Stratasys Ltd (SSYS) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2010 Stratasys earnings conference call. My name is Chris and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions).

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Shane Glenn, Director of Investor Relations. Please proceed.

Thanks, Chris. Good morning and welcome to the Stratasys conference call to discuss our third-quarter financial results. Representing Stratasys's 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 the investor section of our website at www.Stratasys.com or directly by accessing the link provided in our press release.

We will begin with the Safe Harbor statement. All statements herein that are not historical facts or that include such words as expects, participates, projects, estimates, vision, planning, could, plan, believes, desires, intends or similar words constitute forward-looking statements covered by the Safe Harbor protection of the Private Securities Litigation Reform Act of 1995. Except for the historical information herein, the matters discussed in this news release are forward-looking statements and involve risks and uncertainties.

These include statements regarding projected revenue and income in future quarters, the size of the 3-D printing market, our objectives for the marketing and sale of our Dimension and new print 3-D printers and our Fortus 3-D production systems, particularly for the use in direct digital manufacturing, our agreement with HP to expand the distribution sales of our 3-D printers, our WaveWash support removal system, the demand for our proprietary consumables, the expansion of our Paid Parts service, and our beliefs with respect to the growth in demand for our products. Other risks and uncertainties that may affect our business include our ability to penetrate the 3-D printing market; our ability to maintain the growth rates experienced in this and preceding quarters; our ability to introduce, produce and market new material such as ULTEM and the market acceptance of these and other materials; the impact of competitive products and pricing; our timely development of new products and materials and market acceptance of those products and materials; the success of our new R&D initiative to expand the DDM capabilities of our core FDM technology; and the success of our RedEye On Demand and other Paid Parts services.

Our actual results may differ from those expressed or implied in our forward-looking statements. These statements represent beliefs and expectations only as of the date they were made. We may elect to update forward-looking statements, but we expressly disclaim any obligation to do so even if our beliefs and expectations change.

In addition to the risks -- in addition to the statements described above, this forward-looking statements include the risks and uncertainties described more fully in our report filed or to be filed with Securities and Exchange Commission including our Annual Reports on Form 10k and Quarterly Reports on Form 10Q.

The information discussed in this conference call include financial results that are in accordance with US Generally Accepted Accounting Principles or GAAP. In addition, non-GAAP financial measures are included they exclude certain expenses. The non-GAAP financial measures are provided in an effort to give information that investors may deem relevant to the Company's operations and comparative performance.

Primarily, the identification, exclusion of expenses associated with impairment charges, restructuring expenses and expenses associated with stock-based compensation.

The Company uses these non-GAAP financial measures for evaluating comparable financial performance against prior periods. The appropriate reconciliations between non-GAAP and GAAP financial measures are provided in a table at the end of our press release.

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

Good morning and thank you for joining us to discuss our third-quarter financial results. The third-quarter results of $30 million and $0.15 per share in GAAP EPS reflect the improvement in business conditions we continued to observe within our core markets.

Considering the seasonal weakness that is typical during the summer months, the strong third quarter also indicates a continued building of positive momentum. Sales growth of our system area was very, very impressive, with 3-D printer systems revenue increasing by 26% and Fortus system revenue growing by 39% during the third quarter over last year. Our game-changing collaboration with HP continued to generate positive results during the period. Orders for their new DesignJet 3-D printer were strong and end customer demand continued to build.

Unit sales of DesignJet in markets served by HP were more than double the comparative uPrint sales generated within those markets last year, an impressive achievement. We remain pleased with the progress of our distribution agreement with HP and are optimistic about expanding the collaboration in the future.

Our consumable revenue grew by 34% during the third quarter, the fastest quarterly growth rate within the past three years. We believe this positive momentum can be sustained, given the usage trends that we are observing within the channel. In addition, strong unit system growth, which grew by 39% during the third quarter, bodes well for future growth in consumable sales.

