did when we did the program the first-time last year.

I think that, as we said on the last conference call, given the backlog that we had going into the second quarter implying that we were going to be shipping a lot of Dimension units in the second quarter and that's what happened.

Okay. So we were more effective at shipping out that demand this year than last year?

Yes.

On a percentage basis?

Yes, I think it's reflected -- in the quarter we shipped 351 systems compared to 281 in the previous year.

Overall.

Overall.

I was just talking about the percentage of -- in that program the percentage of those that actually got out the door this year was higher than last year.

I think, yes, that's correct. If we understand your question, yes.

That takes care of me. Thanks.

Jeff Evanson, Dougherty Financial.

I'm trying to understand the operating margin and tax guidance here. Is that going to be a new -- let's start with the tax. Is that going to be an ongoing new tax level?

What we tried to give was the guidance for the year to say -- we said in the quarter we had a discrete item that's a tax benefit of 325,000. Exclusive of that the effective tax rate for the year we expect to be at 34% to 35%. And that's a comparable number to the 37% to 39% that we gave previously.

Right. And so the 34 to 35 is -- basically what I'm getting at is that what we should model in '06? Are these permanent changes in your tax structure?

(technical difficulty) during my time here, but I haven't gone out and modeled out the 2006. And clearly we haven't given 2006 guidance at this point.

Sounds like we need to -- we need to work on that.

So most of the reduction in the operating margins is it's really just attributable to the gross margins being down in this quarter. And you expect that to be what continues into the back half I take, right?

You've got a combination -- as we said, our mix within the quarter led to some of our lower margin products relative in our business and what we're seeing. We're looking at our overall level and, again, we've reduced our guidance on the operating income line.

And Jeff, the other issue is the paid parts business. As we'd indicated in the call, the revenue there -- we invested there, we expect it to be a nice business for us going forward. We didn't get the growth we expected in the second quarter. And as you are aware, it's an incredibly high margin business. That would obviously have an impact.

I'm a little confused about high-end units in Europe. They were weak in Q2, is that correct?

Yes, that's correct.

You expect they will improve in the back half, but seasonality, which typically happens in Q3, is your biggest question on how well that could improve.

We commented on the European economy and then I think what we've done is we've made some forecast estimates showing weak productivity high-end systems, but more than likely strong 3D printing Dimension systems which we have seen now during the last recession. So I think that's fairly good and the sales team believes it's a good assumption.

Okay, I got that.

I just want to add on to that. I didn't mean to imply that Europe was our biggest -- the seasonality in Europe was our biggest question in the third quarter. What I meant to say is that the economic environment within Europe is probably our biggest question in the second half of the year.

Okay, got it. So a little bit more of a macro than a seasonal pattern.

And also as we've noted, we saw and we're seeing for the remainder of 2005 some real strength in the other regions U.S. and Asia seems to be going very, very strong. China is very strong. So you might be seeing some good makeup there.

You talked about -- when you made your comments about gross margin decline you indicated that a shift in 3D printing was part of that GM decline. Am I to assume that that means you've had some shift back from SST to BST, which I've always believed is a little bit lower gross margin product.

It's definitely product mix shift -- does one of you guys want to detail more?

No, there was a shift and it was a favorite shift towards SST's with percentages dramatically higher for the convenience of our water works solution on the Dimension productline.

So the trend we saw in Q1 is carried into Q2?

Oh, absolutely.

I think, Jeff, what we were referring to is the fact that when you look at the overall mix in Q2 versus Q2 of last year, we're obviously selling a lot more Dimension 3D Printers. And Dimension 3D Printers, as we've indicated, relative to some of our other high-end systems, have lower gross margin whether it's an SST or a BST.

Right. And the obvious elastic business model is high-volume.

Got it. When you talked about SG&A being up, you mentioned some operations expansions. Can you elaborate on where and what those expansions were?

