Stratasys Ltd (SSYS) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2008 Stratasys earnings conference call. My name is Dan, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. In the interest of time, please limit your questions to one question and a follow-up, and then rejoin the queue. (Operator Instructions). I would now like to turn the call over to your host for today's call, Mr. Shane Glenn, Director of Investor Relations at Stratasys. Please proceed, sir.

Good morning. Welcome to the Stratasys conference call to discuss third-quarter financial results. Representing Stratasys' executive management on the conference call today is the Chairman and CEO of Stratasys, Scott Crump and CFO, Bob Gallagher. A quick reminder that today's conference call is being transmitted over the Web and can be accessed through our Investors section of our website at www.stratasys.com.

We will begin with the Safe Harbor statement. All statements herein that are not historical facts or that include such words as expects, anticipates, projects, estimates, vision, planning, believes or similar words are forward-looking statements that we deem to be covered by and to qualify for the Safe Harbor protection covered by the Private Securities Litigation Reform Act of 1995. Our belief that we have the largest part-building service is based on the total number of dedicated machines.

Except for the historical information herein, the matters discussed in this conference call are forward-looking statements that involve risks and uncertainties. These include the continued market acceptance and growth of our Dimension 3-D printer line, FDM 200mc, 360mc, 400mc, 900mc, Maxum, Titan and Vantage productline, the size of the 3-D printer market, our ability to penetrate the 3-D printing market, our ability to maintain the growth rates and positive momentum experienced in this and preceding quarters, our ability to introduce and market new materials, such as ABSplus and ABS-M30 and a market acceptance of these and other materials, the impact of competitive products and pricing, the timely development and acceptance of new products and materials, the success of our recent R&D initiative to expand the direct digital manufacturing capabilities of our core FDM technology, the success of our RedEye RPM and other Paid Parts services and the other risks detailed from time to time in our SEC reports, including our quarterly reports filed on Form 10-Q to be filed throughout 2008 and our annual report on Form 10-K filed for the year ended December 31, 2007.

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

I would like to confirm the date of our fourth-quarter earnings release and conference call. Stratasys' fourth-quarter results will be released on or before the morning of February 18, 2009, followed by a conference call on the date 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 and thank you for joining us. We are pleased to announce our record third-quarter financial results. We are especially pleased given the current economic environment. Revenue grew by 20% for our proprietary products and services in the third quarter. Operating profit increased by 30% over last year, and this was the fastest growth in operating profit since the first quarter of 2007.

Our high-end FDM system business grew by an impressive 68% during the quarter, driven by new products and the positive impact of our direct digital manufacturing initiatives. This growth was helped by the first commercial shipments of our new FDM 900 manufacturing center, our largest and fastest system ever produced. Our consumables and Paid Parts businesses also contributed to our growth during the quarter, increasing by 20% and 22% respectively.

In September, we announced that Jeff DeGrange joined Stratasys as Vice President of New Business Creation for our direct digital manufacturing initiatives. Jeff was a senior technology manager with The Boeing Co. and has more than 20 years experience in advanced manufacturing. So we are excited to have him join our team.

Okay, 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.

Thanks, Scott. Prior to discussing the details of the financial results, we would like to outline the relative impact of discontinuing our product distribution agreements in 2007. As we have previously outlined, we have discontinued the distribution of EDEN and Arcam products, which created certain issues when conducting year-over-year comparative analysis of our financials.

In the third quarter of 2008, we recognized no revenue related to those discontinued distribution products compared to approximately one million in the same period last year. Total revenue increased by 16% to $30.6 million for the third quarter of 2008 compared to $26.5 million for the same period last year. Revenue from proprietary products and services, which excludes all distributed product-related revenue, increased by 20% in the third quarter over the same period last year.

The Company shipped 497 systems during the third quarter versus 521 last year. The decline in units resulted from lower 3-D printer unit volume compared to last year. As expected, the issues we identified last quarter within 3-D printer continued into the third quarter. 3-D printer sales have been impacted by our more recent focus on higher-priced printers and a weaker manufacturing environment. Despite the weaker economic conditions, our three highest priced 3-D printers -- the 1200 SST, Elite and 768 SST -- represented approximately 70% of our 3-D printer unit volume during the third quarter.