We generated nearly $12 million in cash from operations during the third quarter alone and now maintain approximately $84 million in cash and investments. Our financial health is the strongest in our Company's history. We are optimistic about the fourth quarter and entered the period with positive sales momentum and a strong pipeline of opportunities.

Okay, I will return later to update you on some of our initiatives. But first I'd like to turn the call over to our CFO, Bob Gallagher, who will further highlight our third-quarter results. Here's Bob.

Thank you, Scott. Total revenue was $30.3 million for the third quarter, a 24% increase over the $24.3 million reported for the same period last year. The Company shipped 631 units during the third quarter, a 39% increase over last year. This represented a record third quarter per unit shipments.

The strong unit expansion was driven by growth in both our 3-D printer and 3D Production Systems sales. Domestic sales grew by 31% during the third quarter and represented $16.8 million or 56% of total revenue. International sales grew by 17% to $13.4 million. Slower international growth was due to a more modest 6% growth in the Far East.

Third-quarter product revenue was $24 million, a 33% increase over the $18 million reported for the same period last year. Several factors impacted our product revenue growth during the quarter.

First, Fortus system sales increased by 39% when compared to the third quarter of last year. As you may recall from our comments last quarter, we entered the third quarter with a strong backlog of Fortus system sales. In addition, we observed strong orders for Fortus systems during the quarter which, when combined with our strong Fortus backlog, contributed to an impressive growth over last year.

The second item impacting our product revenue during the third quarter was a 34% increase in our consumable revenue compared to last year. This represents an acceleration from the growth rate we experienced during the second quarter and is a continuation of a positive trend that we began late last year. We continue to believe that our strong consumable growth represents a positive leading indicator for our business going forward.

Lastly, our 3-D printer system revenue increased by 26% when compared to the third quarter of last year, driven by strong sales of all our 3-D printers. This growth was a result of strong sales for our own Stratasys branded 3-D printers as well as strong orders for the new DesignJet systems we shipped to HP.

During the third quarter, unit sales of DesignJet in the five countries served by HP were more than doubled with comparable uPrint sales generated within those markets last year. Our total 3-D printer unit volume within the HP markets, which includes both DesignJet and Stratasys branded 3-D printers, increased by 88% in the five countries served by HP.

Although HP has only recently initiated their marketing programs, we believe that this is strong evidence of a positive impact on the market. Despite these positive trends, we want to remind everyone that HP's rollout is still limited to only two products in five European countries, and they are more focused over the near to midterm on refining their go-to-market strategy to better prepare for future expanse rated -- expansion and accelerated sales volume.

Third-quarter services revenue was $6.3 million which was flat compared to the same period last year. Our maintenance revenue declined by 8% during the third quarter compared to last year. The recent declines in maintenance revenue are expected and reflect an extension in the warranty period we have implemented in 2009 for most of our systems.

Revenue in our RedEye Paid Parts business increased by 21% in the third quarter compared to last year. This represents a positive trend that began early this year as RedEye continues to recover from a period of overly competitive pricing that occurred during the recent recession. RedEye is also benefiting from a resurgence in orders activity from automotive customers as well as new DDM applications within the medical device industry.

The addition of several Fortus 900 MC Systems within RedEye has also provided improved capacity for customers that need large parts.

Gross profit was $14.7 million for the third quarter of 2010, a 24% increase over the $11.9 million reported for the same period last year. Gross profit as a percentage of sales was 48.6%, which was relatively flat when compared to the same period last year and flat when compared to the second quarter of this year. The sales of our lower margin 3-D printers were strong during the third quarter which negatively impacted our gross margin percentage. However, this negative impact was greatly offset by the positive impact generated by the sales mix within our Fortus system sales as well as the strong sales of our high-margin consumerables.

We want to highlight in the third quarter the positive dynamic between our lower margin system sales and our higher margin consumable revenue, given the long-term financial implications. Any near-term acceleration in lower margin system sales should ultimately provide significant financial leverage as the higher installed basis system consumes an increasing quantity of higher margin consumables.

