Stratasys Ltd (SSYS) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth quarter Stratasys' earnings conference call. My name is Gina, and I will be your coordinator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes. Now I would like to turn the presentation over to your host for today's call, Mr. Shane Glenn, Director of Investor Relations. Please go ahead.

Thanks, Gina. Good morning, and welcome to the Stratasys conference call to discuss our fourth quarter financial results. Representing Stratasys' executive management on the conference call today is 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 the Investor section of our website at www.Stratasys.com, or you could also access it directly by 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, anticipates, projects, estimates, vision, planning, could, plans, 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 that involve risks and uncertainties. These include statements regarding projected revenue, and income in future quarters, the size of the 3D printing market, our objectives for the marketing and sale of our Dimension and uPrint 3D printers, and our Fortus 3D Production Systems particularly for use in direct digital manufacturing, our agreement with HP to expand the distribution and sales of our 3D printers, our WaveWash support removal system, demand for our proprietary consumables, the expansion of our paid parts service, and our beliefs with respect to the growth and demand for our products.

Other risks and uncertainties that may affect our business include our ability to penetrate the 3D printing market, our ability to maintain the growth rate experienced in this and preceding quarters, our ability to introduce, produce and market new materials and the market acceptance of those 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 recent 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 are 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 statements described above, such forward-looking statements include the risks and uncertainties described more fully in our reports filed, or to be filed with the Securities and Exchange Commission, including our annual reports on Form 10-K and our quarterly reports on Form 10-Q.

The information discussed within this conference call, includes financial results that are in accordance with US Generally Accepted Accounting Principles or GAAP. In addition, non-GAAP financial measures are included that 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 operation, and comparative performance, primarily the identification and 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 the table at end of our press release. Now I'd like to turn the call over to our CEO, Scott Crump, who has partially lost his voice, possibly due to an extreme ice fishing event. But here is Scott.

Well, good morning, and thank you for joining us to discuss our fourth quarter financial results. We are very pleased with our record fourth quarter performance, as we observed strong positive sales momentum across all of our businesses. During the fourth quarter, our revenue grew faster than any other quarter in 2010. Total revenue expanded by 29% to a record $33.8 million. In addition, our margins improved both sequentially and year-over-year during the fourth quarter, which contributed to a 72% increase in operating profit over last year.

A highlight for the quarter was an impressive 39% increase in Fortus system revenue over last year. Equally impressive, was a 38% increase in 3D printer system revenue during the period. We continued to observe incremental progress in our game-changing collaboration with HP during the quarter. In the five markets that are currently served by HP, unit sales of HP DesignJet 3D printers were more than triple, compared to uPrint sales generated within those same markets for the same period last year. And now we're looking forward to the next phase of our collaboration with HP, which currently calls for the expansion into new markets later this year.

Not to be overlooked, was a 29% increase in our consumable revenue, and a 19% increase in our RedEye paid parts business during the fourth quarter. Consumable sales continued to expand with our rapidly growing install base of systems, as unit sales grew by 33% in 2010 to over 2,500 units. In addition, RedEye continues to find innovative ways to help our customers with their new product development cycle to accelerate their products to market. All of these factors contributed to an 80% increase in net income during the fourth quarter.

In addition, we generated nearly $24 million in cash from operations during 2010. And, of course, this is stacked in addition to the $25 million of cash generated back in 2009. Although we purchased a new 90,000 square foot facility in December to consolidate some lease facilities and address our future expansion, we still increased our cash and investment balance to $90 million. And more importantly, we finished the year in a position to be very optimistic about 2011. I'll 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 fourth quarter results. Here is Bob.

Thank you, Scott. Total revenue was a record $33.8 million for the fourth quarter, a 29% increase over the $26.2 million reported for the same period last year. The Company shipped 632 units during the fourth quarter, a 47% increase over last year. This represented a record fourth quarter for unit shipments. Unit growth was driven by both our 3D printer and 3D Production Systems sales, which grew by 48% and 37% respectively over last year. Domestic sales grew by 24% during the fourth quarter, and represented $17.9 million or 53% of total revenue. International sales grew by 35% to $15.8 million. Fourth quarter product revenue was $27.2 million, a 36% increase over the $20 million reported for the same period last year.

