Stratasys Ltd (SSYS) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Stratasys, Inc. third quarter 2006 earnings conference call. At this time all participants are on 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. Welcome to the Stratasys conference call to discuss third quarter financial results. Representing Stratasys's executive management on the conference call today is the Chairman and CEO of Stratasys, Scott Krump, and Chief Financial Officer, Bob Gallagher.

A quick reminder that today's conference call is being transmitted over the Web and can be accessed through our Investor section of our 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 that involve risks and uncertainties. These include the continued market acceptance and growth of our Dimension line, Prodigy Plus, Maximum Advantage and Tieton product lines; the size of the 3D printing market; our ability to penetrate the 3D printing market; our success in launching new 3D printing products in the future and the market acceptance of those products; our ability to maintain the growth rate experienced in this and proceeding quarters; our ability to introduce the marketing 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 manage the transition period following the discontinuation of the object distribution agreement; our ability to effectively and properly market and distribute the 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 parts service, as well as the other risks detailed from time to time in our SEC reports, including the 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 principals, 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 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 fourth quarter and fiscal year 2006 earnings release and conference call. Stratasys's fourth quarter and year-end results will be released on or before the morning of February 15, 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 Krump.

Good morning. We are pleased to report a record third quarter for Stratasys. We sustained strong revenue growth in the quarter which increased by 28% over the third quarter last year to $25.1 million. Total system shipments have increased 40% year-to-date compared to last year.

Our year-over-year EPS growth continued a trend of healthy improvement, expanding by 35% over last year's third quarter to $0.27 per share, which excludes the impact of option-related expenses in 2006. Including the option related expenses, year-over-year EPS growth was also a healthy 25%. The profit growth we generated during the third quarter reflects the positive impact of our consumable, maintenance and paid parts businesses, which achieved record performances.

Our 3D printing business continues to outperform plan and we are pleased that our high end system business grew significantly during the quarter.

I will 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 third quarter results. Here is Bob.

Thank you, Scott. Total revenue increased by 28% to $25.1 million for the third quarter of 2006, compared to $19.7 million for the same period last year. The company shipped 383 systems during the third quarter, an increase of 25% over last year.

The sale of 3D printers continues to drive unit growth, expanding by 30% during the quarter compared to the same period last year. We continued to observe strong demand for the new Dimension 1200 line, which provides expanded functionality for the end user compared to the Dimension 768 line. Our bookings forecast for Dimension did not match our production schedule during the quarter, as bookings for the Dimension 1200 exceeded our forecast. Consequently, we have an increased backlog of Dimension 1200's at the end of the quarter and our fourth quarter production schedule has been modified accordingly.

Third quarter product revenue increased by 28% to $19.8 million compared to $15.5 million for the same period last year. The major contributor was a 36% increase in consumable revenue over last year. 3D printer revenue grew by 18% and was impacted by the increased backlog of Dimension 1200's.

High end system revenue increased by an impressive 26% during the quarter, driven by our distributed product lines. However, sales of our proprietary high end systems grew by 20% over last year. In addition, bookings of our proprietary high end systems grew by 10% over last year.

Sales growth of our distributed EDEN PolyJet systems, which we will no longer distribute beginning in 2007, grew by 39% over last year. Although the growth rate of EDEN systems has fallen from levels experienced earlier in the year, third quarter EDEN sales were in line with expectations.

We would also note that we shipped our first Arcam system during the quarter. We currently recognized Arcam revenue on installation of the system given the system's complexity.

Service revenue increased by 29% to $5.4 million for the third quarter compared to $4.2 million for the same period last year. Service revenue was significantly impacted by growth in the paid parts business, which grew by an impressive 70% during the quarter. This growth was driven by contributions from RedEyeRPM.com, our online part quoting and ordering system. In addition, the growth in paid parts was significantly impacted by rapid manufacturing orders, or orders for end use parts. In addition a record level of maintenance revenue, which grew by 15% for the quarter, contributed to the growth in service revenue.

