Stratasys Ltd (SSYS) 2006 Q2 法說會逐字稿

Good Morning, ladies and gentlemen. Welcome to the Stratasys Inc. second quarter 2006 earnings conference call. At this time all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Shane Glenn, Director of Investor Relations. Thank you, Mr. Glenn. You may begin.

Good morning and 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; Chief Operating Officer Tom Stenoien; and Chief Financial Officer, Bob Gallagher.

A quick reminder that today's conference call is being transmitted over the Web and can be accessed through the Investor section of our website 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 that involve risks and uncertainties. These include the continued market acceptance and growth of our Dimension lines, Prodigy Plus, Maxum, Vantage and Titan product lines; the size of the 3-D printing market; our ability to penetrate the 3-D printing market; our success in launching new 3-D printing products in the future and the market acceptance of those products; our ability to maintain the growth rates experienced in this and preceding quarters; our ability to introduce and market new materials such as 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 PolyJet line and Arcam product line; the success of our recent R&D initiative to expand the rapid manufacturing capabilities of our core FDM technology, and the success of our RedEye RPM paid part service, as well as the other risks detailed from time to time in our SEC reports, including Form 10-K for the year ended December 31, 2005 and form 10-Q filed throughout 2006.

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

We would like to confirm the date of our third quarter 2006 earnings release and conference call. Stratasys' third quarter results will be released on or before the morning of October 31, 2006, followed by a conference call on the day of the release. We will release the conference call time and details about two weeks prior to that date.

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

Good morning. We are pleased to report our second quarter financial results this morning, which reflect the positive impact of record performances across multiple business groups. We will provide details on our financials shortly. I would like to highlight the record level of systems sold during the quarter, which grew by 50% over the second quarter of last year. I'd also like to highlight our record levels of revenue and operating profits for the second quarter, which grew by 29% and 21% respectively.

As you know, in January we began a new strategic initiative within the 3D printing market that introduced new price points for our legacy 3D printers. Our new strategic initiative culminated in April with the introduction of four new Dimension 3D printers. As we indicated during our first quarter conference call, we believed that our new Dimension 1200 3D printer would augment the growth we had begun to recognize in the first quarter as well as provide an opportunity for improved profitability through expanded margins. We achieved this goal as strong interest in the improved functionality of our new Dimension 1200 line, combined with the price elasticity impact of our lower-priced Dimension 768 line, were the primary contributors to growth during the quarter.

In addition the second quarter was a record for our paid parts business as that business benefited from several rapid manufacturing projects. We believe this is a precursor to additional growth in paid parts as well as an indicator of the future opportunity to sell systems for rapid manufacturing applications.

I will return later in the call to discuss our initiatives in more detail. But first, I'd like to discuss the changes we announced today in our high-end system business. We currently distribute the Eden product line for the Israeli-based Objet Geometries. After long and serious consideration we have concluded the best long-term alternative for both companies is to discontinue the distribution of the product line starting in 2007. We have made this decision based on strategic and financial considerations. The Eden line maintains a substantially lower contribution margin compared to our proprietary products and the costs of a distribution relationship do not justify the long-term gain. In addition, we believe our FDM technology is better suited for the faster-growing segments of our industry, specifically 3D printing and rapid manufacturing. We have committed to provide a smooth transition to our customers as we intend to continue the sale of Eden products until the end of the year, 2006, and service all systems that we've sold until August of 2007. However, going forward we believe we can better serve our shareholders by focusing on many opportunities presented by our proprietary fused deposition modeling, particularly given the FDM's competitive position in 3D printing and rapid prototyping as well as the future potential for the rapid manufacturing of end-use parts.

I will return later to discuss some of these initiatives in more detail. But first, I'd like to turn the call over to our CFO, Bob Gallagher, who will further highlight the second quarter results. Here's Bob.