Several factors impacted our product revenue growth during the quarter. First, Fortus systems sales increased by 39%, when compared to the same period last year. Fortus sales continue to exhibit strong positive momentum, driven by the overall improvement in market conditions, as well as the rising demand from customers using our systems for new DDM applications. The second item impacting our product revenue was a 38% increase in 3D printer system revenue, compared to last year. This growth was the result of strong sales for both Stratasys branded 3D printers, as well as the new DesignJet systems we manufacture for HP.

During the fourth quarter, unit systems sales of DesignJet in the five countries served by HP, were more than triple the comparable uPrint sales generated within those markets last year. Our total 3D printer unit volume within HP markets, which includes both DesignJet and Stratasys branded 3D printers, increased by 123% in the five countries served by HP. This compares favorably to the 48% increase in 3D printer unit volume we generated across all markets world-wide. This continues a positive trend we observed throughout 2010, that provides strong evidence of HP's positive impact within their markets. However, despite our near term successes and positive trends, we want to remind everyone that HP's roll-out is still limited to only two products in five European countries. The long term success with HP will require an expansion of the collaboration in the coming period, that leads to a significant step function in unit volume sales.

The last item impacting product revenue was a 29% increase in our consumable revenue, compared to last year. This continues a trend we have observed throughout the year for consumables. The growth in consumables has been driven by the improvement in market conditions, and a rapidly growing install base of systems. Fourth quarter service revenue was $6.6 million, which was up 5.8%, compared to the same period last year. Our maintenance revenue was flat during the fourth quarter. The recent trends in maintenance revenue are expected, and reflect an extension of the warranty period we implemented in 2009 for most of our systems. Our system reliability has continued to improve, which has allowed us to extend our warranty periods.

Revenue in our RedEye paid parts business increased by 19% in the fourth quarter, compared to last year. This represents a positive trend that began in 2010, as RedEye continues to recover from the market downturn. RedEye is also capitalizing on opportunities that provide value to our customers from prototype through production. In addition, we are observing a significant amount of business coming from our current install base of system owners, as they access RedEye service to address project overflow.

Gross profit was $17.2 million for the fourth quarter of 2010, a 29% increase over the $13.4 million reported for the same period last year. Gross profit as a percentage of sales was 50.9%, which was flat when compared to the same period last year, and up when compared to the 48.6% we reported for the third quarter of 2010. The sales of our lower margin uPrint and HP DesignJet 3D printers were stronger in the fourth quarter, which negatively impacted our gross margins. However, this negative impact was offset by the positive impact generated by a strong sales and favorable mix within our Fortus system business, as well as consumables.

Operating expenses -- excuse me -- operating profit was $6.2 million for the fourth quarter of 2010, a 72% increase over the $3.6 million reported for the same period last year. While revenue increased by 29% during the fourth quarter, operating expenses increased by only 13% over last year to $11 million. Consequently, operating profit as a percentage of sales increased to 18.2%, when compared to 13.6% for the same period last year. The biggest impact on operating expense growth was a 24% increase in sales and marketing expenses, driven by higher commissions, incentive compensation that resulted from our strong sales and earnings growth.

In addition, the R&D expenses increased by 15%, driven by our new product initiatives within both 3D printing and 3D Production Systems. Funds provided by our unnamed Fortune 500 partner to develop DDM applications for our Fortus line were $351,000 for the quarter, versus $320,000 for the same period last year. This compares to $352,000 for the third quarter of 2010. We expect this R&D collaboration will continue in 2011.

SG&A expense in the fourth quarter included $144,000 of stock-based compensation expense net of tax, compared to $243,000 for the same period last year. Pre-tax profit was $6.5 million for the fourth quarter, almost double the $3.3 million for the same period last year. Income tax expense amounted to $2.1 million in the fourth quarter, or an effective rate of 33.3%, compared to $940,000 or 28.3% for the same period last year. While some of you may have expected a lower effective tax rate in the fourth quarter, with the reinstatement of the Research and Development Credit, this positive impact was more than offset by increases in our tax contingency reserves for positions taken in prior years, resulting in a slightly higher fourth quarter rate, when compared to earlier periods.

Net income was $4.3 million for the fourth quarter or $0.20 per share, compared to $2.4 million or $0.12 per share for the same period last year. Non-GAAP net income was $4.4 million or $0.21 per share, compared to $2.9 million or $0.14 per share for the same period last year. Non-GAAP net income excludes stock-based compensation expense in both periods, as well as other discrete items. A table provided within our press release provides itemized details surrounding all non-GAAP items incurred during both periods.