Third-quarter product revenue as reported increased by 16% to $24 million when compared to $20.7 million for the same period last year. We recognize no distributed product revenue during the quarter compared to $784,000 in revenue we recognized during the same period last year. Excluding this revenue, proprietary product revenue increased by 20% over the same period last year.

Two main factors drove our proprietary product revenue in the third quarter. First, proprietary high-end system revenue increased by an impressive 68% when compared to last year. This was a result of the positive momentum we are experiencing from our new high-end systems. The 900mc was a significant contributor to growth during the quarter as we successfully began a commercial production and shipment of this product early in the period. We should note that order activity for the 900mc has remained strong in the first part of the fourth quarter.

Second, our proprietary consumables grew by 20% during the third quarter when compared to last year. This was driven by our ongoing expansion of our installed base of proprietary systems.

3-D printer system revenue declined by 3% during the quarter, driven by a decline in 3-D printer unit volume. This more than offset higher average prices for 3-D printers compared to last year and with a continuation of the expected trend we reported during the second quarter.

Third-quarter service revenue as reported increased by 14% compared to the same period last year. We recognized no distributed product-related service revenue during the third quarter compared to $261,000 in revenue for maintenance contracts we recognized during the same period last year. Excluding distributed product-related service revenue, total proprietary service-related revenue increased by 20%.

Our Paid Parts revenue increased by 22% for the third quarter compared to last year. This was a significant improvement in the 5% year-over-year growth we generated in the second quarter.

Gross profit increased by 17% to $15.8 million for the third quarter of 2008 when compared to $13.5 million for the same period last year. Gross profit as a percentage of sales increased to 51.7% compared to 51% for the same period last year. The improvement in gross margin percentage was driven primarily by the elimination of the distributed product-related revenue, which had an immaterial gross margin contribution during the third quarter of last year.

Operating and profit increased by 30% to $5.3 million for the third quarter of 2008 compared to $4.1 million for the same period last year. Stock-based compensation expense required under statement of financial accounting standards or SFAS 123(R) amounted to approximately $238,000 in the third quarter compared to $203,000 for the same period last year.

Operating expenses increased by 12% during the third quarter compared to last year. As you will recall, we undertook some cost reduction initiatives in the second quarter, which lessened the overall level of operating expenses we had previously expected. Consequently, the third quarter included approximately $150,000 in severance charges related to those cost reductions.

Total interest and other income for the third quarter decreased to $381,000 versus $525,000 last year. The decline was a result of lower interest rates, combined with the impact of lower cash balances, driven by significant stock repurchases during the period.

Pretax profit increased by 23% to $5.7 million for the third quarter of 2008 compared to $4.6 million for the same period last year. Excluding stock-based compensation expenses, pretax profit increased by 24% to $6 million for the third quarter of 2008 compared to $4.9 million for the same period last year.

Income taxes reported amounted to $2 million or a rate of 34.7% compared to $1.4 million or 29.8% for the same period last year. The tax rate in 2007 was favorably impacted by employees' exercise of stock options during the quarter, as well as a change in our estimated tax benefits from research and development credits. Excluding the impact of stock-based compensation expenses, income tax expense amounted to $2.1 million or 34.2% for the third quarter versus $1.4 million or 29.1% for the same period last year.

Net income increased by -- excuse me -- net income increased by 15% to $3.7 million for the third quarter of 2008 or $0.18 per share compared to $3.2 million or $0.15 per share for the same period last year. Excluding stock-based composition expenses, net income increased by 15% to $3.9 million or $0.19 per share for the third quarter 2008 compared to $3.4 million or $0.16 per share for the same period last year.

Our diluted shares outstanding declined by 792,000 shares from the third quarter last year, a result of our lower stock price, as well as significant share repurchases. We repurchased approximately 866,000 shares during the third quarter for approximately $50 million or $17.50 per share. We have approximately $11 million remaining in the current repurchase authorization.

Our cash and investment position amounted to approximately $42 million at the end of the third quarter compared to approximately $61 million at the end of fiscal 2007. We have no long-term debt on our balance sheet. The change in cash and investments from the end of fiscal 2007 is a result of the cash used for stock repurchases, combined with higher working capital requirements, offset partially by cash flow from operations. Year-to-date, we have bought back approximately 1.1 million shares for approximately $19 million for approximately $17.50 per share.

