Stratasys Ltd (SSYS) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen and welcome to the Stratasys Incorporated fourth quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] This conference is being recorded.

It is 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 fourth quarter financial results. We apologize for the late start this morning, our conference providers had some weather related problems with getting staff in this morning, so we do apologize for that. Representing Stratasys's Executive Management on the conference call today is the Chairman and CEO of Stratasys, Scott Crump and Chief Financial Officer Bob Gallagher. A quick reminder that today's conference call is being transmitted over the web and can be accessed through our Investor section of our 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 line, Prodigy Plus, Maxum, Vantage and Titan 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 rates experienced in this and preceding quarters, our ability to introduce and market new materials such as ABS Plus and the market acceptance of these and other production grade materials, the impact of competitive products and pricing, the timely development acceptance of new products and materials, our ability to effectively manage the transition period following the discontinuation of the Objet distribution agreement, our ability to effectively and profitability market and distribute the RTM product line, the success of our recent R&D initiative to expand the direct digital manufacturing capabilities of our core FDM, technology and success of our RedEye RPM paid parts 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-Qs filed throughout 2006. Information discussed within this conference call includes financial results and forward-looking financial guidance that are in accordance with the 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 effect to give information that investors may deem relevant to the company's operation and compare performance, primarily in the identification and exclusion of expenses associated with stock based compensation required under SFAS 123R. We would like to confirm the date of our first quarter earnings release and conference call. Stratasys' first quarter results will be released on or before April 26, 2007, followed by a conference call on the date of 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 on our CEO, Scott Crump.

Good morning. Stratasys is very pleased to report a record quarter as well as a record full year financial results. We just finished the best quarter and full year in our history, providing us with several impressive company milestones which include the strongest quarterly performance in the company's history and the surpassing of the $100 million revenue mark. We finished the year with strong performances from all of our major businesses including 3D printing, high end productivity systems and paid parts, as well as strong growth from our recurring revenue components. We sustained strong revenue growth in the quarter, which increased by 26% to approximately $30 million. In addition, we grew our full year results 25% to approximately $104 million. Total system shipments continued a pattern of strong growth during the fourth quarter and finished the year up 38% over last year. More importantly, our EPS growth continued a trend of strong growth, expanding by 27% over last year's fourth quarter to $0.38 per share on a non-GAAP basis. Including stock related expenses, year-over-year EPS growth was also a healthy 17% in the fourth quarter on a GAAP basis. I would like to highlight the fact that growth in operating profit accelerated in each successive quarter during 2006. I'll return later to discuss some of our strategic initiatives, but first I would like to turn the call over to our CFO, Bob Gallagher who will further highlight fourth quarter and fiscal year results. Here's Bob.

Thank you, Scott. Total revenue increased by 26% to $29.7 million for fourth quarter of 2006 compared to $23.5 million for the same period last year. The company shipped 483 systems during the fourth quarter, an increase of 33% over last year. The sales of 3D printers continues to drive unit growth, with 3D printer units growing by 40% during the fourth quarter when compared to the same period las year. We continued to deserve strong demand for the highest priced SST systems, which represented approximately 66% of 3D printer unit volume during the quarter. Fourth quarter product revenue increased by 29% to $24.4 million when compared to $18.9 million for the same period last year. The major contributors to product revenue growth in the fourth quarter were a 38% increase in 3D printer system revenue and a 41% increase in consumable revenue over the same period last year. High end system revenue increased by 14% during the quarter, driven by our distributed product lines. Sales growth our distributed Eden systems, which we will no longer distribute in 2007, increased by 20% over the last year by -- to approximately $2.7 million, $2.5 million, excuse me. Service revenue increased by 15% to $5.3 million for the fourth quarter when compared to $4.6 million for the same period last year. Growth in service revenue was driven by a 22% increase in our paid parts business during the fourth quarter. In addition, a record level of maintenance revenue, which grew by 12% for the quarter contributed to the growth in service revenue.