We generated nearly $10 million in cash from operations, or approximately $0.50 per share during the fourth quarter, and $24 million for all of 2010. We now maintain approximately $90 million in cash and investments on our balance sheet. Our current cash position includes the net effect of approximately $3 million outlay for the purchase of a 90,000 square foot facility in December. The new building which is partially sub-leased, will be used to consolidate some existing lease facilities, as well as expand our manufacturing capacity. We expect to invest an additional $4 million to $6 million in the new facility over the coming quarters.

Inventory balances were $17.9 million at the end of the fourth quarter, which is down compared to the $18.7 million at the end of the third quarter, and up from the $14.6 million at the end of fiscal 2009. Inventories have risen year-over-year to match the strong order flow and forecast, for both systems and consumables. Accounts receivable was $20.1 million at the end of the fourth quarter. Day sales outstanding or DSO, improved to 55 days, compared to 60 days at the end of the third quarter, and compared to 68 days at the end of fiscal 2009. Overall, we are pleased with our financial performance during the fourth quarter, and the continued improvement in our markets. And now I would 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. And we continue to observe positive trends in our markets, and we're optimistic about the coming quarters. However, we continue to evaluate the various scenarios for our collaboration with HP in 2011 and beyond, all of which could have varying impacts on our financial performance. Consequently, we will not give specific revenue earnings guidance at this time. We hope you can appreciate that there are many moving parts to our relationship with HP that currently include uncertainties in the location of new market expansion, 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're pleased with fourth quarter performance, which was driven by a continuation of strong, positive sales momentum across all of our businesses. As we mentioned earlier, we continued to observe incremental progress in our game-changing collaboration with HP, as sales of HP DesignJet 3D printers were more than three times the comparable uPrint sales from last year. While this is an impressive achievement, our initial roll-out of the 3D printer with HP has been limited to only two products in five European countries. HP has executed a controlled expansion into the 3D printing market to refine their go-to-market strategy. We believe that they're becoming increasingly confident in the market's significant potential. We're now turning our attention to the next phase of our collaboration, which should include the expansion into new markets.

Over the past 15 years, our Company has sold more than 15,000 systems world-wide, with over 10,000 of those systems sold in the past five years. This expansion has helped drive our growing, high margin consumable revenue. Despite our rapid growth, we believe the market remains relatively under-penetrated, within the applications for 3D mechanical design. We estimate the potential market for mechanical applications at approximately 500,000 systems worldwide.

Looking beyond the current opportunities, we see other markets that should develop for 3D printing, such as applications within architectural design. We estimate the architectural applications represent less than 5% of our business today. Relative to mechanical design, architectural CAD has yet to incorporate the functionality needed to make using 3D printers a seamless operation. However, we believe this is being addressed by the leading CAD software companies. Regardless of the market, we believe our industry-leading technology, combined with HP's market-leading brand, the HP marketing machine, and their extensive sales distribution capabilities, will help us significantly expand in the future.

The growth in our Fortus 3D Production Systems was particularly strong during the fourth quarter, increasing by 39% over last year. Expanding our core FDM technology into direct digital manufacturing applications remains a clear driver behind this growth. We estimate that approximately 30% of the Fortus systems shipped during fourth quarter, addressed a DDM application. Our success with DDM provides evidence of incremental growth opportunities for our proprietary technology that go beyond traditional rapid prototyping applications.

One example is the US Navy and their Fleet Readiness Center, which recently purchased a 400mc to produce tooling for military aircraft repair. This type of application is ideal for unique capabilities of our propriety FDM products, which produce highly durable and highly accurate thermoplastic parts. Jeff DeGrange, our VP of Manufacturing Solutions, has been instrumental in driving our DDM efforts. A progressive example of our technology capabilities was recently showcased by Kor Ecologic in Winnipeg which created Urbee, one of the world's most fuel efficient and environmentally-friendly vehicles. The Urbee's body and exterior components were all printed with our proprietary FDM technology on our Fortus systems, so the Urbee project demonstrates the extensive capabilities of our technology. And additional information surrounding this innovative application, can be accessed by the link provided in our press release today.

Our RedEye paid parts business increased by 19% in the fourth quarter over last year, as the business continued to recover from the market downturn. In addition, RedEye continues to find innovative ways to help our customers through their new product development cycle.