Inventory balances were $19.8 million at the end of the third quarter, which is up from the $12.8 million at the end of fiscal 2007. Our build-up inventories this year is attributable to four main reasons -- a build-up in the inventory to support our new product introductions, particularly 900mcs; last times buy for legacy system inventory; an increase in consumable inventory to meet future customer demand; and strategic additional purchases of consumable raw materials in anticipation of future needs and price increases.

Accounts receivable at the end of the third quarter was $31.5 million compared to $26.3 million at the end of fiscal 2007. Days sales outstanding or DSOs were approximately 94 days at the end of the third quarter compared to 100 days at the end of the second quarter. Although down from the second quarter, DSOs remain elevated. Obviously, it has to do with the timing of collection, but also the fact that many of our sales come toward the end of the quarter.

Another factor that influenced DSOs was a relatively strong sales growth we experienced from our international markets during the quarter, which grew 29% versus 6% domestically. The international markets typically operate on terms that are more extended than our domestic channel. International sales represent 46% of revenue during the third quarter versus 41% last year. While I am disappointed in the DSO number at September 30, I look forward to further improvement at the end of Q4.

I would like to summarize what I believe are the key financial highlights for the quarter. First, we have strong sales growth coming from our high-end systems sales, proprietary consumables and Paid Parts, as expected, weaker 3-D printer system revenue, driven by lower 3-D printer unit volume. Third, strong operating profit growth and positive cash flow from operations. And last, a tremendously healthy balance sheet. 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 provided the following information regarding its financial guidance for the fiscal year ending December 31, 2008. Maintaining revenue guidance of $125 million to $130 million, maintaining our non-GAAP earnings guidance, which excludes stock-based composition expense required under SFAS 123(R), of $0.79 to $0.84 per share, maintaining GAAP earnings guidance of $0.75 to $0.80 per share. Stock-based composition expense required under SFAS 123(R) is estimated at $0.04 to $0.05 per share.

In conducting your year-over-year analysis for the fourth quarter, we would like to remind you of the approximate $1.4 million in distributed product revenue we recognized in the fourth quarter last year relating to products that we now no longer distribute.

In addition, the fourth quarter of 2007 includes approximately $700,000 in previously unrecognized tax credits. This amounted to approximately $0.03 per share in fourth-quarter earnings in 2007. Our earnings growth projections remain strong, but we are cautious given the current economic environment. While we are experiencing some deferred orders, our guidance incorporates our current growth and product mix expectations, coupled with the inherent limitations created by the current dynamic economic conditions.

While the economy has clearly weakened from the second quarter, our 900mc orders remain strong and our high-end systems are reaching new markets. Our Paid Parts business has continued its positive momentum. Consumable revenue is tracking our growing installed base, and maintenance is relatively predictable over the next three months. We would be foolish not to be concerned about our system sales in the fourth quarter, but not to the extent to adjust our guidance given what we know today.

Appropriate reconciliations between the GAAP and non-GAAP financial measures are provided in the table at the end of this press release. We are providing the non-GAAP financial estimates for those analysts and shareholders that want to use that information to evaluate our performance. Now I would like to turn the call back to Scott Crump.

Thank you, Shane. Once again, our quarterly results reflect our ongoing success with our new high-end precision systems -- the FDM 200, 360, 400 and 900 manufacturing centers. Following the introduction of the 900mc last December, we began commercial production and shipment of the systems during the third quarter. The performance of the 900mc in the field has definitely exceeded our expectations. In addition, orders for the 900mc remain strong, and this product is on track for exceeding our original 2008 sales estimate.

Growth in the high-end business continues to defy conventional expectations given the current economic environment. This is a testament to the successful new product and marketing strategy our team initiated this last year. Our strategy, which targets new applications for direct digital manufacturing or DDM is driving incremental sales for the high-end systems. Our initial success within DDM has come from a targeted application in the manufacturing industry for fabrication and assembly tools.