Before discussing our fourth quarter gross profit performance, I would like to draw your attention to changes we've made in the recording of certain operating expenses. Historically, the costs associated with the customer service department have been accounted for in the SG&A expense line. Given that the customer service department perform services related directly to the maintenance and installation systems, these activities are directly related to the revenue generating process. There for we are now including those expenses in cost of sales, and they have been accounted for accordingly in our financial press release. We also would like to note for the purposes of conducting your quarterly financial comparisons in 2007, the press release provides quarterly restatements for the balance of 2006. The changes have no impact on our operating profit or net income, and only represent a shift in expenses between operating and cost of goods. Fiscal year reclassifications for periods before 2005 will be included in on our 10-K filing.

Now on to the gross profit for the quarter. Gross profit increased by 22% to $15 million for the fourth quarter, 2006 when compared to $12.3 million for the same period last year. Gross profit as a percentage of sales declined to 50.5% from 50.3% for the fourth quarter of last year. The gross margin percentage benefited from the growth in our consumable, maintenance and paid parts businesses during the period. However, these benefits were offset by the growth of the distributed Eden product line, which maintains gross margins that are substantially below corporate average. I will provide additional color on the Eden product line later in the call. Operating profit as reported was $5.1 million for the fourth quarter. Excluding stock-based compensation expenses, operating profit increased by an impressive 31% to $5.4 million for the fourth quarter of 2006 compared to $4.1 million for the same period in 2005. Excluding stock-based compensation, operating profit as a percentage of sales was 18% compared to 18% for the same period last year.

Operating expenses as reported were $9.8 million. Excluding stock-based compensation expenses, operating expenses increased by 17% in the fourth quarter from the $9.1 million for the same period in 2005. Operating expenses and operating profit as reported in fiscal 2006 included stock-based compensation expense required under statement of financial accountings standard or SFAS 123R. Stock-based compensation expenses amounted to $284,000 during the fourth quarter of 2006, but were not required and thus not included in the 2005 fourth quarter financial results. Operating profit was favorably impacted by a strong growth in consumables, maintenance and paid parts businesses. A sales mix within our high end productivity system business that favored distributed Eden products produced a negative offset to these favorable contributions. Total interest and other income for the fourth quarter increased to $410,000 versus $299,000 last year. Pretax profit as reported was $5.5 million for the fourth quarter. Excluding stock-based compensation expenses, pretax profit increased by an impressive 31% to $5.8 million for the fourth quarter 2006 compared to $4.4 million for the same period in 2005. Excluding stock-based compensation, pretax profit as a percentage of sales increased to 20% from 19% in the same period last year.

Income taxes as reported amounted to $1.9 million or a tax rate of 34.2%. While the fourth quarter effective tax rate benefited from the reinstatement of the research and development credit in December, this benefit was offset primarily by higher effective state and international income tax rates. Excluding the impact of stock-based compensation expenses, income tax expense amounted to $2 million or 34% for the fourth quarter versus $1.3 million or 29.1% for the same period last year. Net income as reported was $3.7 million or $0.35 per diluted share for the fourth quarter. Excluding stock-based compensation expenses, net income increased by 23% to $3.9 million for the fourth quarter 2006 or $0.38 per diluted share. This compares to $3.2 million or $0.30 per diluted share for the same period in 2005. It's important to note that the fourth quarter 2005 benefited from an unusually low tax rate due to the annualized impact of previously underrecognized benefits.

Our diluted shares outstanding dropped by approximately 170,000 shares from the fourth quarter last year, a result of significant stock repurchases we have completed over the past five quarters. The Company repurchased approximately 129,000 shares during fiscal 2006 and maintains approximately $8 million in authorization under the current $20 million stock repurchase authorization.

I would like to highlight the cash flow from operations generated from the fourth quarter which exceeded $7 million for the three month period. The strong cash flow was due to strong earnings as well as favorable changes in our working capital, included a significant sequential drop in inventories and relatively slower sequential growth in accounts receivable. I will discuss these items in more detail later in the call.