A great example is, with a medical device company, whose products enable surgeons to perform minimally invasive arthroscopic and endoscopic procedures. This customer recently came to RedEye, initially for a prototype project. RedEye ultimately helped the customer throughout the entire product development process, including shipment of their initial products with parts printed directly from our system. And now, they are a proud owner of our FDM 400mc system.

Consumable revenue grew by 29% in the fourth quarter, continuing a trend of consistently strong quarterly growth throughout the year. As our proprietary systems grow, so will the sales of our high-margin proprietary consumables. And that this should be true, regardless of the application.

But we have exciting growth opportunities on multiple fronts. And in anticipation of this growth, we recently purchased a 90,000 square foot facility in December with the intention to expand our production incrementally over time. This new facility will bring our total manufacturing capacity to over 10,000 systems per year.

As we continue to grow, the Company must remain committed to our customers through continuous improvement and customer service, and product quality. The ISO certification awarded to Stratasys in January, is evidence of this commitment. ISO certification is awarded to companies that adhere to strict management practices, within manufacturing and customer service. This award will ensure that Stratasys remains a customer-centric Company, as we execute our aggressive growth plans. I'm very proud of our organization, and all the hard work by our employees to make this certification a reality.

Okay, and in summary, we continue to experience positive sales momentum, and a strong pipeline of opportunities. The HP collaboration remains a central focus of our expansion strategy within 3D printing, and we believe HP is confident in the significant market potential. And we're excited to be their partner. To support our many growth initiatives, we're hard at work on new products that we believe that will further penetrate the 3D printing market, as well as provide expanded functionality for our growing DDM opportunities. I believe that we are well-prepared to address the growing demands of our customers in our core markets.

Okay. I'll 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.

Thank you.

(Operator Instructions).

And your first question comes from the line of Brian Drab of William Blair. Please go ahead.

Good morning. Congratulations on a great close to the year.

Thanks, Brian.

Can you first, just quickly repeat the unit -- the volume numbers for Fortus and 3D printers?

The unit 3D printer volume went up by 48%, and the Fortus unit volume went up by 37%.

Right. Got it. Okay. And with the new facility that's going to be coming on line, when do you plan to have that come on line, and when should we start to see things like depreciation and other ramp-up costs start to flow in? And how do you -- can you give us any guidance in how to think about start-up costs, and maybe a margin challenge as a result?

Yes, we would -- we would perceive that's going to come late in the year, probably towards the end of the Q3 or beginning of Q4, that we would see that facility coming on-line. So relative to 2011, I don't expect there to be a significant ramp-up. There will be some start-up costs, but it is going to be relatively nominal I think in 2011, overall.

Okay. Great. And then, can you give us any -- any additional color on the timing of continued roll-out, and the next geography that you would be targeting, through the HP partnership?

Yes, one thing about HP is -- HP started selling in the market in 2010, and is really only nine months ago. And they have been only doing two products in five European countries. And it -- most likely it takes some time to understand the market, refine their message, and to determine if the opportunity is real. I think we often forget, that this is a brand new market for HP. We now think that they think -- we now believe that they see a big opportunity, as we always have. But we're uncertain as to the timing or magnitude of any changes in the relationships, and consequently we can't really predict that. Also, if you look at it -- if and when they decide to expand, we will also respect their desire to keep that information confidential until the market launch.

That was very similar to our April 19th launch. HP did that launch -- Stratasys did there in 2010.

Okay. Thank you very much.

Thanks, Brian.

Thanks, Brian.

Your next question comes from the line of Jim Ricchiuti from Needham & Company. Please go ahead.

Thank you. Good morning.

Good morning, Jim.

The question I have is just with respect to Fortus. I was hoping you would expand on a comment that you made about the increase in Q4 that was tied to a DDM application. Can you expand on that? Can you a little bit, perhaps more specific, in terms of either the application, the vertical market, whether these are multiple customers or not?

Are you talking about -- which DDM application are you talking about, the one --?

Well, you made a comment, that you said a purchase decision for approximately 30% of the Fortus systems shipped in Q4, was based predominantly on fulfilling a DDM application. So I was wondering if you could expand on that a little bit? And maybe talk about where you're seeing the real -- which vertices, which specific verticals, or perhaps customers you're seeing this increase in DDM?