Fabrication and assembly tools are a unique jigs and fixtures that are not incorporated directly into a finished product, but are critical to a specific manufacturing process. These tools enable the efficient manufacture of a product and are essential for almost any size manufacturing operation. In fact, we use them extensively in our own manufacturing processes. These tools are ideal for DDM because they are often produced in single or limited quantity and maintain complex designs, which need to change easily and repeatedly.

BMW is a great example of a DDM application. They have user technology as a standard practice in the product development for a number of years for prototyping their designs. However, BMW has more recently expanded the use of our technology beyond prototyping, incorporating FDM into their manufacturing processes. With every new car model, their department of jigs and fixtures will use FDM to built assembly tools that are unique to a specific car design. Compared to traditional processes, this has reduced their costs and produced assembly tools that are more ergonomically designed.

Because the assembly tools are used in a manufacturing environment and are design-critical, the robustness and accuracy of the tools are also essential. Consequently, we believe FDM is ideally positioned for these applications given our durable materials and industry-leading accuracy.

Although the applications for fabrication and assembly tools is a relatively small segment within a broader manufacturing industry, we estimate the market is several times larger than our $1.1 billion market for rapid prototyping and content models. In addition, we believe broader opportunities exist within DDM that go beyond fabrication and assembly tools, and we remain excited about other emerging applications for production parts.

As I mentioned earlier, we are excited to have Jeff DeGrange join our team to lead new business creation within the DDM area at Stratasys. Jeff has more than 20 years of experience in advanced manufacturing technology at The Boeing Co., which included leading an advanced manufacturing research and development program. He has first-hand knowledge of our technology and will work with our Stratasys team to accelerate the Company's development and marketing of new DDM applications.

The flat performance within 3-D printing for this last third quarter was a continuation of the trend we observed in the second quarter and is now reflective of our short-term expectations. The business continues to be impacted by customers that are less inclined to make innovative investments within an uncertain manufacturing environment.

In addition, our recent strategy to market higher-priced printers has also had an impact. We believe these trends will continue in the fourth quarter. However, we are optimistic that 3-D printers, in terms of overall growth, will accelerate in the 2009 time period given our planned initiatives then. We remain confident in our longer-term vision for 3-D printing and believe a significant, underpenetrated market still remains ripe for expansion.

Our Paid Parts business continued to improve in the third quarter with revenue expanding by 22% over last year. The performance is attributable to improvements that we've made within our sales and marketing activities. In addition, we are experiencing growth from new opportunities for architectural and direct digital manufacturing applications.

We introduced an exciting new service in the first quarter that offers architectural models to our customers. These are for homes and office building models. This service is called RedEye ARC and it builds architectural models that allow the architect to effectively and more quickly communicate their designs. The number of architectural CAD workstations that exist worldwide is significant and the industry's adoption of 3-D software from companies like Autodesk is accelerating.

Although architectural applications currently represent a small amount of the Company's total revenue, we are excited about this growing future opportunity given the number of architectural CAD workstations that exist globally, and that outnumbers the mechanical CAD market that we currently serve. We would like to encourage you to take a look at our new service by logging on to redeyearc.com. Overall, we believe this positive momentum in Paid Parts will continue in the fourth quarter.

Consumable revenue grew by 20% over last year, a result of our growing installed base of systems. In addition, we believe our consumable sales are benefiting from the recent expansion of our high-end FDM systems. The FDM system being used in a production environment will operate at significantly higher rates of consumable usage. For example, the FDM 900mc productivity system, which is our largest and fastest system, will typically consume approximately $50,000 in materials per year, which is 10 times the usage of an average 3-D printer.

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

Andrew Nowinski, Piper Jaffray.

Good morning, guys. Nice quarter. Just wanted to touch -- kind of get some color on the gross margin side. It looks like gross margin was fairly in line with your historical Q3 seasonality, but given that high-end sales in consumables and Paid Parts were all up and 3-D printers were flat, I guess I would expect it to be a little higher than it was. Can you just give a little more color on that?

We have a -- I think probably a misnomer out there is we have a wide variation in our product gross margins, not only on our 3-D printers because essentially the products that -- we sell 3-D printers from $18,900 to $34,900. But on our high-end systems, we have a price range from probably about $50,000 up to $400,000. There is just as much variation in our gross margins on the high-end systems as there are in 3-D printers. So that is not necessarily a correlation that you can make from high-end to 3-D printers within the quarter. So obviously, the quarter gave us influence because it is a high quarter for education for us, as typically is the case in the third quarter. But we are happy to show margin improvement year-over-year.