Total revenue increased by 25% to $103.8 million for the 12 month period ended December 31, 2006. The company shipped 1,796 systems during the 12 month period, an increase of 38% over the same period last year. Net income as reported was $11.1 million or $1.08 per diluted share for the 12 month period. Excluding stock-based compensation expenses, net income increased by 14% to $12.1 million for the 12 month period or $1.17 per diluted share. This compared to $10.6 million or $0.99 per diluted share for same period in 2005. As we observed in the fourth quarter net income comparison, fiscal 2005 also benefited from a relatively low tax rate. Our cash and investment position amounted to $45 million at the end of the fourth quarter versus $41 million at the end of fiscal 2005. The increase in cash and investments from the end of fiscal 2005 is a result of positive free cash flow from operations in 2006 combined with positive changes in our operating assets and offset by certain fixed asset additions and stock repurchase activity throughout the year.

Inventory balances declined to approximately $9.9 million from approximately $10.9 million at December 31, 2005. The decline is largely due to a a reduction of Eden product inventory related to our transition out of Eden product distribution. Net property and equipment increased to $20.4 million at the end of the fourth 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 included patents and capitalized software. Accounts receivable grew slower then sales in fiscal 2006 and finished the year at $25 million compared to $20 million at the end of fiscal 2005. The increase was principally due to increased sales as well as an $800,000 December receivable under development contract with a Fortune 100 company. As with you will recall we do not recognize this contract as revenue but as an offset to R&D expenses on a percentage of completion basis. In our press release yesterday we discussed the shipment a prototype unit under this contract as well as the customer's confidence in our progress.

Despite this addition to receivables, day sales outstanding or DSO was approximately 77 days compared to 78 days at the the end of fiscal 2005 and down from 85 days at the end of the third quarter. As predicted. our DSO declined significantly from the third quarter as resellers paid for the demo units that they had purchased on extended payment terms earlier in the year. This follows a similar pattern we have observed now for four years. Our DSOs will likely continue to be impacted by our successful program by our resellers that allows participants to purchase a limited number of 3D printers on extended 180 day payment terms during the year. We offered the same program at our annual reseller conference last month, and the voluntarily program has proven to be a very valuable selling and marketing tool to sell multiple system for our resellers. The current level of participation per reseller is consistent with historical levels, and we have made no significant changes to the program. We believe our past history has proven the program's value and manageability. You will note that our allowance of doubtful accounts declined by approximately $318,000. This is because we wrote off a $434,000 receivable from a French distributor in the second quarter of 2006. Net of this writeoff we had an increase in the reserve by approximately $116,000 since December 31, 2005.

Now we would like to give brief insight on the financial impact of the Objet distribution relationship as we have discontinued the distribution of Eden products at the beginning of fiscal 2007. Eden revenue for fiscal 2006 was approximately $16.2 million of which $9.7 million was systems, $5.7 million was consumables, and $800,000 was maintenance. The gross profit margin we recognized on that revenue was approximately 27%. For the purposes of conducting quarterly comparisons in 2007, I will now provide you with Eden revenue for each quarter of 2006. Q1 revenue was $3 million, Q2 was $4 million, Q3, $4.5 million, Q4, $4.7 million. Let me repeat those. Q1 was $3 million, Q2 was $4 million, Q3 was $4.5 million and Q4 was $4.7 million. We will have some Eden revenue in 2007 which will include some system revenue in the first quarter and maintenance revenue through the beginning of August. We estimate this revenue will approximately $1.5 million for fiscal 2007. Our internal P&L indicates the distribution relationship with Objet Geometries operated at approximately a break-even level for fiscal 2006. This analysis includes direct costs such as marketing and personnel dedicated to the Objet product line as well as non direct manufacturing and SG&A costs that are shared across multiple product lines. These cost include joint trade shows, sales, accounting and order processing. Certain direct costs associated with Objet have been eliminated for fiscal 2007. In addition, we have streamlined and redirected our resources to focus on growing our proprietary products in 2007. We will recognize approximately $250,000 in severance cost as a result of these changes. These costs will be recognized mostly in the first quarter and are included in our financial guidance for 2007. Now, I would like to turn it over to our Director of Investor Relations, Shane Glenn, to outline our financial guidance.