Yes, I think some of the areas we've seen it, are in aerospace, automotive and medical. And a lot of it is surrounding, Jim, around this area of the fabrication and assembly tools, the jigs and fixtures that help in the assembly of other products. Or in the case of Navy example that we gave, where they're using that to make fixtures for repair of aircraft. So I think it's -- it's kind of in the areas where we've seen it in the past, focused in on these jigs, fixtures, assembly tools, repair applications.

Okay. And then to the European market, where HP is -- is selling the DesignJet, you made a comment about the printer being -- seeing roughly a three-fold increase versus uPrint, versus the year ago period. But then I think you made a comment -- and I wasn't sure if you were talking about 3D printing in general, that within those five markets, you saw an increase of about 120%, 123% in those five countries. Is that right?

Yes, the 123% talks about all 3D printing units, within those -- within those five countries. As you recall, we continue to sell the Dimension line.

Right.

-- in the markets that are currently being served by HP. So if you look at -- if you look at all of the -- all of the system that we sell, you're looking at about 123 -- a 123% increase. Just to give you a little bit additional --

It would be Dimension and the uPrint and DesignJet, all 3D printing categories. That's correct.

Okay. So are you saying then, the HP relationship is leveraging sales of your other products in those markets? Is that what you're seeing in those markets initially?

Yes, that's definitely happening today, because the Dimension products within the HP markets were up approximately 46%.

Okay.

So awareness is a big theme here, in addition to just selling, awareness of 3D printing and the use of FDM, endorsement of FDM.

So it's not necessarily just the improvement in the economic conditions in those markets, you see a direct connection to the HP relationship, that's really driving the overall units in those markets?

Yes, what we're seeing is HP is creating awareness. Remember, several of the people that are selling the DesignJet, are people who also sell our Dimension systems. So a little bit frustrating sometimes to HP, that a lead will go to that reseller with HP's intent, obviously, to be a DesignJet, And then sometimes, rather than buying DesignJet, they're buying a Dimension product day.

And Jim, just to make sure we're clear -- obviously, the statistics we provided you are pretty -- they're impressive statistics, as far as the growth is concerned. But keep in mind, and everyone keep in mind, that this is still just two products in those five countries. We want to keep everything in perspective, as we move forward here.

Okay. Fair enough. Thanks a lot.

Thanks.

Your next question comes from the line of Andy Schopick of Nutmeg Securities. Please go ahead go ahead.

Thank you, and, good morning.

Good morning, Andy.

Scott, I just want to follow up on one prior question about the new product roll-outs, or the anticipated introduction of new products. Are these new-product roll-outs in any way tied to HP's future plans to expand it's current -- beyond its current geographies?

Well, our new product development is focused on DDM, as well as 3D printing, and --

I'm referring specifically to 3D printing.

I understand. And the intention is to go global with HP this year. So some of our portfolio also focuses on products within 3D printing that -- that HP will handle.

Yes, Andy, let me add to that. As you can appreciate the development of new products is not something that you do just in a 12-month period of time. We've had -- we've had a product road map that we've had for several years, and we continue to work on that product road map, which is really the more dependent on our ability to bring products to market. What HP, I think brings to the game, is some discipline as it relates to reliability and quality of the overall products on the initial launch. But in terms of the actual road map, in terms of features and whole product offering for the customers, that's more driven by Stratasys today.

Okay. A couple of quick ones for you, Bob. The Fortune 500 R&D collaboration, what was that for the full-year? I know you gave it to us for the quarter. I think last year in 2009, it was around $2.2 million, and what was it for 2010?

$1.2 million.

$1.2 million. So it was down significantly.

It was down $1 million. You're absolutely right.

Okay. The growth rates in 2010 for the full-year, could you give that to us for consumables, for Dimension 3D printing, and for Fortus? I mean, we have these numbers by quarters, but we don't have the actual numbers to compute for the full-year. So I'm wondering if you could just tell us what the consumables growth rate was for the year, and for Fortus as well?

Yes, Andy, we will have to get back to you on that. We don't have those numbers right -- right in front of us. Well, what I can give -- actually, I can give you a couple. Consumables for the year was up about 28%. Okay. What was the other couple that you mentioned?

Dimension and 3D printing?

Dimension revenue was up -- let's see -- for the year, was up about 30%.