We're expanding our marketing efforts and channel development efforts overseas as well as domestically, signing up some additional resellers or actually culling some of the lower performers and that's an ongoing -- on an ongoing basis. We're also investing in some of our IT infrastructure where we've identified that as an opportunity for us -- and actually a requirement for us to ensure that IT doesn't become an impediment to our future growth we have brought on a new IT director. We've also brought on internally and will continue to attempt to expand our leasing program. A lot more focused and in fact an executive that is concentrating on leasing. So those are the types of activities that should be reflected in that SG&A line.

Also consistent with our comment that we think the number one impediment to the sales is the awareness is we substantially increased our advertising year-over-year.

So while we're on leasing, I noticed that leasing really has been -- the receivables anyway have been quite flat in the first-half of the year while your sales have been growing strongly. Why have you -- obviously you're doing less leasing relative to sales I would assume. So have you backed off on leasing or is it just waiting for this new guy to come on and get his initiatives in place? Or is it just something in the numbers I'm not understanding?

The numbers that you are interpreting do reflect some of the current trends. I can assure you we are committed to leasing. We think it's a very valuable tool to grow our business. I think the biggest issue causing a little bit of the sluggishness in that area involved our internal processes. We've streamlined the processes, we've eliminated unnecessary ones. We've identified the bottlenecks -- became the number one issue identified by our resellers was the length of time it took to get a lease through and we're committed to dropping that time lag dramatically in the coming weeks.

So you'll be able to lend at a faster rate now?

Absolutely.

On the hedging, the foreign currency hedging, no change to the program, just expanding it or what?

No, what we do is -- historically what we had done is we carry euro receivable balances and historically we have hedged a portion of the receivable balance and now we've taken --.

With some debt, right?

Actually they're called forward contracts. And what we've done is we've increased the amount of the forward contracts that we're buying to be more matched to our actual receivable balances.

Okay. So what percentage of your exposure do you think you have hedged now?

At the end of June I would say I was very close to 100%. Going forward.

Just the sales of the euro which isn't all of Europe even.

Just a couple more questions. I appreciate your patience with all this. So inventories are up due to higher end products in Europe?

No, inventories are up predominantly due to our requirements to bring on a long lead item which is the Objet systems that we actually take ownership of when it leaves Objet's dock. In addition to some of the softness in the T-Class high-end systems that we mentioned, we had built up for a higher forecast and we anticipate selling those. Lastly, some of the systems that we are anticipating going into the paid parts business because of some of the sluggishness mentioned earlier we do not transfer over.

And that's a temporary Q2 type of transfer.

We hope that's a very temporary situation.

Last question. I did just happen to notice that intangibles are creeping up just a little bit. What's driving that?

If you look at the investment that we make within our research and development that we gave, we're clearly spending more in that area and creating some intangible assets.

So you're capitalizing some of your development costs.

You're required at a certain level to do --.

Okay. Thank you very much.

Brian Bears (ph), Bears Capital Management.

Bob, just two things. What's year-to-date CapEx and what's your budget for the year?

I don't have that in front of me. I think CapEx for the year was running somewhere -- I don't have that in front of me and I'd hate to give a number out over the phone that I'm --.

Brian, call back after the --.

That's fine. And then what is the 3.3 million in long-term investments that you've got.

What we've done, given our cash and investment position, we have some maturities actually of AA-rated municipal bonds that have maturities longer than a year.

Just extended over a year. Okay, great. Thank you.

Brion Tanous, Merriman & Co.

Can you give me the number of reseller locations you're currently at if you haven't already?

We're over 145 now, Brion.

You're over 145, Okay. And you did increase some dealers in Europe?

Yes.

And what part of Europe was that?

Predominantly Italy. We've also recently increased some in Asia. We're, as you may know, really more focused on the finalization of our productivity program. I believe with our last Dimension University class is going on right now in China and I think you'll see in Q3, and Q4 a refocus in on more of the growth of the locations whereas in the past year most of our focus has been on productivity and working with those resellers that are committed.

Was education strong again relative to the other sectors?

Education continues to be one of our stronger verticals.

Do you have more demo units to ship to dealers in Q3 or have you flushed them all out in Q2?