Gross profit increased by 21% to $13 million for the third quarter compared to $10.8 million for the same period last year. Gross profit as a percentage of sales declined to 52% from 55% for the third quarter of last year. The gross margin percentage benefited from the growth in our consumables, maintenance and paid parts businesses during the quarter. In addition, the growth in our proprietary high end systems, which generally maintain gross margins higher than corporate average, made a positive contribution to gross margin percentage during the quarter.

However, these benefits were offset by the growth of our distributed products, which maintain gross margins that are substantially below corporate average. I will comment further on EDEN gross margin later in this call.

Operating profit as reported was $3.5 million for the quarter. Excluding stock-based compensation expenses, operating profit increased by 29% to $3.8 million for the third quarter of 2006 compared to $3 million for the same period in 2005.

Excluding stock-based compensation, operating profit as a percentage of sales was 15% compared to 15% for the same period last year. Operating expenses as reported were $9.5 million. Excluding stock-based compensation expenses, operating expenses increased 18% to $9.2 million in the third quarter compared to $7.9 million for the same period in 2005.

Operating expenses and operating profits as reported include stock-based compensation expense required under statement of financial accounting standards, or SFAS 123R. Stock-based compensation expenses amounted to $284,000 during the third quarter of 2006, but were not required and thus not included in the 2005 third quarter financial results.

Operating profit was favorably impacted by the strong growth in consumables, maintenance and paid part businesses. A sales mix within our high end system business that favored our distributed products produced a negative offset to these favorable contributions.

Total interest and other income for the third quarter increased to $350,000 versus $323,000 last year. Pretax profit as reported was $3.9 million for the third quarter. Excluding stock-based compensation expenses, pretax profit increased by 27% to $4.2 million for the third quarter of 2006 compared to $3.3 million for the same period in 2005. Excluding stock-based compensation, pretax profit as a percentage of sales declined to $16.6 [million] from $16.7 [million] for the same period last year.

Income taxes reported amounted to $1.3 million, or a tax rate of 34.2%. Excluding the impact of stock-based compensation expenses, income tax expense amounted to $1.4 million, or 33.3% for the third quarter versus $1.1 million or 34.3% for the same period last year.

Net income as reported was $2.6 million, or $0.25 per diluted share for the third quarter. Excluding stock-based compensation expenses, net income increased by 29% to $2.8 million for the third quarter of 2006, or $0.27 per diluted share. This compares to $2.2 million, or $0.20 per share for the same period in 2005.

Our diluted shares outstanding dropped by over 560,000 shares from the third quarter last year, a result in part from significant stock repurchases we have completed over the past four quarters. The Company repurchased 128,500 shares during the third quarter and maintains approximately $8 million in authorization under the current $20 million share repurchase authorization.

Total revenue increased by 25% to $74.1 million for the nine month period ending September 30, 2006. The Company shipped 1,313 systems during the nine month period, an increase of over 40% for the same period last year.

Net income as reported was $7.5 million, or $0.73 per diluted share for the nine month period. Excluding stock-based compensation expense, net income increased by 11% to $8.3 million for the nine month period or $0.80 per diluted share. This compares to $7.5 million or $0.69 per diluted share for the same period in 2005.

Our cash and investment position amounted to $39.1 million at the end of the third quarter versus $41.4 million at the end of fiscal 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 as well as stock repurchases during the third quarter.

Inventory balances have increased to approximately $13.4 million from approximately $10.9 million at December 31, 2005. The increase is largely due to two reasons -- the build up of Dimension 768 units due to differences in our forecast mix between 768 and 1200's versus actual demand, and increases in consumable material inventory to support our increasing installed base.

Net property and equipment increased to [19.10] at the end of the third 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 investments include patents and capitalized software. Accounts receivable were $23.3 million at the end of the third 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 of our extended terms under our Dimension demo program.

Day sales outstanding or DSO was approximately 85 compared to 78 days at the end of fiscal 2005, and down from 87 at the end of the second quarter. As we indicated in the first quarter conference call, our DSOs will likely continue to be impacted by our program for resellers that allow 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 per reseller is consistent with historical levels and we believe our past history has proven the program's value and manageability.

I would like to give you some brief insight on the financial impact of the Objet distribution relationship. EDEN product and maintenance revenue and consumables for the first nine months of the year was approximately $11.5 million. The gross margin percentage we recognize in the revenue was approximately 27%. We currently estimate the sales of EDEN systems consumables and maintenance will generate $14 million to $16 million this year.