Thank you Scott. Total revenue increased by 29% to 26.7 million for the second quarter of 2006 compared to 20.8 million for the same period last year. The Company shipped a record 527 systems during the second quarter, an increase of 50% over last year. As Scott mentioned, our record unit volume was a result of strong growth within our 3D printer business as 3D printer units grew by an impressive 61% during the second quarter when compared to the same period last year. This growth resulted from the successful launch of our four new Dimension 3D printers we introduced in April, which combined the benefits of the lower price points and improved functionality.

Second quarter product revenue increased by 28% to $21.7 million compared to 16.9 million for the same period last year. The strong growth in 3D printer units contributed to our record level of 3D printer system revenue, which grew by 39% during the second quarter. In addition growth in product revenue was driven by a record level of consumable sales, which grew by 39% during the quarter. High-end system revenue was flat compared to last year, but in line with our expectations. Sales of our high-end FDM systems were down domestically and flat in the international markets compared to last year. Sales of our distributed Eden PolyJet systems, distributed only in North America, nearly doubled over the second quarter of last year.

Service revenue increased by 29% to $5 million for the second quarter compared to 3.9 million for the same period last year. Service revenue was significantly impacted by growth in the paid parts business, which grew by an impressive 75% during the quarter. This growth was driven by contributions from RedEye RPM, our online part quoting and ordering service. In addition, the growth in paid parts was significantly impacted by rapid manufacturing orders or orders for end-use parts. Over 20% of our paid parts revenue during the second quarter could be classified as rapid manufacturing. In addition, a record level of maintenance revenue, which grew by 18% for the second quarter, contributed to the growth in service revenue. We would like to emphasize that the record system sales recorded in the second quarter bode well for the ongoing strong growth in the recurring revenue components of our business, which include both the maintenance and consumables.

Gross profit increased by 20% to 14.6 million for the second quarter of 2005 compared to 12.2 million for the same period last year. Gross profit as a percentage of sales declined to 54.7% from 58.6% for the second quarter of last year. However, the gross margin percentage improved from the 53.1% recorded in the first quarter of this year. The gross margin percentage benefited from the growth in our consumables, maintenance, and paid parts businesses during the quarter. In addition, gross margin percentage benefited from strong orders for our new Dimension 1200 line, which we introduced in April. The 1200 SST maintains significantly higher margins than its lower-priced counterpart and represented a significant portion of 3D printer system revenue during the quarter. Our distributed Eden product negatively impacted gross margin, which maintains dramatically lower gross margins compared to our proprietary products.

Operating profit, as reported, was $4.2 million. Excluding stock-based compensation expense, operating profit increased by 21% to 4.4 million for the second quarter of 2006 compared to 3.6 million for the same period in 2005. Excluding stock-based compensation, operating profit as a percentage of sales declined to 16.5% from 17.6% for the same period last year. Operating expenses as reported were 10.5 million. Excluding stock-based compensation expenses, operating expenses increased 16% to 10.2 million in the second quarter compared to 8.6 million for the same period in 2005. The increase in operating expenses was driven in part by over 250,000 in one-time promotional activities directly related to the launch of our four new Dimension products. In addition, we expensed approximately 100,000 of outside costs directly related to our efforts in resolving our Objet relationship. Operating expenses and operating profit as report included stock-based compensation expense required under a statement of financial accounting standards, or SFAS 123R. Stock-based compensation expenses amounted to 284,000 during the second quarter of 2006, but were not required and thus not included in the 2005 second quarter financial results.

Operating profit was favorably impacted by the strong growth in 3D printers, consumables, maintenance, and our paid parts businesses. The sales mix within our high-end system business that favored our distributed Eden products, produced a negative offset to these favorable contributions. We expect operating expenses will continue to track materially ahead of comparable periods as we continue moving through fiscal 2006, driven by higher R&D expenses as well as the higher expense associated with our expanding operations.