Okay, got it. And then last question, on the high-end side, high-end were up 68% year-over-year. How much of that was driven by your shipments to that Fortune 100 customer?

Well, the high-end is global markets, global opportunity. So I think the answer is that it basically went globally.

We are not going to break out the percentages as it relates to a specific customer in any quarter.

Okay. Thanks, guys.

Eric Martinuzzi, Craig-Hallum.

The high-end systems -- I assume most of this is coming from the 900, what is the runway there? We've just seen our first quarter of real commercial shipments of these. Is this a four-quarter phenomenon, a two-quarter phenomenon, 18 months? What is your sense?

We have a strong sales activity that definitely carried over into the fourth quarter. Our commercial launch, as I mentioned, was very successful. The customers really love it. And the product is on track to exceed our original 2008 sales estimates. Since it is a new product, both from a launch, as well as from a commercial standpoint -- it has been out, well, since the beginning of the third quarter -- It is fairly difficult to estimate or forecast for 2009. But from what I can see so far, it is definitely a home run.

But just from a sense, like a backlog sense, how does it compare to 90 days ago?

What we are seeing from -- we had good strong orders at the beginning of the fourth quarter for the 900, so the momentum that we had in the third quarter has continued into the fourth quarter for us.

Eric, as you know, we still have backend-loaded quarters and it is still going to be dependent on -- we'll have to see what kind of carrythrough we have through the rest of the quarter.

Okay, and then just one more on the Dimension. When I see a 0% comp for that product, and I just took a look at last year's press release for the September '07, it was a 50% growth number in the Dimension a year ago. Now we are flat, dramatic drawdown. I know there is a couple of reasons for that, but I'm wondering about market maturity. What percentage of the Dimensions are going to new customers?

Because we are going through an indirect channel through the reseller channel, I don't think we have statistics of what is in new customers versus existing customers. We only have anecdotal evidence from the channel out there where we are finding that people are adopting to a second system much more readily than people are going for new technology in this economic environment.

We continue to believe, and our observations support it, that the opportunity is a based on a price-elastic business model. And is still on the early stages of the early maturity with being very underpenetrated filled with a huge opportunity.

Thank you.

Ryan Thibodeaux, Maple Leaf Partners.

Good morning. Bob, just one housekeeping item first. Can you say what the operating cash flow was either for the first nine months or for the quarter?

For the nine months, it was approximately $5.8 million, and I think through the first six months of the year, I think we were actually negative operating cash flow, about 5.2, so it was a very positive quarter, close to $11 million for operating cash flow for the quarter.

Okay, and then back on the gross margin question, could you kind of, if possible, just give a little bit more granularity into how we should look at the gross margin bands within Dimension and within the high-end systems? Because it seems like if you are having a lot of growth from the initial shipments of the 900, that your gross margins may be better within the high-end systems. Is that not correct?

That is a reasonable assumption. There is a couple of factors that are influencing the year-over-year comparative analysis. So let me try to highlight a little bit of that. Previously, our software amortization previously had been included in G&A, and we now moved that up to cost of sales, product cost of sales and it was approximately $350,000 in Q3 of 2008.

In addition, we've reallocated some of our costs of our refurbishment department between products and services between the tiers and that has a $280,000 impact between the two groups in Q3 of this year. So there are certain factors there that are influencing the year-over-year comparative analysis. We don't think those reclassifications were material so that we had to go back and restate the previous year, but they are significant when doing the type of analysis that you are.

So let me just repeat that. Software amortization was approximately $350,000, and the costs which came out of G&A and the cost of the refurbishment, which is a switch between products and services, was approximately $280,000.

Where was the refurb before?

In services, cost of sales, services. So it doesn't affect the overall gross margin, but it does affect the comparison between products and services.

Okay, all right, and then along the same line of thinking, is there any tendency on the Dimension towards the lower-priced offerings now that we're kind of, given the comments you said earlier on the economy and how that is affecting Dimension sales?

No, we have not seen that. Obviously, we did, as Bob mentioned, see a great Q3 to education, which tends to buy in the low-price range. But that is not really your question, so no, we have not seen that.