Operating profit was $4.1 million for the third quarter of 2010, a 69% increase over the $2.4 million reported for the same period last year. Operating profit as a percentage of sales increased to $13.4 million when compared to 9.9% for the same period last year.

Operating expenses increased by 13% over last year to $10.6 million during the third quarter. The biggest impact on operating expenses was a 12% increase in selling and general and administrative expenses. This was driven by the acceleration in commission and incentive compensation expenses, which has resulted from strong sales and earnings growth.

In addition, the R&D expenses increased by 13% driven by our new product initiatives within both 3-D printing and 3D Production Systems. Funds provided by our unnamed Fortune 500 partner to develop video applications for our Fortus line was lowered during the quarter at $352,000 versus $405,000 for the same period last year.

SG&A expense in the third quarter was $262,000 -- included $262,000 in stock-based compensation expense, net of tax, compared to $210,000 for the same period last year.

In other income, the third quarter included a foreign currency gain of $228,000. This gain was the result of the significant appreciation of the euro, relative to the dollar during the period.

Pre-cash profit was $4.6 million for the third quarter compared to $2.6 million for the same period last year. Income tax expense amounted to $1.4 million in the third quarter for an effective rate of 30.3% compared to $1 million or 39.7% for the same period last year. The tax rate for the third quarter benefited from a reduction in contingency reserves pertaining to positions taken in our 2006 return, as well as a higher projected 2010 manufacturers' deduction as we are now projecting higher 2010 taxable income.

Net income was $3.2 million for the third quarter compared to $1.6 million for the same period last year. Non-GAAP net income was $3.4 million or $0.16 per share compared to $1.8 million or $0.09 per share for the same period last year. Non-GAAP net income excludes stock-based compensation expense in both periods. A table provided within our press release provides itemized details surrounding all non-GAAP items incurred during both periods.

We generated nearly $12 million in cash from operations during the third quarter alone, and now maintain approximately $84 million in cash and investments on our balance sheet. Inventory balances were $8.7 million at the end of the third quarter which is up compared to the $14.6 million at the end of fiscal 2009.

Inventories have risen to match the strong order floor and forecasts for both systems and consumables. We expect inventories will decline as we move through the last three months of the year.

Accounts receivable were $9.7 million at the end of the third quarter. Days sales outstanding or DSO improved to 60 days compared sequentially to 66 days at the end of the second quarter and compared to 68 days at the end of fiscal 2009.

Overall, we are very pleased with our financial performance in the third quarter and the continued improvement in our financial position. Now I'd like to turn the call over to our Director of Investor Relations, Shane Glenn, for comments regarding our outlook.

Thank you, Bob. We appreciate the need to provide financial guidance to our shareholders and investment community. We continue to observe an improvement in market conditions during the third quarter and we are optimistic about the balance of 2010.

We are currently evaluating various scenarios for our collaboration with HP in 2011 and beyond, all of which could have varying effects on our financial performance. It is our ultimate goal to provide a long-term target operating model which is supported by our expectations of a broader HP relationship.

We hope you can appreciate that there are many moving parts to our relationship with HP that currently include uncertainties on the location of new market expansion, the timing of that expansion, as well as the inclusion of new products. Now I'd like to turn the call back over to Scott Crump.

Thank you, Shane. We are very pleased with the rebound in our financial performance over the past nine months. We are optimistic that our positive momentum will be sustained. We remain excited about the potential of our game-changing agreement with HP as the collaboration continues to generate positive results.

As we outlined earlier, HP's entrance into the market six months ago is having a positive impact on 3-D printer sales within HP's markets. These trends suggest that HP's distribution capabilities, brand power and marketing muscle and expand 3-D printing awareness, and can greatly accelerate the sales of our 3-D printers. HP's near- to midterm goals remain the refinement of their go-to-market strategy and to better understand the 3-D printing market.

To achieve that goal, HP has assembled a dedicated 3-D printing team managed out of Barcelona, Spain and have begun to engage their reseller network. They have produced marketing materials to promote their DesignJet series of 3-D printers and have attended multiple tradeshows within the five countries that they currently serve. They are monitoring customer feedback on product performance and customer uses and are observing the expansion of the 3-D printing opportunities.