Total interest and other income for the second quarter increased to 328,000 versus 95,000 last year. The increase primarily resulted from the relatively small impact of foreign currency translations due to the euro movement relative to the dollar. Pre-tax profit as reported was 4.5 million. Excluding stock-based compensation expenses, pre-tax profit increased by 27% to 4.7 million for the second quarter of 2006 compared to 3.7 million for the same period in 2005. Excluding stock-based compensation expense, pre-tax profit as a percentage of sales declined to 17.7% from 18% for the same period last year. Income tax as reported amounted to 1.5 million for a tax rate of 34.2%. Excluding the impact of stock-based compensation expenses, income tax expense amounted to 1.6 million, or 33.3% for the second quarter of 2006 versus 852,000 or 22.8% for last year's second quarter. We would note that the tax liability for the second quarter of last year included adjustments, including a $325,000 benefit for filing changes identified to our 2004 and 2003 tax provisions.

Net income as reported was 2.9 million or $0.28 per diluted share. Excluding stock-based compensation expenses, net income increased by 9.4% to 3.2 million for the second quarter of 2006 or $0.30 per diluted share. This compares to the non-tax-adjusted 2.8 million or $0.27 per diluted share for the same period in 2005. Our diluted shares outstanding dropped by over 316,000 compared with the second quarter last year, a result in part from significant stock repurchases we completed during the fourth quarter of 2005. The Company repurchased no shares during the first half of 2006 and maintains approximately 11.1 million in authorization under the current $20 million stock repurchase authorization.

Total revenue increased by 23% to 48.9 million for the six-month period ended June 30, 2006. The Company shipped 930 systems during this six-month period, an increase of 48% over the same period last year. Net income as reported was $5 million or $0.48 per diluted share for the six-month period. Excluding stock-based compensation expenses, net income increased by 4% to 5.5 million for the six-month period or $0.53 per diluted share. This compares to the non-tax-adjusted 53.5 million or $0.49 per diluted share for the same period in 2005.

Our cash and investment position amounted to 39.8 million at the end of the second quarter versus 41.4 million at the end of 2005. The decrease in cash and investments from the end of fiscal 2005 is a result of changes in our operating assets and certain fixed-asset additions. Inventory balances have increased to approximately 13.4 million from approximately 10.9 million at December 31, 2005. The increase is largely due to the acquisition of Arcam Systems as well as the intentional buildup of Dimension 1200 units. The remainder is primarily due to the approximately $564,000 increase in consumable materials inventory to support our increasing install base.

Net property and equipment increased to 18.8 million at the end of the second quarter compared to 17.3 million at the end of fiscal 2005. The growing components of our business have required much of the capital expenditure in 2006 including manufacturing fixtures for the Dimension 1200, consumable manufacturing, and paid parts. Net cash used for payments for intangible assets and other investment included patents and capitalized software.

Accounts receivable were 25.6 million at the end of the second quarter compared to 20 million at the end of fiscal 2005. The increase was principally due to increased sales as well as the timing of sales within the quarter and some impact from the extended terms of our sales demo program. Day sales outstanding, or DSO, was approximately 87 days compared to 78 days at the end of fiscal 2005. As we indicated in the first quarter conference call, our DSOs will likely continue to be impacted by our program for our resellers that allows participants to purchase a limited number of 3D printers with extended 180-day payment terms. The voluntary program has provided the resellers with a valuable selling and marketing tool to sell multiple systems. The current level of participation for resellers is consistent with the historic levels. We believe our past history has proven the program's value and manageability.

We would like to give some brief insight to the impact of the Objet Distribution relationship. We estimate the sale of Eden systems consumables will generate $9 to $13 million in low-margin revenue this year. Our internal P&L indicates the distribution relationship Objet Geometries was losing money. We have consistently communicated that the Eden products are low-margin products for us. However, the sale of Eden products absorbs a portion of our non-direct manufacturing and SG&A costs. Taking into consideration the impact of new products introductions and the impact of potential new rapid manufacturing applications as well as shifting resources to the faster-growing parts of our business, we expect the impact from discontinuing Eden products distribution to be slightly negative to neutral on our high-end productivity systems business in 2007.