About 70% of the market is still going for our three highest-priced printers currently.

Okay, and then as it relates to OpEx, given some of the cost reductions, do you expect -- are we at a -- is the run rate that we were at in Q3, is that a reasonable run rate for Q4?

We don't comment on specific line items as it relates -- we give our overall guidance and we try to stay outside the box in between that, other than to say some of our new product initiatives, both on -- (inaudible) move down the price elasticity curve, as well as new direct digital manufacturing operation opportunities. Both of those will require continued investment, so we will see us continuing to investment in our R&D area as we move forward.

Okay. Thank you.

Graeme Rein, Bares Capital.

Good morning. Scott, you stated that you believe the 3-D printers will see some expansion in 2009 based on some of the initiatives you have in place. Can you provide some more detail on what those might be or is that new products, is that a pricing strategy or something else?

Well, we don't comment on new products other than we continue to have them. We are investing about $10 million overall in this activity for new products on an annual basis, but as far as specific new products, we are really not, for competitive reasons, commenting.

And have you seen any change in the competitive environment in that 3-D printer market from Z Corp or 3D Systems?

Not with Z Corp in terms of V-Flash. No, that potential product is pretty much invisible worldwide. However, we do continue to competitively monitor it. So I would say no, there is no real -- on a competitive basis on the 3-D printing side, we are not seeing any competitive changes.

Okay, thanks. And then the last one thing, Bob, the $1.9 million broken out in available for sale securities on the balance sheet, what does that relate to? Is that the auction rate securities or is that something different?

No, auction rate securities is exactly what it is. We recognize approximately -- we had a third-party outside analysis of our Jefferson County auction rate security again this quarter. We took an additional impairment of approximately $50,000, so we have a total impairment that we've recognized on a long-term basis for that security of $440,000 year-to-date.

Okay, so there is no other, in that long-term investments line, there's no other auction rate securities?

Only that one. We do have one other auction rate security with Lorain County, and that continues to be AA-rated with a AA-rated insurance company behind it, too, with really strong financial statements from the issuing entity.

Okay. Thank you.

Jeff Evanson, Dougherty & Co.

Good morning. This is Charlie in for Jeff. Just a couple questions. I wonder if you could talk about that 3-D printer revenue accelerating next year. You made the comment there, just to go back to that. I wonder if that is having to do with the fact that you are selling more of the expensive products there and so you are going to get an ASP lift next year or if you are actually going to be thinking about growing units next year.

That's a good question. Again, we are not commenting on -- in terms of new product releases. One thing I can say as an overall that we do believe that the 3-D printing opportunity is at its early stages still. The more we are in it, the more we look at it, the more we talk to some of the other CAD-oriented companies in the business that are now focusing more on 3-D, like for instance Autodesk, there is more focus and there is certainly significantly more installed base of the three-dimensional mechanical CAD.

But the bottom line is it is not just about price. You need to consider other whole product offerings. We need to look at other -- for instance, the other key three criteria, that of product offering, the distribution and the service. But our mid-term and long-term strategy is to continue to expand the price range of the 3-D printers.

And then a question just on international sales. I noticed that the revenue growth rate was pretty much the same as Q2 and a lot of the companies who are selling equipment right now are seeing a big deceleration there in Q3. How was it able to hold up for you guys, and do you expect it to hold up?

Is that related to capital equipment?

Yes.

Obviously, and you mentioned the third quarter. We saw strong growth in -- because with some of the new product offerings and we are going into some additional markets that we haven't been in the past and the high-end systems with the direct digital manufacturing. So that has given us some good, strong growth. What we are trying to do is reduce [severed] development costs, shorten our product release cycles and have some alternatives through additional manufacturing applications. So it is an uncertain environment out there, but we have some positive momentum going for us currently.

Maybe I can tag onto that, Bob. The economy is impacting, for instance, on the high end, our traditional rapid prototyping business, which remains as a slower grower set for picking up difference and getting the significant growth from these new applications of the DDM, which are huge.

Got you. And then just one last question relating to the high-end systems. Can you guys say with specificity that the backlog in those high-end systems is up quarter-to-quarter or flat or down?