Well, we have a program and so there is like a two-part answer. When we either have a new marketing initiative like we had with the price point and the whole product offering with the SST you see an event. And that was in the first quarter, but our primary program is ongoing. We want and the reseller wants to move the demo units to keep fresh every three to six -- never holding it more than a year because they get dinged up and you have to move them into customer sites as well as into the tradeshows so in that process, as Demo units go out new ones come in, so there's a double program there.

Okay.

I think the answer is it's an ongoing -- although I think your original question went to the Q1 event and then those are by and large all shipped out either in the first or the second quarter, but it is an ongoing program.

It sounds like the bulk of the total demo units in the year went out in the first half.

Yes, that's going to seed the ongoing through to end-users sales which I'm very, very optimistic on seeing in Q3 and Q4 and going forward because you need those as sales tools.

Was there any difference in the paid parts business in the U.S. versus Europe relative to strength or weakness?

No, I think we continue to do well and grow in Europe. We're more of a provider there. And in the U.S. really the only thing that's significantly or noteworthy spotty is that we are in the rapid manufacturing business of parts as well as rapid prototyping parts and I think we can say that last year we saw a bit more of the rapid manufacturing orders which I think is just at this point more random because we don't really have a -- while we have a program to fulfill, we're trying to develop a consistent program to sell into the rapid manufacturing. So that would be the only thing that would be noteworthy and that's only in the U.S.

Okay. Then the final question, was Q2 weaker in Europe than Q1 was in Europe?

They've been weak in the first half.

Did it get worse or do you think --?

I'd have to take a look at it because we did sell a fair number of Dimensions. You have your ongoing consumables, but really the weakness was one of high-end systems within that territory.

Okay. Thank you.

Clint Morrison, Feltl & Co.

Just quickly. On the paid parts you're talking about it being an ongoing program, does that suggest that we're not going to see a big bulge again at the beginning of next year? Has something really changed in this program?

Could you repeat or give me more details on your question?

Originally we thought the paid parts was kind of a one shot. When your dealers got together you got all these orders, you had the big bulge in Q1, shipped out in Q2 kind of deal --.

I think there was maybe a miscommunication. In the reseller network they used demo systems and so I think we can say that that event is more of a one shot on a product. Now as we come out with new products then I think you can expect that at the time of release of the product, which may or may not happen at the beginning of the year, it's more relative to when the market is ready and we're ready to satisfy. And the resellers are not associated with the paid parts.

No, I was talking about the demo. So the demo we will continue to see these bulges?

Although, and it's a very good question. At the Board level we talk a lot about not the concern over a bolds because we like that. It's sales. But how you get higher, faster reaction times to fulfill without -- just solving it with inventory. I'm pretty optimistic as we go forward -- especially going forward into next year that we'll have better reaction times and be able to fulfill to move forward with that sales link program where you have to have the demo and then the demo yields up to 15 -- basically 15 systems per location if you've got the demo tool out there. And usually only until you get the demo unit out there.

Thanks.

Eric Martinuzzi, Craig-Hallum:

You've commented about the high-end issues in Europe, but your comment in your press release is that slower than expected I guess across the board. Could you address just North America, what you attribute it to and if it's a macro issue or if it's a platform issue for you guys? Thanks.

I think just in general -- I think we can focus more on Europe. Understand that at prices between 100,000 to 250,000 per system, it doesn't take very many unit fluctuations to see a quarter-to-quarter change. But I think we also mentioned that we're very confident in our high-end productivity systems going forward in general.

So you're saying no issues North America, the issues are with Europe?

Yes, our high-end system is still growing and what I think we said in the release is that it was slower than expected and particularly in Europe for the quarter and it's still a very good part of our business.

And to add to that, the high-end was influenced more heavily by our successes in North America and sales to the Objet systems versus some of the other systems that we offer.

The question I was asking was had it not been for Europe high-end would have met your expectations?

Yes.

Thank you.

Okay. We'll end the call of this point. We appreciate your interest. Have a great day and we'll be talking in about 90 days. Thank you.

Ladies and gentlemen, that does conclude our conference call for today. You may now disconnect and thank you for your participation.