Our internal P&L indicates the distribution relationship with Objet Geometries is operating at a loss for the first nine months of this year. This analysis includes direct cost, such as marketing and personnel dedicated to the Objet product line, as well as nondirect manufacturing and SG&A cost that are shared across multiple product lines. These costs include joint tradeshows, sales, accounting and order processing.

Taking into consideration the impact of new product 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 to maintain a strong EPS growth profile next year -- this despite discontinued EDEN product distribution in 2007.

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

Thank you, Bob. We increased our revenue guidance this morning to $100 million to $103 million -- a range of $100 million to $103 million versus our previous revenue range guidance of $98 to $102 million. This increase revenue guidance translates to growth of 21% to 24% over fiscal 2005.

We reaffirmed 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 still $1.05 to $1.15 per share.

Our desire to maintain a relatively wide range in our earnings guidance is driven by the following considerations -- first, our wide range of gross margins and the potential impact of variations in product mix, or variations in our geographic sales.

Secondly, variable compensation impacts as a currently unknown number of sales executives reach quota and begin triggering commission accelerators.

We currently expect to provide specific earnings guidance for fiscal 2007 with the release of our fourth quarter in fiscal year end 2006 earnings release. However, given where we are in the strategic planning process for 2007, we currently expect to generate year-over-year EPS growth of at least 20% next year. This includes consideration, as Bob mentioned, of the elimination of EDEN product distribution.

The reconciliation between non-GAAP and GAAP financial performance and projections is provided in a table at the end of the third quarter press release. We are providing non-GAAP financial estimates in an effort to give investors continuity in our earnings comparisons.

We have attempted to provide guidance that incorporates our plans for new product introductions, our current growth and product mix expectations coupled with limitations of predicting our operating environment over the next several months.

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

Thank you, Shane. We are in the process, as Bob mentioned, of finalizing our operating plan for 2007, which includes a strategy to address the elimination of the low margin EDEN product distribution we announced last quarter.

These changes within our high-end productivity system business are progressing smoothly, and we are preparing for a more focused commitment to our proprietary technologies next year.

In 2007, our high-end product initiatives will focus on new FDM products and marketing strategies, as well as improving our current FDM product line. Part of the strategy is to target new applications for rapid manufacturer of end use parts. We believe rapid manufacturing will ultimately lead to a significant new opportunity for Stratasys over the coming quarters.

As we noted earlier in the call, sales of our highly profitable consumable and maintenance revenue are expanding rapidly with our growing global installed base of systems. With the introduction of our 3D printer line in 2002, we have experienced a dramatic expansion of systems sales which recently culminated in the installation of our 6,000th system to Dell Computer.

It is significant to note that over the 15 year history of our Company, almost half of our system sales have occurred within the past two years. Furthermore, we continue to believe that we are in the early stages of this growth trend, which bodes well for our long-term goal of growing a large base of installed systems that generate highly profitable, reoccurring consumable and maintenance revenue.

Our strategy in 3D printing continues to deliver the demand for our new Dimension 1200 line introduced in April is exceeding our expectations. We believe our Dimension 3D printer is the best whole product offering in the industry. Equally as important is the competitive advantage provided by our highly trained reseller channel of over 185 global reseller locations.

We have the most expansive reseller network in the industry. We have continued to expand this market reach with the recent establishment of a sales office in China and the addition of six new distributors in the Asia Pacific region. We believe a market exists for over 500,000 3D printers at the right price, as we have said in the past.

In terms of paid parts, the paid parts business remained our fastest-growing business during the quarter, which was driven by the success of our online instant quote part ordering system -- RedEyeRPM.com. The highly profitable growth of the paid parts business is creating a need for additional systems and order processing as well as fulfillment resources within paid parts which we will be addressing over the coming quarters.

In addition, the paid parts business continued to receive a significant contribution from orders from rapid manufactured part applications. We estimate that 20% of our RedEye business is generated from rapid manufacturing applications. Once again, the use of real production grade thermal plastics and superior accuracy has been critical to these rapid manufacturing opportunities, the combined characteristic that is unique to our Stratasys proprietary FDM technology.