Despite their need to better understand the 3-D printer market over the near term, we believe HP's dominance within the 2-D plotter market give them an extensive appreciation of the end customer as well as the 3-D printer market in terms of the market's potential.

Following their recent successes, HP has communicated their desire to expand into additional markets and we are currently involved in discussions surrounding this expansion. As we have communicated previously, the near-term financial impact of the current phase of our agreement with HP is expected to be relatively immaterial and that our expansion with HP will likely remain a gradual and measured process. However, we look forward to expanding the collaboration over the mid to long term as the potential effect becomes more significant.

We continue to believe this game-changing relationship represents the beginning of a revolutionary new phase of our Company's history. Stratasys and HP believe that millions of product designers are now ready to bring their designs to life in 3-D and we are collectively preparing to satisfy that demand.

Within our Fortus line, strong system sales were driven by incremental demand creating -- created by the emerging direct digital manufacturing or DDM applications, as well as the ongoing economic recovery. We now have a dedicated effort at Stratasys called the Stratasys Manufacturing Solutions Group that is proactively working with customers to develop innovative manufacturing applications using our technology.

The aerospace industry is a leading innovator in the use of these applications. As you can appreciate, aerospace applications require a low-volume manufacturer of parts that must maintain stringent part, material characteristics, and part performance.

In addition, many of these complex parts and assemblies are often difficult to manufacture through traditional techniques, making them ideal for our DDM solutions.

A great example of this is a project with Delta Airlines to provide a DDM solution to address a priority maintenance issue on approximately 200 of their aircraft. This unique application will ultimately include several hundred in-use parts produced on our Fortus systems using our high-temperature resistance ULTEM material.

Another example of a successful DDM application is with our customer DST Controls in Sweden, which makes advanced, embedded, electromechanical products, mainly for unmanned aerial and ground vehicles. DST uses Fortus to manufacture 20 of the components for an electro-optical gimbal or 'eye' that rotates on two axises providing stabilized images.

Aside from the camera and the wiring, the mechanical components and the enclosure were produced with direct digital manufacturing on our systems. These -- this customer reduced part cost by 66% and approved production time by 63%. We believe these proven applications will provide a springboard for other opportunities not only with Delta and DST controls, but other major airlines and aerospace companies.

Well, as Bob mentioned, our strong backlog of Fortus system orders to begin the third quarter was augmented by strong order activity throughout the period. We are optimistic that we can repeat this performance during the fourth quarter, given the positive impact from our strengthening of markets and our DDM growth initiatives.

We continue to observe strong positive trends within our consumable sales and our RedEye business. As Bob mentioned RedEye is benefiting from an improved market conditions as well as new DDM applications.

More impressively, our consumable revenue grew at the fastest rate within the past three years during the third quarter. We believe this positive momentum can be sustained, as channel surveys suggest consumable usage is accelerating while reseller inventories remain relatively tight.

In addition, the 39% growth in unit system sales for the third quarter bodes well for future growth in consumable revenue.

Okay. In summary, we enter the fourth quarter with a positive sales momentum in nearly all aspects of our business, and a strong pipeline of opportunities. We have successfully leveraged our growth with a distribution strategy that minimizes the expansion of our operating expenses, while continuing to invest aggressively for the future. We believe these investments will yield evolutionary new platforms that can further the adoption of our products.

We are well positioned competitively and our financial health is the strongest in our Company's history. Most importantly, we look forward to expanding our distribution agreement with HP and realizing the full potential of that collaboration. So I'm very excited about our future.

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

(Operator Instructions). Troy Jensen.

Congratulations on the nice quarter, gentlemen. So, quick on the HP expansion, is it logical to think that they would roll out the remaining countries in Europe before they move into the other continents first?

You know, it is difficult to say where they would expand next. I think they have a strong presence within those five European countries and it doesn't necessarily mean that the next expansion would be within Europe. It has to do with where their strongest partner is in demand.