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

Thank you Bob. We affirmed revenue guidance of 98 million to 102 million or growth of 18% to 23% over fiscal 2005. We reaffirm earnings guidance of $1.15 to $1.25 per share on a non-GAAP basis, which excludes the impact of stock-based compensation required under SFAS 123R. Earnings guidance on a GAAP basis is $1.05 to $1.15 per share. Reconciliation between non-GAAP and GAAP financial performance and projection is provided in a table at the end of the second quarter press release. We are providing non-GAAP financial estimates in an effort to give investors continuity in our earnings comparisons from last year. We have attempted to provide guidance that incorporates our plans for new product introductions, our current growth and product mix expectations coupled with the limitations in predicting our operating environment over the next several quarters.

Now I'd like to turn the call back to Scott Crump.

Thank you Shane. Over the coming months, our high-end product initiatives will focus on improving our current FDM product line as well as introducing new FDM products and marketing strategies. This strategy is similar to our successful approach in 3D printing will expand our price points and provide customers with more options in machine functionality. Over the past three years we've dedicated a significant portion of the Company's resources to the distribution of low-margin Eden products. Starting in 2007, these resources will be more dedicated to the sale of our proprietary product set maintain substantially higher margin. Consequentially, as we recommit to the high-end FDM product line, we believe we will have the opportunity to grow our high-end FDM sales, particularly in the North American market.

The second quarter results provide additional evidence of our proven strategy within the 3D printing market. We will continue to execute a strategy that drives demand through lower-priced products as well as new printers with premium margins that provide improved functionality over to our customers. We continue to believe an addressable market of 500,000 3D printers exists, a market we've only begun to penetrate.

Rapid manufacturing orders represented approximately 20% of the revenue within our paid parts business during the second quarter. This represents an opportunity that is incremental to the demand for conventional prototypes. We believe this is a positive indicator of future potential for FDM system sales used for the manufacture of end-use parts. Early-stage feasibility evaluations are ongoing with major manufacturers for rapid manufacturing applications, which could lead to significant new growth opportunities for the Company over the coming quarters. The use of real, production-grade thermoplastics has been critical to these rapid manufacturing opportunities, a capability that is unique to our proprietary FDM technology. In addition, more manufacturers are beginning to recognize FDM as the most dimensionally accurate rapid prototyping technology on the market today, another key criteria for the rapid manufacturing applications.

We are pleased to announce today that we've booked our first ARCAM® EBM S400 in the second quarter, a rapid manufacturing and prototyping system that makes solid metal parts. We anticipate the system will be delivered to the customer and recognized as revenue in the third quarter. We remain optimistic about the opportunity for Arcam sales in the North American and believe the technology could be an ideal platform for the rapid manufacture of metal parts.

Our vision takes the Company beyond applications that address new product design and development with a long-term goal of providing innovative solutions for end-use part manufacturing. We are excited about this emerging opportunity and believe that we are positioned to be a leader in these new applications. We remain confident in our growth goals for 2006 following our second quarter results. Our new 3D printer initiatives are driving demand with lower price points and expanded product functionality. We are poised to expand our high-end FDM products supported by new products and marketing initiatives. Our recurring revenue components are building and new applications for our technology are emerging. We are looking forward to continuing our strong growth in the second half of 2006.

At this point, we'd like to address any questions that you might have.

Diego, we're ready for Q&A. Could we please keep the questions to one question and one follow-up.

Thank you. (OPERATOR INSTRUCTIONS). Eric Martinuzzi with Craig-Hallum.

Good morning, gentlemen. Your growth goal for this year based on your reiteration of top-line guidance puts it at an 18% to 23% revenue growth versus '05. If we back out Eden from 2006, is the growth assumption – for those of us who are trying to project out for 2007 – what rate should we be using there?

What you have to do is back out the estimate that we gave for the Eden products out of the 98 to 102 million.

Alright, but is it fair to say Eden was growing faster than the rest of the products? Does that slow down the '07 comp?

Objet was part of our high-end productivity systems. That is the slowest-growing segment of our market. Eventually we believe that RM will reinvigorate the growth from the high-end and our FDM technology is well poised to work in RM. In the meantime, if you look at the other two pieces of our business, the 3D printing, we showed a 61% increase in unit volume and 39% in revenue for the quarter. And our paid parts business grew by 75% for this quarter. So, while not giving guidance, we're excited about the growth going forward into 2007.