Thank you, Bob. Stratasys released the following information regarding its financial guidance for the fiscal year ending December 31, 2007. Revenue guidance of $105 million to $120 million. [sic - see press release] Non-GAAP earnings guidance of $1.37 to $1.49 per share, which excludes the impact of stock-based compensation required under SFAS 123R. GAAP earnings guidance from $1.28 to $1.40 per share. SFAS 123R expenses are estimated net of tax to be approximately $0.09 per share in fiscal 2007 with the expenses recognized equally across all quarters. As Bob mentioned, our fiscal 2007 earnings guidance includes approximately $250,000 of severance expenses, or approximately $0.02 per share. We currently estimate that the fiscal 2007 tax rate will approximate 34% to 35%. The reconciliation between non-GAAP and GAAP financial projections is provided in a table at the end of our press release. We are providing non-GAAP financial estimates for those analysts and shareholders that want to use that information in evaluating our performance.

Although we do not provide quarterly financial guidance, we would like to make some observations regarding the first of half of this year. Looking at operating expenses, we would note that our Dimension reseller conference was held in January this year, or the first quarter, compared to 2006 when it was held in April or the second quarter. This conference represents a substantial cost for the company of around $200,000 and will shift into the first quarter in 2007. Following the same pattern, we have observed over the past four years we've received significant orders for a number of 3D printers at our reseller conference held this year in January. Last year, a substantial number of those orders were for the new Dimension 1200 line. We began producing Dimension 1200s well in advance of the reseller meeting last year and most of the order were fulfilled in the second quarter. In 2007 our reseller conference was in January and has produced a substantial number of orders for this year's new product the Dimension Elite, which Scott will discuss later. Unlike 2006, we've only begun to manufacturer this year's new product, the Dimension Elite, and consequently these orders will be fulfilled more evenly between the first and second quarters. We have attempted to provide guidance that incorporate ours plans for new product introductions, our current growth and product mix expectations, coupled with limitations predicting our operating environment over the next several quarters. Now I would like to turn the call back to Scott Crump.

Thank you, Shane. Our guidance for fiscal 2007 demonstrates our confidence in another strong year. The reoccurring revenue component of our business, which includes system consumables and maintenance continued to generate record levels of revenue, a direct result of the ongoing expansion of our install basis systems. Our notable announcement last September of our 6,000 system installation and FDM advantage to Dell Computer has already been eclipsed by our 7,000th installation last quarter. Our unit shipments are accelerating. Of the 7,000 systems that we've shipped over the 15 year history of Stratasys, approximately 3,000 of them have been shipped in just the last two years. This continued rapid expansion in unit sales should provide for a continued strong growth in our recurring revenue.

Our 3D printing business exceeded our plan throughout the year. This success has been a function of providing the best whole product offering within the industry for the past five years. This whole product positioning goes beyond price and includes system reliability, reseller education and training, customer support, materials, ease of use and office compatibility. It's not just about price. Although our distribution capabilities are unsurpassed within the industry, we continued to improve upon this valuable asset with significant expansion in the Far East as wells as through extensive education and training programs like Dimension University, which improves the productivity of our resellers. We will continue to expand and improve our distribution capabilities in 2007. We have been pleasantly surprised that our best selling 3D printers in 2007 were our higher priced systems that provided our customers with added value that goes beyond just a low price. We followed the successful launch of the Dimension 1200 line last year with our recent introduction of the Dimension Elite, our highest price 3D printer yet at $32,900, and the fifth 3D printer within the product family. The Elite 3D printer provides customer with stronger more functional models that exhibit finer feature detail and improved surface finish. More importantly the Elite uses a stronger, it's a new ABS material called ABS Plus. Although we believe our standard ABS material already provides users with the most durable material option within the industry, ABS Plus is on average 40% stronger then our standard ABS material when used in our Dimension, making it even better suited for testing the fit and functionality of prototypes.