Okay. And then for the Fortus, if you have that?

Sure, 41%. And we're talking -- those are last two are revenue.

Yes, and that is what I was asking. The last -- and the last two -- well, consumables would be revenue, too, wouldn't it?

Yes. Correct.

Okay. So it's all revenue. And that's what I'm looking for. And lastly, Bob, yes, I was one of the guys looking for a reduction in the overall tax provision for the tax quarter to reflect the R&D credit. Didn't see that. And what's confused me, is your comment about an increase in cash contingency reserves. Because what I recall from the third quarter, was that there was a reduction in the contingency reserves, which resulted in a slightly lower rate for 3Q. And so, yes, I'm little confused about what is happening in the tax provision. And can you just give us any guidance on where we should be bracketing the tax provision for 2011?

Yes, and so, I will be specific, as it relates to Q3. As periods close -- periods close when a tax return close. So any tax contingencies reserves that you have related to return that closed three years ago, will always impact Q3. So you are always going to see a potential impact, if any company has a tax contingency reserve related to three years ago, you will always see impact of that in the third quarter. In terms of looking at things on the fourth quarter, we looked back at our positions. And some of the positions that the IRS has been taking more recently, relative to certain parts of the tax code, we re-evaluated the contingency reserves we had established in those years. And took a more conservative stance on those years, which impacted our fourth quarter rate. In terms of looking forward, you saw an effective rate of about 32.3%. I would say, probably somewhere in the 32% to 34%, would be a good effective rate on a go-forward basis.

And that would include the availability of the R&D tax credit, as well?

It would.

Okay. Thank you.

Thanks, Andy.

Your next question comes from the line of Graeme Rein from Bares Capital. Please go ahead.

Good morning.

Good morning.

Hi, Graeme.

Now that you have -- you're starting to get more and more installed systems that are using -- that are being used for DDM applications. Do you have any -- any more recent data about consumable usage within those units, that might be different than six months ago? Do you have -- I know 3,000 to 5,000 for a 3D printer, is what you have sort of estimated as consumable usage. Do you have any data on what DDM application would look like?

Yes, we -- what have is anecdotal evidence. But we've looked at the overall install base, and I don't have the numbers in front of me. But I sat in a meeting a couple of days ago, that showed the average usage on our Fortus product line is up about 10% over the previous year, in term of consumables. Which is a combination of people doing prototypes, as well as DDM applications, but it is clearly having an influence for more consumable usages on our Fortus line.

And, I think we can say a range, that we are seeing examples out there in the $20,000 per year per machine, as high as $50,000 on the upper end of the range, per year per machine, for these type of Fortus DDM applications.

Yes, but --

$50,000, yes, that doesn't give us an average, though.

No, that doesn't give us an average.

It gives us a range. (Multiple speakers).

And so, I think on an average basis, we're seeing about a 10% increase across the Fortus install base.

And certainly, Graeme, the $50,000 is an outlier. And for a 900mc, where it is being used almost on a 24-hour basis. But we have seen that kind of usage. And it just depends on how they're using it for DDM, and that can vary from customer to customer.

Right. Okay. That is helpful. And then, too follow on that, have you seen any pricing pressure on consumables?

No.

Okay. Thanks for your time.

Thanks, Graeme.

Thanks, Graeme.

Your next question comes from the line of Andrea James, Dougherty & Company. Please go ahead.

Hello, good morning.

Good morning.

Just a question about that metric with the uPrint sale grew three times in the HP market, did you give that same metric for the non-HP market?

We did not. We did not., Andrea. The one metric that we do have, is that if you look at 3D P units world-wide, and you take into account everything, which includes HP, our own Stratasys brand systems, the units were up about 48%.

Okay. Okay. And then that decision -- can you give us more color about the decision to expand the manufacturing capacity? And how much of a role is HP playing in that decision, and in the -- did they come out and look at the plant? I don't know, anything you can just give us there.

Well, we definitely need more facility in order to grow. With HP, we are going to need to accelerate some of that. The new building essentially allows us to consolidate some of the existing lease facilities that we have. And then as I mentioned, also address production growth as we go forward. And that does include some growth from HP, but it is not predominantly HP.

Okay. What is your capacity now?

If you look at our capacity -- we Could probably do in the -- we've said in the neighborhood of about 5,000 units today.