Yes, we don't comment on backlog quarter-to-quarter. We only give our backlog number year-to-year. We just wanted to highlight that there was continued positive momentum in the 900mcs at the beginning of the Q4 here.

Got it. Thanks for taking my questions.

Clint Morrison, Feltl & Co.

Hey, guys. Consumable consumption, any comment with regards to tough economy, consumables aren't cheap? Are you seeing any change in the rate at which that is bought or anticipate any?

Quarter-over-quarter, we saw 20% growth in our consumables, Clint.

I'm thinking more of kind of as a per user basis, are people tending to buy less because the economy is tough and do you think that is happening?

Well, time will tell, but we are not anticipating that. What we have seen and studied over the years with a decline in the economy is if it is a soft decline in the economy, and again, this is business-to-business type transactions, that companies actually invest more in this new product or product extension, productline extension business, which actually may increase the actual usage. If it is a serious economic downturn, then you probably would see less consumable usage.

But from what I have been reading, the issues that are affecting the tightening of the credit may or may not affect business. The actual business -- loans to business are still -- they are still flowing. Where they are not flowing is into the real estate and area and we are in the B2B business. We don't do transactions with B2C or with anything to do with the financial industry or the real estate industry. So we are kind of a B2B company.

Okay. With the introduction in the quarter of the 900mc, is there a margin pick-up as that product matures, or do you pretty much hit stride the second you start making and shipping?

We are always looking for ways to cost-reduce our products. That is something that is a normal part of ours, so we will continue to look at it as we move forward, but it is a good margin product for us now.

Okay. Finally, Bob, do you have sort of an actual sharecount at the end of the quarter?

It should -- if you look at the -- I don't have it in front of me, but if you look at the face of the financial statements on the balance sheet, encapsulate on the far left hand would be the sharecount.

Okay, thanks.

In fact, it was just put in front of me. It's 25,906,000.

Thank you.

Steve Denault, Northland Securities.

Good morning, everyone. Thanks for taking my call. You make reference to new markets, and this is in regards to the high-end. I think you are suggesting new applications as opposed to geographies. Is there anything in terms of product attributes of the 900mc, whether it be speed or envelope size or anything of that nature, that makes it more friendly or conducive to direct digital manufacture?

Yes, hold that for just a moment. We wanted to clarify the previous question for a minute.

Clint had asked a question on sharecount and I said 25,906,000 and that excluded our treasury shares, which is 5,687,000. So I wanted to make sure people didn't go out with the wrong sharecount number. So it is 25.9 million, less 5.7 million essentially. Sorry. Now if you could repeat the question so people keep on track. Sorry about that.

That's okay. You talked about new markets for the high-end systems. I am assuming you are referencing new applications. Is that correct?

Yes.

Is there anything specifically related to the FDM 900mc that makes it more conducive to these new markets or direct digital manufacturing or anything of that nature? What is driving it?

Definitely, the 900mc was designed specifically for DDM. So for instance, in this area of fixtures and assembly tools where you need higher accuracy, higher speed, a little bit stronger materials, that product does that. It is a much higher accuracy system, it has a higher speed and also it is large. Some of these fixtures have to be large to hold, let's say, a large part or a large assembly while it is being produced. So we can do parts now, for instance, on the diagonal up to four feet in size. And prior to that in the industry, you really didn't see parts that large. So yes, it's very targeted towards the DDM area. And as we make improvements, we will further expand not just the low-hanging fruit, but other opportunities globally.

Okay, and is it safe to assume that the strengths within the high-end and strength within international are interrelated in the quarter itself?

Our strength internationally comes from both sides of our business, both from our high-end, as well as our 3-D. We saw some strength there in the 3-D printers relative to the US market.

Have there been any programs put in place either domestically and/or international that, as a result of maybe recent bailout packages, that have called for the accelerated depreciation of capital goods in any way?

Yes, we haven't really seen anything that we would put to the effects of that to date. That has a possibility for some late Q4 activity, but we haven't seen any of that yet.

So there are programs in place internationally?

Not so much internationally, but I guess I was speaking more to the domestic market.

Okay. But that has been around for the better part of six months, right?

Right, but there are some questions as to whether that would carry over into the next year or not, which may actually put some acceleration there for certain people making decisions who are on the fence.