Okay. And then, shifting gears, on the Delta example that you guys gave for the direct digital manufacturing. Was that a system order or is that a Paid Parts customer?

Actually, Troy, that order was serviced by a service bureau that has that is qualified to do that for aerospace customers. So it was done by a third party.

A third party. Okay but --.

But obviously using our equipment.

I will queue in for more questions.

Brian Drab.

Good morning. Congratulations on a solid quarter. I know the year-over-year growth rates are just looking outstanding, but I was hoping that maybe you could give us a little color on how things went sequentially from second quarter to third quarter, particularly within Fortus and the consumables market. Because clearly the growth rates look better from second quarter to third quarter but could you talk about the direction absolute sales of those products went and what we -- maybe what we could expect going forward?

Yes, I think what you really saw in terms of our overall revenue, you saw that it was very similar to what we had in the third quarter. Remembering that the third quarter is usually our seasonally weakest quarter, we had strong sales with in our Fortus systems as we entered the quarter with a strong backlog in there. And then sequentially, consumables were predominantly flat on a quarter-to-quarter basis as well as RedEye maintenance.

So it was a very comparable quarter in terms of overall product mix and color to the second quarter, remembering then again that we had that seasonal weakest quarter.

And then going forward into the fourth quarter, it sounds from your commentary like you would expect sequential improvement in most of those businesses.

Yes, again, if you take Q3 as a seasonal weakest quarter traditionally what you'd see for us is Q4 as being one of our stronger quarters.

Yes. Okay. And then just one more quick one. Regarding gross margin, I mean sales [aren't] clearly much improved from last year and you made some comments in gross margin. So I may have missed this, but would -- could you say that the main reason that gross margin is up only about 60 basis points, even on such strong sales improvement, is the HP agreement and having to give up some value to HP now that they are in the picture?

Well, certainly HP is a part of that. But if you look at our products that we've introduced and one of the comments that we made during the call is that, since last year, we -- our products are more focused on the uPrint, uPrint Plus which are lower average selling price within the products. So we've moved on some of our price points in there.

Offsetting part of that was improvements, then, in Fortus product mix as well as consumable products themselves.

Yes, Brian. If you look at the -- during the quarter, our higher mar -- what we call our higher margin 3-D printers and the higher margin 3-D printers include the Stratasys Dimension line as well as the uPrint Plus. So what is excluded from that is the basic uPrint as well as the DeskJet systems that we sell to HP.

But if you just look at the Dimension line plus the uPrint and you add the uPrint Plus that was about 58% of our total 3-D printer volume during the quarter. That's versus around 55% if you do a similar analysis for last year.

So we still sold a lot of higher margin printers, you know. But certainly, you know, the HP systems as well as the basic uPrint are definitely lower margin systems.

Okay. Great. Thank you.

Jim Ricchiuti of Needham & Company.

Good morning. Just a question regarding the strength you are seeing in consumables. I know it is still very early but is there anything you can point to in the European business, with HP now in the market, that perhaps is having some impact on consumables?

I think you said it right when you said it is very early in the relationship. It has only been six months now that HP has really been selling products into the marketplace, and we don't really have anything on the dynamics to point to any difference in that market relative to the rest of the world.

Can you talk a little bit about whether you were seeing more strength in growth in consumables with Fortus versus the 3-D printers?

We have actually seen a rebound in use of both systems. What we're trying to do is focus our Fortus product line on direct digital manufacturing applications and a good example is the one that we talked about with Delta Airlines. That is where a customer of ours is going to generate a tremendous number of consumable sales in order to make all those parts.

So we are continuing to direct -- try to drive higher volume in the PDM applications. But we've also seen a rebound compared to the 2009 levels on our 3-D printers.

Thank you.

Ryan Thibodeaux of Maple Leaf Partners.

Good morning. Could you expand a little bit on the comment that HP is refining their go-to-market strategy? I guess refining it from what is the question.