The one thing to also remember is that obviously our direct channels in North America have the Eden products available to them this year. Next year they won't, but they will still have other products to grow that business next year.

Thanks.

Troy Jensen with Piper Jaffray.

Congrats on a nice quarter. First question would be, can you give us any color on the mix between 768s and the 1200s. Was there any initial stocking of the 1200 this quarter?

Being a new product, it's part of our sales demo program that we would have seen within the quarter. If you look at the mix between SST and BST, it is probably a 60/40 split in favor of the SST. I am including both the 768s and the 1200s there. The best-selling SST is the 1200. The best-selling BST is the 768. To me that is a good sign as I think the 768 BST at 18,900 is proof of the price elasticity curve. The 1200 SST gives us a good price/value proposition and the ability to capture more margin. All of them give us the opportunity to sell more consumables.

A follow-up question for you, Bob. On capitalized software, I am looking through the old Ks, I notice that you ended the year in '05 with 5.6 million in capitalized software versus 4.3 million. I am curious to know, why do you capitalize software development costs versus expensing it?

In Q2, we capitalized 257,000, I think in capitalized software compared to amortizing 223,000 in the quarter. If you look at the accounting literature – not to turn this into an accounting meeting – but the literature – because guidance is FAS 86. It says in order to qualify for capitalization you must have a complete product design and detailed program design. The detailed program must be consistent with the program design traceable to the product's specs and the detailed program has been reviewed for high-risk issues.

If you take the 1200 as an example, we had a complete product design, detailed program and marketing specked over a year ago. So it was based on our FDM technology. It really doesn't have much risk effort in it. From a standpoint of FAS 85, it requires our software to be capitalized. It's not something that is optional for us. From a human perspective, at the end of 2004 we had a 12-person software group and five in the quality and reliability area. Many of those people spent time in the software efforts. Now we have over 24 people dedicated in this area, which has a direct payroll of over $2 million. The direct payroll excludes any benefits in normal overhead costs.

But with the 1200 and other initiatives that we are in the midst of, they require capitalization. Put it in perspective, this quarter we had over $0.5 million of direct payroll in these areas. We only capitalized less than 200,000 of direct payroll. I think what we are doing is very conservative. Not only that, we're amortizing it over a three-year life, which in my opinion given the life of our technology, is very conservative. It's gone up because of our 3D printer development efforts. But I think we're being very conservative in what we're doing.

So the bottom line is we're following the rule and it's not optional.

Right.

Perfect, got it. Keep up the good work.

Jeff Evanson with Dougherty & Co.

Good morning. Thank you for taking my questions. I want to ask you a little bit more about the Eden transition. Scott, you clearly are alluding to the fact that you are going to have some strategies around that product set in the future. I am wondering, do you see those new strategies kicking in, in '06? Or can they really not transpire until we are into '07 and beyond some of the Eden relationship?

We are committed to making a smooth transition in 2006 to ensure that our customers are not impacted negatively. So we, in agreement with Objet, will continue to sell, service, and market their systems through the end of the year. Our strategies, which have been evolved over the last several years, involve introductions of new products periodically throughout 2007, which involve both our high-end systems as well as our 3D printing systems, that we believe will more than adequately fill the gap that is a result of this termination of the Objet Geometries distribution agreement. That being said, we also think there are some significant opportunities for RM, or rapid manufacturing, that I don't think is appreciated, even inside the Company.

I'll give you a couple examples. In our paid parts business we are seeing a ramp-up of the demand for functional RM parts that end up in end-user applications. I'll give you one specific example – I can't name the customer. There are actually parts that are being used in combat in both Iraq as well as Afghanistan. So it's the durability of those parts and the requirements that only our paid parts and our technology could satisfy. We believe that focusing on those efforts, as we have been in 2006, but expanding in 2007, will also open up some tremendous opportunities for us.