These characteristics are what helped us secure the multi-year, $3.6 million R&D initiative with a Fortune 100 manufacturer in 2005. The collaboration continues to progress well as we continue to achieve additional milestones in developing applications. These applications will combine with the Company's traditional manufacturing processes. If we are successful with this collaboration, as we are so far, we believe that our opportunities will broaden beyond this specific customer and will lead to a commercial product for the general market in rapid manufacturing in 2007.

Looking forward, we believe that we are positioned for a strong finish in 2006 with the current earnings projections within the guidance we provided at the end of last year. In addition, we are optimistic for a strong profit growth next year and we worked to sustain the growing components of our business while developing the incremental growth opportunities available to our core technologies.

Well, at this point, we would like to address any questions that you might have.

(OPERATOR INSTRUCTIONS). Troy Jensen, Piper Jaffray & Co.

I want to start with a quick question for Bob. Bob, I ran the numbers, assuming about $15 million in Objet, 27% gross margin, I guess I just want you to confirm my math here. Is your organic gross margin roughly 58%?

I haven't run the numbers to pull it out on an organic basis but I think it's pretty easy to do the math backwards.

A question for Scott -- can you talk about high-end system sales, maybe? When was the last time you guys had a product refreshed there? Do you intend to maybe introduce a new product next quarter here with the discontinuation of Objet? Give the sales guys a new high-end product to sell?

Well, we have had sufficient time to think through a very good transition plan. We don't typically pre-announce products. That usually has a negative effect on the quarter that you are in. But we do have a very good transition plan and you will see in 2007, new products.

Eric Martinuzzi, Craig-Hallum Capital Group.

You talked about 185 reseller locations. That's up nicely but I was wondering -- how much of that is tied to the GrafTech announcement from August? And what do you expect as far as a contribution from that new Asia Pacific relationship?

We're trying to get about a 35% growth in locations; to your question, about half of those were attributed to GrafTech. And obviously, as we bring in new reseller locations, we go through a very intensive training through our Dimension University program. So it's, of course, not just bringing them onboard, but also making them effective and getting demo and benchmark parts out there.

Is it fair to say the non-GrafTech reseller ads were primarily outside the U.S.?

Yes.

Jeff Evanson, Dougherty & Co.

Bob, what was the impact on gross margins this quarter of the 1200 series backlog?

We just wanted to indicate that we did have a backlog of the units. We are not giving you a difference on our operating guidance in terms of what we book versus what we put in our revenue. But we did want to indicate that the backlog of 1200's have grown.

Was that more skewed to SSTs or BSTs, that backlog?

SSTs.

It wasn't quite clear from what I heard -- did you recognize revenue on that Arcam shipment in the quarter?

Yes, we did.

And how is your backlog for Arcam?

We continue to be excited about the Arcam technology and hope that it has a broad appeal. But we've just put in our first system. While we tend to be optimistic about it, we don't want to talk about backlog for competitive reasons.

Congratulations on the strong paid parts growth. I do recall last year in Q4 that had a bit of a seasonal weakness. Do you think you will see that same type of seasonal weakness this quarter, Q4 here? Or are you able to plan through that better with some of these bigger RM type orders?

The weakness that we really saw in Q4 last year really came in the month of December. And we don't know if part of that was due to the fact people weren't designing as much in the December month. We know that it is off to a strong start in Q4. So we remain cautious just because we are looking at the trend last year where the drop-off was really weighted to December.

And then my last question, probably for Scott -- Scott, this transition away from the EDEN Objet products towards the productivity systems, it's early in the process. But if I look at the growth rates of the different products, I question, do you feel like you're on track, making progress there? And give us some color around how you feel that transition is going, please.

Well, of course, the transition is part of an overall 2007 plan, which also includes heavy growth in both 3D printing as well as paid parts growth and growth in FDM systems. So I think we are progressing quite well on it. Obviously, we are still in the aggressive process of finishing the year with Objet. That transition away from Objet occurs January 1.

Ryan Thibodeaux, Maple Leaf Partners.

I think I may have missed -- did you break out the, I guess, the revenues within the product sales grouping, I guess, between Dimension consumables and the others?