Well, they started off selling on a very similar basis and looking at some of the techniques that we use. Now they are in the process of going back for the systems that they've solved -- or sold, as well as systems where they haven't been as successful. They are doing customer surveys and follow-up within the marketplace and talking to additional resellers to find out the reaction from the marketplace.

They are very good at going back and double-checking things within the marketplace and surveying the market, much better than Stratasys has ever been at that.

So would that indicate that the rollout to date is going better or worse than expected? From HP -- (multiple speakers)?

It's -- for HP it's definitely gone better than their initial plans.

But they are still having to refine the strategy even though (multiple speakers).

Right and remember this is only two products in five European countries. So it's what they are doing in the short term.

And maybe I can add to that. HP, as a company, are experts in two dimension -- two dimensional printing. They are now expanding or this group is expanding the Company into three dimensional so it's more than just the go-to-market. It is also an interesting education and expansion process for the Company with obviously some huge upsides for full Stratasys and HP.

Okay and then, Bob, you usually break out the uPrint as a -- as a percentage of the total dimension shipments. I think Shane may have said it offhandedly. Can you just clarify that again?

Yes. The dimension line in the uPrint plus was 58% of the total volume. The DeskJet and the basic uPrint is the balance.

Okay. And then last question --.

Could you get back into the queue? I want to be respectful of the other people.

Chad Bennett of Northland Capital Market.

Yes, just a couple of questions. Fortus for the quarter, was there anything unusual in terms of ASP and larger systems going out? Or can you give us some type of comparison either sequentially year over year, kind of what the ASP was overall for that business?

Yes. The ASP on that business is really because the products range from a 360 MC that has a ASP out at the retail level of $80,000 to $100,000. And then you move all the way up to a 900 MC that will retail out at about $400,000. You'll see a huge mix of the ASP isn't necessarily meaningful within that market.

But to give you a little bit of color of that, we saw an increasing demand for our 900 MC products which is the large build envelope and the one that has average end customer selling price for around $400,000.

I got it. Okay. And you talked about kind of the backlog coming into the quarter and strong quarters throughout the quarter. Do we have any way of -- what's backlog going into the fourth quarter here? Or is it similar up down versus what you had coming into third quarter?

Yes, we don't -- unfortunately we don't give you the exact backlog. You know, it's -- we've tried to get a little bit of qualitative flavor around the numbers say it's a strong backlog relative to typically what we see, but we are not going to give out the specific number.

Okay. And then, I think you know a couple of callers have tried asking this, but so the HP units in the quarter, I guess you gave one metric that the business basically doubled year over year in those five countries versus uPrint last year. Was uPrint last year in those five countries even a meaningful number to base that off of?

Yes. Because if you look at the color around last year's numbers, last year was down substantially from the 2008 levels. But business was down much more dramatically in the US markets last year. And Europe actually held up relatively strong. So we think it is important. It is a small measure because it's the only -- the two products in the five, but we think it is a significant measure.

Yes. I think, Chad, if you look at uPrint last year it was by far the best seller. I'm talking system-wide here, I don't actually have the Europe numbers in front of me. But if you look at --, system-wide it was by far the best seller last year in the third quarter.

Right, yes, no I understand. I just wanted -- I didn't know the relative geographical breakout, specifically when you get down to five countries in Europe if that is a meaningful metric to base it off of. Okay. I guess just lastly I will ping --.

Chad.

Yes.

We need to -- I need -- seeing how I already did it to one other person I will need to do it to you, to ask you to get back in the queue.

Thanks.

Andy Schopick of Nutmeg Securities.

Thank you and good morning. I will try to keep this quick.

Bob, I wonder if you can give us any color at all such as you did last quarter on the sell-through in the HP channel? Whether there was really anything here that would provide a little additional color on to what is happening?

Yes. Most all the systems that we shipped to HP just like last quarter, most all the systems sold through to end customers.

Okay and secondly, Bob, R&D tax credit. Do you have any greater visibility or can you give us any color on what might happen if Congress does renew that R&D tax credit, how that will affect your tax rate given the adjustments you already -- you've made here in the third quarter to lower the overall effective rate?