My follow-up to that is, congratulations on the RKM sale. Let me just pose this philosophical question. You've stepped away from the distribution strategy with Eden because you found it less-than-optimal profitability. How is the RKM program different strategically and financially for you then that you are going to keep up with that, but not the Objet relationship.

We believe that our RKM can ultimately fill a role in providing metal parts into rapid manufacturing applications. Therefore, we view it differently. Having said that, we will use a shorter timeframe in our evaluation of that than we did in the Objet relationship.

Great, okay. Thank you.

Ryan Thibodaux with Maple Leaf Partners.

Thanks for taking my call. A question on the allowance for doubtful accounts in the quarter went to 1.1 million, down from 1.6 last quarter. What is the reason for that? What, if any impact, does it have on the income statement?

The reason for the decrease – I am glad that you asked that in the allowance for doubtful accounts – is that it is a direct write-off of a specific account. We wrote off between $450,000 and $500,000 related to a distributor in France that we cancelled. It was something that we – its impact on the quarter was negligible because we had to 100% reserve that in the past. Hopefully we will be able to recover part of that through the French courts. But as of now, we've written it off 100%. That is the reason for the decrease in the allowance.

So that $0.5 million – did that impact SG&A or offset anything at all?

No. Basically it's a reclassification from a gross receivable against the allowance, so it has no impact on the P&L.

Will you have to then in the future true-up your allowance back to a normalized 7% to 9% of gross AR in the future? Or should we expect this 4% to 5% range going forward?

We do a combination of looking at accounts based on the aging of the accounts as well as specific identification. The reason the reserve was so high going into the quarter was because of the specific identification of the French distributor. Going forward, I think you'll find it a similar rate to what it is today.

Thank you.

[Jeff Korfman] with Symmetry Peak.

A quick question. Just in terms of your unit growth versus the growth of your revenues, does that suggest that pricing on an ASP level is coming down significantly?

We are seeing a decline in – one of the things that we have in the Dimension product line is we now have four price points. As we indicated in the Dimension's – I think the unit growth was 61% – or unit growth was 61%. The revenue growth was 39%, which with the introduction of 768s starting at the $18,900 price point – yes, the average ASP is declining. But that is part of our price elasticity curve and part of our ongoing strategy. You are going to see us continue, on the Dimension product line, to continue to move down the price elasticity curve.

As well as expand with new functionality to some higher price points in addition.

Just a housekeeping question. I missed your cash balance this quarter and what it was versus last quarter.

I believe it was – it was 39.8 million at the end of the second quarter versus 41.4 million at the end of fiscal 2005. I don't have the March balance sheet in front of me.

Thank you.

Andy Schopick with Nutmeg Securities.

Thank you. Good morning. A couple of my questions have been asked and answered. But Eric did raise a fair point on the Objet relationship and I wonder if you can address it. In order for those of us to make apples-to-apples comparisons or adjustments for the discontinuation of this relationship, can you give us some insight as to what the contribution was in 2005. I thought I heard you say you expect it to be 9 to 13 million in revenue contribution this year.

I don't have the – I respect the question, but I don't have the Objet sales for 2005 in front of me. It was less than 10% of our sales in the previous year. We hadn't disclosed that separately. Again, I think we're looking at some of the initiatives that we're talking about in RM as well as some of the 3D printing to help replace some of that revenue in 2007.

Again, I think that those of us who follow the Company are just trying to make the proper adjustment. I recognize that it was under 10%. I wondered whether you would be any more specific at some time maybe later this year or when we start the new years in terms of making apples-to-apples comparisons for this.

Yes, we will review and revisit that in the next quarter.

Thanks. One other question on DSOs and aging of receivables. With DSOs clearly stretching out, can you give any color to the aging? How many – what percentage of your receivables might be over 100 or 120 days – just any color on that.

As I said when we discussed the allowance for doubtful accounts, we do a specific identification and look at the accounts. If I looked at it from this year compared to last year, to give you color, the amount of receivables over 60 days has declined significantly from the previous year. So I think we are doing a good job in monitoring our collections. The other thing I've said in the past is, we sell through small distributors. There is a risk element in the people that we sell to. We will continue to monitor that closely.