No, traditionally we have not given that type of breakout for competitive reasons.

You said something about the consumables growth rate then -- what was that number?

One moment. And another moment.

I guess while you're looking for that then --

36%.

And then is there any chance you could break out like the Dimension unit from a totals number?

No. Again, that's something that we've stayed away from.

And I guess you can't kind of talk about the mix between the new 1200 and the older 768s?

Yes, why don't you comment on that, Bob.

The demand for the -- over half our volume was in the 1200's. Between the BSTs and SSTs, which is in both product lines of the 768 versus the 1200's, we saw the traditional split of about a 60/40 split favoring the SSTs. But specific to your question is, the 1200's was over half of our volume.

And that's virtually -- when was the first quarter that you started shipping the 1200's?

In Q2.

So I guess there's somewhat of a cannibalization effect there and I guess to what extent is the 1200 growth outpacing that?

Well, there is always an effect of a system cannibalization. But from a net standpoint, at least the way we have managed it so far, there is a net growth -- significant net growth. That way you continue to grow and take market share.

I guess the direction of the question would be, do you expect at some point for the 1200's to kind of become a very vast majority of Dimension shipments? Or do you expect the mix to stay kind of where it is right now?

Well, no, I would expect it will stay similar to where it is. The 1200 is more of a commercial-based, and the other product is more towards education, where education typically needs the lower budget price points.

Could you repeat again what the EDEN sales were in the quarter? Did you say that? Is that the $11.5 million -- is that right?

We didn't say it for the quarter, we said a $11.5 for the nine months and it was approximately $4.5 million for the quarter.

Andrew Schopick, Nutmeg Securities.

Bob, I want to ask you a couple of real quick ones. International as a percent of revenue in the quarter?

International was about 33% in the quarter.

And tax rate situation -- the R&D tax credit has not yet been extended. Should we assume a similar tax provision now in the fourth quarter to what we have seen here?

What we put in our tax estimate is based on a forecast of what we think the tax rate will be for the year. We have not, obviously, taken into consideration anything for R&D credit. And the only way that we would in the year is if the legislation passed before December 31.

So right now, the tax rate provision is pretty much what we expect to see?

Yes.

EDEN comparison -- can you give us any comparison for the EDEN revenues for the nine months of 2005 and the approximate gross margin, so that we can take a look at this year-over-year?

In terms of the gross margin, it would have been a similar gross margin between the years. I think we gave a number that, quarter-over-quarter, it grew approximately 39%. I think if you look -- I don't have the nine-month statistics in front of me but I think we've given guidance of how much that distributor product has grown in each quarter.

And the last thing I wanted to ask you is -- there was a question about the organic gross margin. And I would agree that obviously the implications of eliminating EDEN from the equation here will have positive or should have positive gross margin effects for the future periods.

However, to some extent it would seem to me that there will be an R&D offset, especially given what you're saying about the investment you'll be making in the proprietary higher end platforms. And I assume that there is no real R&D costs associated with the EDEN. And I've been watching the R&D drop from about 8% of revenue in 2004 to about 7.5% last year down in the 6's now, in relation to total revenue.

Is that a fair assumption? That the R&D both in terms of absolute dollars as well as a percentage of your revenues is likely to begin to rise as this relationship with EDEN discontinues?

Andy, in regard to R&D, one of the larger projects that we are working with is with our Fortune 100 manufacturer. And there is significant reimbursement which we show as a reimbursement to expenses in the R&D category.

Can you categorize that?

Andy, you are right that there it isn't an R&D that has been associated with the Objet product line at all. So I think when you look at an area like R&D, we have been making a heavy investment in that for both our 3D printing product line as well as our high performance line. So I think as you look forward you look at R&D more as a growth of a year-over-year as opposed to as a percentage of revenue.

And clearly it has been dropping partially as a percentage of revenue because we've had distributed products in there.

Understood. Did you say what capitalized software was in amortization in the quarter?

I didn't say, but capitalized software was $346,000 in the quarter compared with 340 last year. For the nine months, it is I think just under $1 million compared to a very similar number in the previous year.

And the amortization in the quarter?