Yes. The -- I've taken no R&D tax credit into consideration in my effective rate. If it does pass in legislation in the fourth quarter, it specifically has had about a 2% impact on the overall effective tax rate which we would then apply for the effective rate and reduce it in the Q4.

Outside of the year.

Yes.

Yes, I understand. Thank you.

Chuck Murphy of Sidoti & Company.

Good morning. Just kind of coming back to the comment about the HP markets having 3-D printer volume up 88% year over year. Could you say what year-over-year improvement was in like the first and second quarter?

You know what, I think we did, Chuck. You would have to go back and look at our comments in the script. I think the year-over-year improvement in the third quarter is better than the one we reported in the second quarter. I don't think -- I don't believe we provided you one in the first quarter.

And of course the launch was mid-second quarter. So Q3 and definitely Q4 are better measurements.

Okay. And then the other question was any change in the DesignJet's price?

No.

No.

Okay. All right, thank you.

Jeff Evanson of Dougherty.

Hello. Bob, could you tell us if there was any FX impact to the gross margins in the quarter?

Well, relative to the rates in effect at the end of Q2, it would probably be a negative impact of about $115,000. If you looked at it at the year-over-year basis, it was -- from the third quarter of last year, it was probably a negative impact of about $570,000.

Okay. And then, Scott, I guess what I would like to know is what would you put on as the probability that you guys expand this HP distribution relationship into North America in 2011?

Well, I'm definitely optimistic about not only the relationship and the expansion, but the potential for 500,000 systems to go serve the existing [6 million CAD seats], what the probability is is pretty difficult to determine. So I think I'm not going to give an exact probability.

Why would they not expand in Europe at this point instead of potentially go into a new geography? I don't quite understand that.

Yes. It really has to do with where demand comes from within their existing reseller base. But I don't think Stratasys should get into the business of trying to predict HP's marketing strategy. I think they are much better at marketing than we are.

I respect the latter part of that. I guess I'm confused why they wouldn't be seeing continued demand in Europe. That seems not to comport with what you're telling us about strong growth through HP.

Yes. There's a difference between, like I said, they are refining their go to market strategy and it's really a question probably better voiced to HP than it would be to Stratasys.

Okay, fair enough. And, Bob, last question. Sorry. So in simple terms what should I model for the Q4 tax rate at this point?

If you would -- right now, if you look at the effective rate that we have on a nine-month basis, is the best estimate that we have for the year. If you see [past half of] the R&D tax credit into Q4 then the rate would reduce to an expected rate (multiple speakers) 1 to 2 points below that effective rate.

Okay, great.

The one thing that comes into play there is stock options and exercise the ISO stock options which are a discrete item in the quarter and can have a significant impact on the quarterly effective rate. And there is no way to predict that.

Okay. Thanks a lot.

Graeme Rein of Bares Capital.

Good morning. I'm interested in the RedEye business. You mentioned that the pricing has firmed up a little bit. Could you discuss -- is that just due to strengthening in the economy in general or have you seen competitors exit the RedEye Paid Parts market?

Well, I think the market's dynamic, we certainly have seen a year-over-year improvement. RedEye has also done a very good job of analyzing our value proposition. And as we've done that, along with the improvement in the economy and this sector, shored up prices and I think that there will be, next year, some consolidation in effective pricing from that consolidation, but I don't believe that we are seeing that this year.

I think it is more our actions and then an improvement of overall design prototyping, as well as some great orders in DDM and great opportunities in the DDM area for RedEye.

Okay and a follow-up on that. The new applications you are seeing in DDM and other Paid Parts customers, are these translating into system sales or are they more one-off projects?

Well, there's always been -- that is a good question. There's always been a very good correlation between doing thousands of parts and selling tens of units. We call that prospecting and that can be [full] up and down. We do a good job of supporting systems, our system users where they go through a normal design cycle, prototyping peak and valley. When they hit their peak, we are there sometimes in a one-day turnaround, their backup.