Thank you.

David Cohen with Midwood.

A question on the numbers you provided regarding Eden. You said it was – the extra days was $9 to $13 million of unit sales and consumables this year?

Correct.

Can you – what has already taken place in terms of thinking, now that you have made this announcement, what sort of a slope of the sales curve now that there is a different outlook for who is going to be servicing these systems? What have you already realized out of this for the year?

Like our other products, we don't disclose specific revenue in a quarter for those products or for the six-months. We tried to give additional color to this particular product because of the changing relationship. It's difficult to project it going forward because we don't know exactly how the market is going to respond to the announcement that we did today.

To tag onto that, it is basically business as usual for the remainder of 2006. As I mentioned, we'll be servicing those products that we sold to our customers through August of 2007 with an emphasis on an orderly, smooth transition for our customers. Both Objet and Stratasys believe strongly in that.

Did you say that you were – are you making money on this? Or did you say something about having your own internal analysis fully costed that suggests that you weren't making money on it.

Our internal P&Ls for the Objet show that we were losing money on it. However, I did mention that it was covering some indirect manufacturing costs as well as SG&A. So it did have a net contribution margin, even though when we fully burdened it, it was showing a loss.

Last question. Did you give – I got on the call late. Did you give any sense of the mix? If you look at your forward Dimension products, basically 768, 1200 series, the SST – if you look at that two-by-two, what kind of percent composition is there among those different boxes in that matrix?

We tend to look at the SSTs on a combination because essentially the offer the same functionality, it is just different size. We look at the BSTs together for the same reason. The SSTs with the soluble supports represent about 60%. The BST with the break-away supports, represent about 40%.

What measures of traction can you give us around the larger Dimension units?

The best-selling unit of the four was the 1200 SST. The highest-priced system was the best-selling of the SSTs. Of the 768s, it was the BST, which was the best-selling unit.

To tag onto that, the SST with the soluble supports allows for automatic support removal. That is a huge benefit to the customer.

Okay, great. Thanks.

[Graham Rain with Bears] Capital Management.

Congratulations on the quarter. As far as the consumables go, I know you don't break out consumable sales as a percentage of revenue. Can you talk about whether the increase is due exclusively to the increase in install base. Or is it – does it have something to do with the increase in consumables per machine [indiscernible] ?

I would say we haven't seen a significant change in the consumable usage on a per machine basis. That's a good question. What we are seeing is an increase related to the install base.

As a follow-up question, as far as Arcam consumables go, do you participate in that consumable stream at all? Can you talk a little bit about what that looks like.

In the first year of our relationship, we do not participate in the consumable maintenance stream nor do we take the maintenance responsibilities in the first year of the relationship. That was the trade-off we made in the first year as we are getting to know each other and work together.

And moving forward, you will?

Moving forward, I would expect that to change.

In 2007?

In 2007.

Okay. Thank you.

Bill Gibson with Nollenberger Capital.

Thank you. Could you share with us in the paid parts business on the end-use parts, the profile of the typical customer. You have may answered that in part talking about Iraq and parts in there. Are those large companies? Or are they small companies that are in the just-in-time manufacturing mode. Or is there a theme?

Many of our paid parts customers are larger companies. But we also have a smattering of smaller and mid size companies. They are using the parts as end-use parts. Traditionally they are recognizing that we are one of the only service bureaus, probably in the world, that can satisfy large-quantity deliverables in short-order times. Lastly, we are seeing a lot of interest in [fixturing] using our thermoplastics, which are very, very durable and suitable for that application.

So it sounds like its a broad cross-section?

Very much so.

Great. Thank you.

Dennis Wassung with Canaccord Adams.

Thanks. Actually I have a question on the rapid manufacturing side and the paid parts business. Part of it was just answered there. Has the rapid manufacturing piece of that – has that really emerged over the last couple of quarters? You are talking about 20% of that business now. Do you expect that number to just keep climbing? It sounds like you are getting a more broad list of applications in that area.