Industry studies as well as our own internal surveys show that the most popular use of rapid prototyping technologies remain testing the fit and functionality of new product designs. These applications are dependent on having highly accurate and durable prototypes. Independent analysis has shown that our proprietary FDM technology produces the most dimensionally accurate prototypes when compared to other technology. Obviously a critical component when conducting fit analysis of new products. In addition, our industry leading material characteristics have been advanced further with our new ABS Plus material. This new material combined with our industry leading accuracy should help strengthen our value proposition for the most popular uses of rapid prototyping technologies.

After introducing the new Elite and ABS Plus material at our global network of resellers last month, we were pleasantly surprised by the enthusiasm demonstrated by our more than 200 channel partner locations worldwide. This enthusiasm was reflected in the approximate $6 million order that we just received from Marubeni solutions from Japan for 285 systems, the largest single order in our company's history. In 3D printing we continue to observe a market that is significantly underpenetrated, and suffice it to say 2007 is already looking to be another strong year for that business. Within our high end system productivity business, we have successfully transitioned away from Eden product distribution and have stream lined our resources for the purpose of growing our proprietary FDM products.

In addition to focusing on higher margin products, the business should benefit from an acceleration of new product development that began back in 2005 that will well -- better position Stratasys for direct digital manufacturing. Otherwise known as DDM. In other words, the manufacturer of end-used parts. We agree with industry analysts that the future opportunity of using these technologies for DDM could well exceed the opportunity that exists for rapid prototyping and 3D printing combined. We've made significant progress in developing our proprietary FDM technology for DDM applications. As you saw in a press release yesterday, we have completed several major milestones as part of our $3.6 million R&D contract with a -- which is a base to advance our proprietary FDM technology for direct digital manufacturing applications. We began the initiative in September of 2005 with a unnamed global manufacturing company. Our progress to date includes the acceptance and installation of a system prototype the at the customer site, and the customer is pleased with the performance of the system and the progress we have made, and has already requested several additional units to meet their capacity demands.

We have -- we've had a successful first year of launching the Arcam EBM system for metal parts, for example, we successfully installed a Arcam system at Medical Modeling in golden, Colorado. Medical Modeling will use the system to provide surgeons and medical device manufacturers with titanium models for improved surgical planning and implant development. We remain optimistic about our opportunity for Arcam systems in the North American market and believe that the technology could be an ideal platform for a direct digital manufacturing of metal parts. Our paid parts business grew by 45% in 2006, a direct result of our highly successful online part quoting, ordering, and fulfillment service, RedEye RPM, the paid parts service is a high margin and rapidly growing business opportunity. We'll be adding capacity for paid parts in 2007 and expect another very strong year of growth. In addition to -- in addition, given that most customers buy parts before buying systems, we view this service as a profitable tool for sourcing system sales. Notably, direct digital manufacturing orders contributed to a significant portion of our paid parts business in 2006, and we believe this is an indicator of new applications for our technology.

I'll return with some closing comments, but first I would like to address any questions that you might have. Operator, let's open the call up to questions.

Thank you, ladies and gentlemen. [OPERATOR INSTRUCTIONS] Our first question is from the line of David Cohen with Midwood Capital. Please proceed with your question.

Hi, guys. This was a heck a quarter.

Hi, David.

A couple of questions. The Eden sales in 2005 can you tell us what those were for the full year?

I don't have that comparison for Eden in 2005.

Okay, maybe I'll follow up afterwards, or I can e-mail one of you guys. On the Eden cost. You say it's a breakeven operation so with $16.2 million of rev and 27% gross margin that means $4.4 million of cost. How much cost do you think you've taken out with the resource changes you've undertaken?

Now, I think rather than focus on the details of what we've done within the cost structure, I think the two things I would point you to is that we said we would incur severance cost of approximately $250,000. The good news is we have other growing parts of our business where we can rededicate some of those resources in different directions and from there I would just point you to the guidance we've now given you for 2007 which indicates our confidence in the growth in the year rather then dwelling on the specific details.