So it's not only selling systems up, which also leads to the consumables, but then when customers get either a machine or multiple machines, they typically can't -- I guess in no case can they get all the offerings that RedEye has. And so they are a natural -- the Redeye is a natural resource for them.

Okay. That makes sense. Thanks for your time.

(Operator Instructions). [Neil Chatterjee] of Craig-Hallum.

Hello. Just a quick question on -- in light of your cash generation if you could just comment on any plans for using that going forward?

We have been asked about our cash for a long period of time and we continue to say that we have a cash opportunity as opposed to a cash problem. We've looked at -- over the years we've looked at various opportunities and acquisitions on that, and investments within technologies. But those are the type of things you would announce when they come.

Until then, we are focused on generating cash which we think is positive for our business and our shareholders.

Troy Jensen of Piper Jaffray.

Hello. So a couple for Bob here. R&D spending was down sequentially. Is it sustainable at these levels? And then should we expect any commission accelerators in the SG&A line in Q4?

Yes. In terms of R&D, what I said at the end of second quarter is that we expected R&D spending to be at a similar level in the second half than we would in the first half. Q3 was about $2.2 million, Q2 was about $2.7 million and R&D spending probably will come in somewhere between those two numbers in Q3. It will come -- the second half will come close to the first half in terms of our overall R&D spending.

In terms of commissions and accelerators, we are definitely going to see some accelerators on commissions in some of our variable compensation in Q4. We've taken some of that into effect in Q3, but you are also going to see it as an impact in Q4 definitely.

And DSOs, you know, great job this quarter. It has always been an issue for you guys where it was higher than what investors like to see for the DSO line.

Thanks.

Was it collections there or linearity? What improved dramatically here on the DSO line?

One of the things that is a positive impact is the timing of some of our sales within HP itself. I don't want to -- I need to say that my staff is doing a great job of collections, they've got a good system down their definitely. But HP -- we've got our system down, also as it relates to HP. They've done a great job of collections as it relates to our largest customer, too.

Got it. Keep up the good work.

Ryan Thibodeaux of Maple Leaf Partners.

Hello, Scott. A question, just curious on your thoughts in the growth on the emerging open source market. I know that Bits for Bytes Company was recently acquired by one of your competitors and I think they shipped 1,000 units in '09 and they are up 100% year-to-date at a $2,500 price point. So I'm just curious what your thoughts on that business model are?

Well, I think you actually have maybe three business models there. In the open source area, I think by definition it is not really a business, it's more of a sharing. And in terms of Bits for Bytes, they are primarily targeting home hobbyists as well as the area of educators. Not necessarily education but educators as well as the do-it-yourselfers. And within the do-it-yourselfers, that's not in the commercial area.

So Stratasys is focused on a professional [rather] prototype being worldwide as a tool is really focused on commercial use of 3-D printers and there's certainly long-term, both applications and markets in that area. But none of the products out there are what are called whole product solutions for those that want to use them as tools to solve problems. At least at this time.

Okay and then last question for Bob, just a follow-up from an earlier question. Someone asked about gross margin. I believe in the second quarter, you'd commented one of the reasons that you saw the sequential decline in gross margins was because of the weaker euro. I'm just curious if you had a reversal of that effect in Q3?

Yes, surprisingly, we didn't. It was actually -- we continued to have an adverse affect relative to where we were at the beginning of the year and last year on the euro. What we may remember is that the euro was going down in Q2, but it really started off in April and May that the rates for the euro were relatively high to where we're at in the August/September time frame. So relative to the beginning of the year, we still had an adverse effect and actually Q3 had an adverse affect, relative to Q2.

So it was still a negative from Q3 -- from Q2 to Q3?

Yes. It was about a [115,000] negative quarter-over-quarter impact.

Okay. All right. Thanks.

There are no further questions. At this time I would now like to have the call back over to Mr. Scott Crump, CEO.

Okay, in closing, I would like to thank you for your interest and Stratasys and we look forward to speaking with you again next quarter. Goodbye.

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