We've been in the paid parts business with prototypes for over three years. We launched the RedEye for paid parts last October. The rapid manufacturing applications have grown from zero to a few percent – maybe 2%, 6%, 9%. It has jumped recently and we think that it's a trend, as we mentioned, to 20%. The trend is definitely increasing on a percentage basis. Sometimes it evolves with the same customer. They will do a prototype. They might do a second prototype. Then, in order to concurrently launch their manufacturing or pre-production, they will do a run of rapid manufacturing parts that go into their end product perhaps many times prior to the parallel injection molding or doing the tooling for injection molding.

I guess when you look at the systems side of your business, is there any meaningful contribution in the RM side of it today, whether it be the 3D printers or the higher-end systems?

Historically we've said that we've estimated that about 10% of our systems have gone into some type of rapid manufacturing application. We haven't done anything to update the statistics on that in terms of a customer profile or survey. Clearly as we look at our high-end systems going forward, we're putting a focus on development as well as applications in the rapid manufacturing area.

Last question is related to Eden and I guess ties into that last question. You mentioned strategic and financial considerations as part of the rational here. On the strategic side are there – was the competitive dynamic of the product part of that discussion? Or is it really more focused on some of the internal efforts you are talking about whether it be rapid manufacturing driven or other?

The Eden products are very – it's a very good technology, good products – but more focused on the limited market within the early-stage prototype side of the business. That is a nice niche. But it is really not the higher growth area of the rapid manufacturing from what we can see worldwide.

Perfect. Thank you.

Mike Marianacci with Ragnarok Capital.

I apologize. I might have missed this. Did you give the cash flow from operations and the CapEx for the quarter?

No, we didn't give those numbers. The cash flow from operations for the quarter was approximately 800,000 to 900,000. I don't have in front of me what the CapEx was for the quarter. The CapEx for the first six-months of the year was about 2.8 million.

Okay, so 1.5. I can do the math. It sounds like you touched upon it. Could you go back over the allowance for doubtfuls on the AR. It came down dramatically quarter-to-quarter, year-over-year – however you want to look at it – on a percentage basis.

Yes. I want to make sure that that's a clear, so I appreciate you asking again. We had a direct write-off of a receivable from our French distributor, which was between $450,000 and $500,000. So what it is, in basic accounting terms, it reduced our receivables by 500,000. It reduced the allowance by $500,000.

Got it, okay. Alright. Thanks very much.

Jay Harris with Goldsmith & Harris.

As you change your systems mix, what do you expect to happen over what period of time to your gross margin and to your operating expense ratios?

As we change our mix going forward, I think it is going to be favorable in terms of – it will be favorable in terms of the change of the relationship moving forward into 2007. In terms of what we do with our operating expenses, as I said, some of the resources that have been helping contribute to our Objet relationship – some of those resources will be shifted in 2007 to the faster-growing parts of our business.

We're not out there into the – this is a fairly new change in our relationship. We are not prepared to go out and talk beyond that for 2007.

Could you give us some insight longer-term as to what your goals might be in terms of looking out three or four years in terms of operating expense ratios and gross margin ratios.

Are you saying a three-year guidance? Or, what is your question?

Where are your gross margins going over the next three or four years if you are successful? And where is the operating expense as a percentage of revenues going over the next three or four years if you are successful?

I think one of the things that we've said is that we believe – we don't talk from a gross margin line because of the changes in mix in the products from quarter-to-quarter and year-to-year. And certainly Objet has been a part of that. What we have consistently said is that we believe that there is an opportunity to improve the percentage of operating income that we earn on our revenue dollars. That has not changed at all. In fact, we would expect in 2007 that we will be able to continue to increase the operating percentage as it relates to sales moving forward.

Okay. Thank you.

Ladies and gentlemen, there are no further questions at this time. I will turn the conference back over to your hosts to conclude.

Okay. Thank you for your interest in Stratasys. We look forward to speaking with you at the next quarter. Good-bye.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.