The severance doesn't tell me a whole lot. I don't know how many people, I don't know what the costs surrounding those head count reduction was on an annualized basis. That alone isn't very helpful.

Again, I think it goes back to looking at what our guidance is for 2007 and again, I don't want to get into specifics of what we've done with employees, et cetera.

Last question for Scott. The - it was announced a month or so ago from one of your competitors about a new desktop system at $9900. While that's not even in the marketplace you may not even know that much about the technology, what does that price point suggest to you guys in terms of your own planning around how you move down the price curve here?

Are you referring to the V-flash announcement.

[inaudible] yeah.

Well, of course, as I mentioned in the presentation that it is all about whole product offering, it's not about price. It is definitely going to include the other aspects of whole products that I mentioned, which includes one to two years of reliability between service calls. So in other words price elasticity works only if you have all of the other components of the whole product criteria. And we proved that way back in 1997 with our Genisys and others in the industry proved and it and also failed early with 3D printers by not having even one component like reliability. So I think over a period of time our intention, I believe the customers' needs will definitely require both lower priced whole products as well as expansion into new applications which could include higher prices as we just showed as we released our last product. So, I don't believe it's all about --

The other thing David is we, obviously there needs to be a product first to evaluate.

I understand that. I'm not even speaking to product itself just the price point and what that represents.

The one thing I would add to Scott's comments if you look at our most highest selling 3D printers or best selling 3D printers it's our higher ones that provide value. So as Scott mentioned, you know, It goes beyond price you have got to have the rest of the, the whole product criteria.

All right. Thanks a lot, guys.

Thank you.

Thanks.

[OPERATOR INSTRUCTIONS] Our next question come from Jeff Rosenberg with William Blair. Please proceed with your question.

First question I wanted to ask you, as you've seen the mix unfold for your 3D printers during the year, given how the different models have been accepted. Can you comment on the overall year-over-year ASP in 3D printers? You know, roughly what that's changed and how that's gone relative to your expectations?

We've actually, with -- when you go year-over-year you have to remember that we, at the beginning of 2006, we actually reduced the price of the 3D printers in January of last year of our previous Dimension line by about $5,000. So our price points within the marketplace are relatively on the high end are fairly consistent with just the two product we've have had in the previously year. Consequently overall we've seen a small decrease in the average ASP but it's not been significant because people have been buying lot at that $29,9 price point.

And would you have expected that number to be a greater decline given the potential elasticity you might have seen when you went to the $18,9 on the low end, or has that been more consistent with your expectation?

No, I would say earlier in the year we saw that the two best selling models that we had were the BST 768 and then the 1200 SST so we saw our best sells being at the very high end and the very low end. As we got into the fourth quarter, we actually saw more of a shift to both the 1200 SST and 768 SST. So it surprised that it's favored the higher priced units late in the year.

Okay. And then the other question I wanted to ask and this might be in the pro forma numbers you provided, so I apologize if it is. But what was the, adjusting for the change in how you accounted for services what was the sequential change in SG&A?

Yes, that is provided in the tables.

I'll go look for it. Sorry about that. Thanks.

Thanks, Jeff.

Thank you, our next question is from Graeme Rein with Bares Capital Management.

Hi. Could you talk a little bit about the contribution of Arcam to revenue in '06 and more importantly, kind of what you would anticipate in '07?

Well, we had a very successful first year launch. It is new and very exciting technology but it's also high end capital equipment so these type of launches take a while to get going and that's why we are real confident in 2007 this year. We were able to focus in on both the aerospace application for lightweight parts strong-- lightweight parts with titanium as well as some very good penetration into the medical where bone implants and parts like that need higher cycle rates and with the better metallurgy we were able to provide that. It's fairly early. Even though it's been almost, it's been actually a full year, but these new technologies take a while because of the application and the price budgeting of the systems.

So, probably not a material part of revenue in '07?

Clearly not a material revenue of the '06 revenue and I wouldn't define it as necessarily material in '07 either.