Amortization -- depreciation and amortization was $995,000 for the quarter. Then you have to -- remember the stock-based compensation was $284 --

I was just looking for the amortization of prior deferred software versus the $346 capitalized.

The net change in amortization for the quarter was about $288,000.

288?

Correct.

Brion Tanous, Merriman and Co.

Just wanted to clarify on the Dimension manufacturing -- did you have any production difficulties at all in the quarter on making Dimensions? Or was it just a case of backlog building faster than you can make them?

Any time we have a new product launch we will see quarter-to-quarter fluctuations. With the introduction of the 1200 in Q2 and the reseller meeting being in Q2, whereas historically we've had our reseller meetings in Q1, it is usually not surprising to see a slower demand for new product introduction in the quarter following that.

So consequently we forecast and build to a forecast expecting heavier 768 in the quarter. We saw the continued demand then for the 1200 which bodes well for the future.

So basically just a higher mix of the 1200 was realized --

Part of it realized and part of it went into the backlog.

My next question, can you help me think about the paid parts business, the RP services here? Are you seeing more utilization per machine that you have in-house to grow that business? Or are you simply adding equipment here to be able to handle that demand?

In other words, should we anticipate some leverage here for the RP services business? Or should margins really be steady-state going forward as you grow?

If you look at it on a year to year, even though it's a daily business, if you look at it on a year to year basis and either measure it on depreciation as a percentage of sales or utilization, we are definitely getting significantly better utilization as well as overall capacity for paid parts.

That was one of our goals over the last couple of quarters. On the same token, with the growth rates we have you'll also see additional systems that continue to go into paid parts. But to your question, we are getting the benefit of hard-earned efficiency in the utilization.

My last question, I was wondering if you could just comment on the competitive situation regarding 3D printing -- what are you seeing out there in terms of systems? And are your resellers giving you any indication of any competing low end products out there?

Well, we're certainly watching the overall market as you are. And we also get inputs the key analytical group in the industry, Wethers Associates. But if you look at revenue competition, it is very similar to a year ago where there's two primary players -- [Zcorp] and Stratasys. And I believe that we are doing significantly better in the commercial. And I think Zcorp gives us a bit of a run for our money in the education side.

But we are also keeping very close to the changes. As this market grows, we expect other competitors. But to your question, revenue competition -- those would be the two, globally.

We continue to believe that our 3D printers, as Scott said early in the conference call, has the best whole product offering. But equally as important is, we believe that our reseller channel of highly trained 185 location is equally as important as a competitive situation.

Have you gotten a sense that 3G Systems has made any traction at all in this space at the low end?

No. I think they will but right now we haven't seen it for the last five years.

Jeff Rosenberg, William Blair & Co.

I wanted to still try and understand better a decline in gross margin. I guess, looking at your fourth-quarter guidance, even though you have kept a wide range of EPS, I think you are implying that gross margin will improve in the fourth quarter. Is that the case? And if so, (indiscernible) may be a little bit of color as to what gives you that comfort?

I think implied in there is an improvement in gross margin. I think looking at the product mix and again, the 1200 for us maintains a better margin for us than the 768. So seeing the demand in some of the backlog in that gives us confidence of what we expect to see in Q4.

So if you looked at Q3, I think we had a -- we just finished a 52% gross margin. Q2 was 54.7%. I would forecast that Q4 would come out somewhere between those numbers.

In terms of the different things that moved around this quarter, I guess it was a good number in terms of growth for high-and systems year over year, but if I recall correctly you had it easy for comparison. So I wonder if you could tell us, quarter on quarter, how did the mix between the productivity systems and your distributed product shift? There was a greater gross in the distributed product? Was that one of the factors that pressured gross margin?

Well, year over year, without a doubt, there has been significantly larger growth in the distributor products than in our high-end systems. I think consistently, even this quarter, which was good growth in our high-end systems, it was still stronger growth in the distributed products. If you go back to Q1 and Q2, you will see that we had more flat on the -- our own high end productivity systems and strong growth on the distributed products.

So clearly, the distributed products has been a higher portion of the mix.

And that is even true when you look back just quarter on quarter, sequentially in the third quarter versus the second?

Yes, I don't -- .

Yes, when you include -- we did not mention we also shipped our first our cam systems.