Right, okay. That makes sense. And the final question is the strength within Paid Parts, you make reference to changes you've made within sales and marketing activities. Can you provide additional color on that?

Well, just basically being that more efficient, more targeted towards the telesales activities with strong sales management. And we now have a full-time leader for Paid Parts, whereas in prior quarters, we were operating without that.

Steve, the other thing is, as Scott mentioned in his comments, this architectural application. Don't get me wrong, it is still a very, very small part of the Paid Parts business, but we are seeing a lot of interest or some increased interest in using the service for architectural models. So we are excited about that, and as Scott mentioned, that is a really big market that we could eventually go after, not only with the Paid Parts business, but with our systems business as well.

And we are seeing more and more what looks like DDM-type of business. We don't currently have a metric to measure the difference between RP and the DDM, but we are working on that. There is a very large upside opportunity for RedEye within this DDM market as well.

Okay. And if I can just ask a follow-up on the reference to architectural models. What would your service or your additive fabrication tend to ultimately end up replacing in terms of how those models were manufactured in the past?

Well, the worldwide application, worldwide industry today essentially takes a three-dimensional need and provides, through a two-dimensional CAD, two-dimensional computer-aided design blueprint, and then the architect painstakingly takes each one of the pieces, usually with foam core, and then builds a model. This is all manual. So you've got sort of automation in the CAD, but you got manual as an output. And what we are able to do with one-button push is basically build that whole model or build a model where you can take, let's say on a house, you can take the roof off. You can take the second floor and to look at the first floor if you are going through a house or in the case of a building. So it is really about automation compared to the manual processes that are out there. The coloring -- kind of the jury is out on the finishing and the coloring, and we do not provide colors.

Okay. Thank you.

(Operator Instructions). Andy Schopick, Nutmeg Securities.

Thank you. Good morning. Bob, I think you mentioned that amortization of previously deferred software was $350,000 that had been re-classed. What was the capitalization?

It was $576,000 Andy, this -- or $577,000 this quarter, and amortization was $355,000.

$355,000? And also on the R&D tax credit, you will be a small beneficiary I assume of the implementation of that and it will accrue all in the fourth quarter. Can you give us any sense of what that catch-up will be, what the overall effective rate in the fourth quarter might be and for the full year?

Yes, I would expect the overall effective tax rate in Q4 would probably be between 31.5% and 33.5% for the fourth-quarter effective tax rate.

Okay. So it is going to be a relatively small impact?

Yes.

In terms of the accrual. Okay. Also, just in terms of new applications, Scott. I'm wondering, as you look at the development of this market and look at the approach, in particular that Z Corp has taken, being strictly kind of a color printing type company, are there new avenues here that you would like to pursue, new applications or verticals that you think will significantly enhance the market opportunity that you would like to position yourself for over the next year?

There is quite a few submarkets, which isn't your question, where you, on a sale-by-sale basis see expansion through those new applications. But essentially, we are leading and continue to pioneer, lead in the 3-D printing applications on mechanical three-dimensional CAD. Z Corp has launched, as you know, systems initially into the architectural area and we are a follower there. We are an observant follower or possible follower. And we are also looking at the gaming applications, which is collectible outputs for gamers. Per game, you can see up to 10 million --.

Yes, the figurines, the avatars?

Yes, although it is a totally different application and totally different market obviously than mechanical. That is another upside long term for Stratasys.

Okay, thank you.

At this time, we have no further questions in queue. I would now like to turn the call back over to Mr. Shane Glenn for closing remarks.

Okay. In closing, we were very pleased with our third-quarter results. While the impact of the current economic crisis is difficult to predict, our current expectation and outlook remains for a strong finish in 2008. We believe our initiative -- our innovative products and services are helping our customers to reduce development costs, shorten their product release schedules, which gets their products to market faster, and provide alternatives to traditional manufacturing processes. We believe these characteristics should help sustain strong demand for our products moving forward.

Our vision remains to move down the price elasticity curve with our 3-D printers. And we are positioned for improved growth in our 3-D printing business next year. In addition, we expect other new opportunities within direct digital manufacturing and architectural incremental growth numbers in the future. We thank you for your interest in Stratasys, and we look forward to speaking with you again in February. Goodbye.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.