Okay. Thanks a lot.

Thank you, our next question comes from Scott Barry with Sanders Morris Harris. Please proceed with your question.

Good morning, gentlemen. Congratulations on the quarter.

Thank you.

Good morning, Scott. Thanks.

Got a question about gross margin trends. Clearly you're going to see some improvements in '07 with the discontinuing the Eden line. Can you talk a little bit about maybe longer term trends in late '07 and further on? The reason I ask is it seems to me you've got kind of two conflicting potentials here. One is a rapid growth in consumables which should drive your gross margins up above an organic level in in the high 50's and on the other hand you have 3D printers which while you're experiencing greater demand for the higher ASPs seems to me should be below that organic gross margin level. Who's going to win the race? How do you see that playing out in the next couple of years?

As you recall from our guidance, we don't focus on the gross margin line, I think it's important for us to focus both on the top line and what we can bring to the bottom line. Clearly, we have differences within our mix, and we hope to see continued demand and expect continued demand from the 3D printers as well as our high end productivity systems. And going to pull the consumables along with it. So we hope to see that the system sales is still helping for the next several years.

Okay, and just a quick followup. The gross margin you showed for the last fourth quarter was lower if I recall than guidance you had given in the last call. Is that (A), correct, and (B) is that due to more Eden sales then you anticipated.

Scott, we didn't give gross margin guidance.

I thought I had written that down somewhere, okay, fair enough.

Thanks Scott.

Thank you, our next question is from Andrew Schopick with Nutmeg Securities. Please proceed with your question.

Good morning, gentlemen.

Hi, Andy.

I do need a clarification and then I have got a bunch of questions but I'll just ask the ones I really need to ask. The Eden revenues, Bob, in your opening comments I heard you say up 20% equal $2.5 million but later on I heard you say fourth quarter Eden revenues $4.7 million. Is it $2.5 million just product?

Yes that's a clarification. And so there was strong consumable sales of the Eden systems in the fourth quarter.

Okay. Thank you for clarifying that. I also wanted to ask you a little bit about the lease space. How that's growing, how many units are in the lease space and what the average lease period is now? Because you do use a mixture of programs here?

Yes. I don't have the overall how many systems that we have under lease at my fingertips. I can tell you during the fourth quarter there were 27 leases and for all of 2006 we added 90 leases to the program.

And do you have that comparison for ni -- 2005?

I don't have that at my finger tips, you can look at the dollars that we've added to the leasing program and to me it's not -- when you look at our overall balance sheet I don't think it's been significant. The profile on those systems is generally -- it's been a three to four lease program. Focused on a three year lease.

Thank you, did you specify capitalize softwares? You made a general reference to it.

No, I didn't. For the quarter it was $374,000.

Okay, thank you, again.

Thank you, our next question is from Eric Martinuzzi with Craig-Hallum. Please proceed with your question.

Good morning. I have a question about the high end growth rate. You gave a number of 14%. I believe that was for Q4. Was wondering was that including Eden or was that excluding Eden.

That was including Eden.

Okay. what is the number you give for the quarter for 2006 for high end, systems excluding Eden?

Well, we saw on our manufactured systems, in the high end manufacturing systems we actually saw about a 7% growth in the sales in the fourth quarter. We've always said that the top end we thought was growing at about a 6% rate so, and what we saw internally was about a 7%. This is in addition to that we grew our backlog year-over-year by about is $1.3, $1.4 million. And over half of the backlog increase came from the high end FDM systems. So I think this bode well for the high end manufactured systems, especially when you consider that with we have direct digital manufacturing efforts going on in 2007.

Is that to say then that guidance that you've given, this 105 to 110, does that imply an acceleration at the high end or is that just the maintenance of what you achieved in '06 growth rate.

We're cautiously, I would say cautiously optimistic on the high end with the direct digital manufacturers. Probably looking at new product offerings later in the year. So it's less of a contributor in 2007 then we look at for years beyond.