Right.

On the quarter, so yes, when you look at sequentially, certainly.

And I think I understand -- I think you just said something a minute ago that helped understand. Within the quarter, because I would think with more high-end systems and less 3-D printers, that might actually be -- all things being equal -- a positive for gross margin. But it sounds like the mix within 3-D printers was unfavorable in the quarter.

Correct.

(indiscernible).

Are you feeling any pricing pressure on the low-end of any competitor like [Deskstock] Factory? Or do you feel like your $20,000 should be sustainable for the next few years?

Well, you know, we are always operating in a worldwide competitive market. But I would say no, I think that the customers want a whole product solution, and I think it takes a long time for -- actually, at any price -- for a product to come out at a whole product offering. So no significant price pressure.

Earlier, you mentioned there was -- you're going to have to ramp up some of your systems in your paid parts business. Can you talk a little bit about what capacity constraints you're running into, and how much CapEx you'll have to invest in ramping that up?

We aren't really itemizing it. We do have over 60 machines that are billing our paid parts here in -- but beyond that, we are really not itemizing that part of the business.

The difficult part of that business is that we want to make sure we're not turning orders away, which means that we have to put systems out there in order to get to the peak capacity, not on the daily average. During this year, we haven't added significantly to the systems that we have had out there, but we will continue to add systems there, because we want to make sure we don't hit constraints from -- obviously, we manufacture the machine so we don't have a constraint on availability of the machines, and also from a floorspace and a building standpoint, we could add very, very significantly to capacity without any constraint there at all. But what we have will purely be driven by demand.

Troy Jensen, Piper Jaffray.

Bob, a quick follow-up. Operating cash flow -- did you give that on the call? I apologize if I missed it.

No, I did not. For the nine months, it was approximately $5.3 million, which I think would lead to about $4.1 million for the quarter.

Commission accelerators -- I think Shane touched on it. Do you guys expect to pay more on sales in the fourth quarter?

Yes. Some people are going to hit accelerators, while others are going to be under their quota. So it is really going to be driven by where the sales mix comes from in Q4.

Got it. Good luck going forward, guys.

Quint Slattery, Symmetry Peak Management.

I am not sure you said this earlier, but what was the growth sequentially and year over year on the 1200 line?

The 1200 line did not exist previously the previous year. It was just introduced in the second quarter of this year.

Yes, but sequentially?

No, we do not break it down for the 1200 between the 768s.

It is a difficult question and answer either way, in that the first units that always go out on a launch are used for a sales tool, a demo, samples as well as benchmarks. So usually, in the second quarter of a release, -- in this case, it would be our third quarter -- you start to see the units going into the end-users. So the comparison is not -- mathematically, it is good, but it did not have a lot of -- it is a comparison of apples and oranges.

I think you said earlier that inventory went up 30% sequentially. Is that right? Do you expect that to decline next quarter? The same with the DSO?

Inventory, the two drivers in our inventory increases were we said we incorrectly forecast demand on the 768 versus the 1200, resulting in a backlog of 1200s. But it also resulted in us having an inventory of 768s at the end of the third quarter which will clear out during Q4. The other buildup was in consumables, which we will bring down into Q4, also.

With the end of the Objet distribution relationship, you can clearly expect inventory to be dropping by the end of the year.

Quint Slattery; And the DSO was up from 78 to 85, and the trend had been opposite. Do you expect that to settle out here, go lower, go higher?

Traditionally, what we have seen in the fourth quarter of the year is we have watched our DSOs dropped, and we would expect that to drop over the Q3.

Just one clarification. The inventory comparison we gave was versus the end of last year. It was not a 30% increase sequentially.

Gentlemen, there are no further questions at this time.

Okay. In summary, we are pleased with our record third-quarter performance. During the quarter, we announced the installation of our 6000th system worldwide and the shipment of our first Arcam system. Our rapid manufacturing initiatives are making very good progress. We expect to commercialize an RM product in 2007.

In addition, we are expanding our reseller network for 3-D printing in China and the Far East.

Finally, we are positioned for strong growth for fiscal 2007. So thank you very much for your interest in Stratasys. We look forward to speaking with you again next quarter. Goodbye.

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