Okay, and then just a housekeeping item. The share count we finished out in Q4 with is that a good number to use with for our '07 models ?s0

Yes. You know, Eric, I would assume some potential appreciation in that share count assuming the stock is higher, but that's obviously hard to predict.

Okay. Thanks.

Thank you, our next question is from Troy Jensen with Piper Jaffray. Please proceed with your question.

Congrats on the nice quarter, gentlemen.

Thank you,.

Hey, I want to spend time talking about the fortunate 100 direct manufacturing deal. I think when it was originally discussed it was at $3.6 million but it was a mixture of paid for R&D versus future product purchases, given that you guys pulled out, I think you said $800K in the R&D, is the remaining piece of that all future purchases or are there still more milestones for development on the R&D side.

Troy, I'm glad that you clarified that because what I said is we had billed them. We're able to bill them on milestones actually, sometimes that's an advance over internal spending. Because what we offset in the quarter was only $270,000 while we billed them $800,000 in the quarter. So I think we're taking a conservative approach on that. Our overall offset on that contract for 2006 was approximately $1.1 to $1.2 million. I would expect a similar level of offset to be seen in 2007. Because we -- that was an alpha unit. We still have a long ways to go before we get to commercialization of that unit.

We're still in R&D, per plan.

Okay.

Mostly in 2007 you're going to continue to see an R&D offset as opposed to that being a revenue generator within that contract.

Got you. Understood. And then Bob, given all of the moving parts and pieces with Objet and the movement of SG&A up to some GOGS. I know Tom previously gave a business model target. I was wondering if you would be able to provide what you think longer term gross margins and operating margins look like.

We have moved because of the different mixes within our products we really moved away giving that model. Again, we're focusing on growing our operating income as well as top line. And while Tom may have done that previously, I think there's too many moving parts to do that accurately.

Got it. Keep up the good work, guys.

Thanks, Troy.

Thank you, our next question is from Jeff Evanson with Dougherty. Please proceed with your question.

Thanks for taking my questions.

Hi, Jeff.

Scott, I know you like to think beyond just the next year or so. You've got a lot of opportunities in front of you here. Whether it's on the product side with the Dimension Elite, international expansion or on the direct digital manufacturing. Of those three major opportunities you have, which are you most excited about over the next couple of years?

Well, I think there's probably three top ones there. The continued acceleration of the 3D printing and the, you know, consumable flow that pulls along with it. Actually the fastest percentage growth in the company is actually RedEye paid parts so there's a significant amount of not just U.S. but in the longer term worldwide opportunities that are pretty excited with the paid parts and how they tie back into system sales. Very very synergistic. And the still untapped global opportunity for DDM doing the end used parts. I think my answer would be three.

All right, and what is your biggest concern here over the next couple of years?

Well, I think containing growth so that it's a profitable growth. It's easy to grow, it's hard to grow profitably, so, I would say all of the elements of the not just cost control, but also driving the growth in a controlled way.

Sounds good. Thanks a lot.

Gentlemen, at this time, there are no further questions.

Okay, well, we appreciate that. Scott's got a few closing comments.

Okay. In closing I would like to say despite our record performances, we believe that we've just begun to tap our potential. For those that question the market opportunity for 3D printing, I would only reference on you are impressive growth over the past years capped by a fourth quarter that generated an impressive 40% increase in 3D printed -- printer unit volume. Not surprisingly, we continue to believe a significant 3D printer market opportunity exists that could top $500,000 printers worldwide. And while 3D printing is compelling alone, the opportunity presented by direct digital manufacturing is potentially bigger then the opportunity for 3D printing and rapid prototyping combined. We've aligned our high end productivity system business to focus on our proprietary products and we've made tangible progress at targeting the DDM opportunity for both paid parts and in new system development. And finally regardless of the opportunity or application as we grow our install base of systems we're positioned to expand our highly profitable recurring revenue streams. We're excited about 2007 and would like to thank you for your interest in Stratasys and look forward to speaking with you again in April. Goodbye.

Ladies and gentlemen, this concludes today's teleconference. Thank you for your time.