So, in other words, we shipped over 25 or 2,500 this last year. Capacity limits out, with incremental resources at 5,000, and then this facility allows us to expand to at least 10,000 units per year. And probably over time more than that.

Yes, I think it is important -- building purchases are things that you create step functions, in terms of capacity, et cetera, like that. And clearly buying a 90,000 square-foot building, because you don't want to go out and buy 10,000, 10,000 and 10,000. So you do a step function. And fortunately here, we have lease space today of about 45,000 in the area, which we can use to fill part of that. And about some 20,000 square feet of that building is under a current sublease, too.

Thank you. And just finally, just looking at gross margins next year, do you have any concern there? Or do you think you can stay at about 51%?

One of the things we said in the past, is that we're going to see margin pressures with HP as things roll out over time. Obviously, having HP in our distribution chain, creates another participant that needs to make a return for their time and efforts. So you should expect, as HP rolls out further, you should see Stratasys with lower margins. However, over the longer term, you also see lower operating expenses, given that HP will be responsible for the sales and marketing activities. So we would expect to see a longer term -- see a drop in our operating expenses, which can create growth in our operating income.

Do you think it is almost like a one to one offset, you think or --?

It is all going to be a volume-dependent. This is about leveraging our technology, using HP's marketing muscle, to get significant growth in volume, and ultimately operating income. So I think the important message is that you're going to see, a short-term -- midterm pressures on our margins, But we believe that the costs that will happen on that is good for the long term, as we increase that install base, and start to churn higher volumes of our high-margin consumables.

Thank you.

Your next question comes from the line of Chad Bennett with Northland Capital Markets. Please go ahead.

Hi. This is actually Ian sitting in for Chad today.

Good morning.

Just a quick question here. On the last call I talked about -- made a short comment about Q4, being obviously one of your strongest quarters. Just looking at your unit volume in Q4, they were flat, obviously with Q3. Was there anything holding that back in the quarter, particularly on the low end, I don't know competitively or something, that might have contributed to some unit volume -- I don't know, not sort of weak -- but just sort of that flat factor for the quarter?

Yes, that's a great observation. If you look back, you'll see that we actually had that same phenomenon last year. In fact, last year Q4 was down over Q3. And what we've seen in the last couple of years, is that Q3 tends to be higher for the education, which has a lower ASP. And Q4 has less education, and more of the Dimension and Fortus. So consequently, you'll see flat unit volume quarter-over-quarter, but we've seen a 15% sequential increase in systems sales on that flat unit volume. So it really has to do with education in Q3, and that's been a more recent phenomenon in the last two years.

Okay. All right. And then, on HP, obviously, you tripled it here in the quarter. I think last quarter you talked about a doubling. What are the chances that we keep seeing that acceleration going forward?

I think it's very high, that's why we're working with them.

And then -- okay. But--

The other thing to remember here, is that we've talked about -- for this to be a successful collaboration, we have to see some -- some significant step functions in volume. Obviously, in the last couple of quarters we reported some favorable statistics, as it relates to how they're doing in these markets and that's certainly a positive sign. But, will it completely trend like that going forward, every single quarter? It is hard to say at this point. But we expect to see some very high growth rates coming out of this relationship if we're successful.

I think what we've been doing today with them, with just two products in five European countries, has been more about them learning the market, and determining whether there's a big market opportunity. A good takeaway from this call today is that we think that HP now believes there a big market opportunity for our products.

Alright. And then, I mean, if it keeps accelerating at this rate, any chance you start breaking out actually HP units at some point this year?

I think when HP becomes -- becomes a material customer, we will certainly be in that point, but I don't expect that in the near-term here.

Okay. All right. Thanks.

Thanks.

(Operator Instructions).

Your next question comes from the line of Steve Dyer from Craig-Hallum.

Thank you. Good morning.

Hi, Steve.

A couple of different things, and maybe I'm trying to parse words here, but regarding the HP roll-out, you had said earlier in the call that you sort of expected it to roll into additional markets later this year. And then, Scott, I think at a different point, I think you said go global this year. Again, I don't know, again, if I'm looking too much at words, but how should we think about sort of what that ramp looks like? I know you are going to be guarded as to what you can say, but is the next phase additional countries in Europe? Is it the far east? Or what is sort of that step-function look like?

Bob, you want to take that one?

That is really dependent on HP and their marketing plans. And probably, certainly we had discussions with HP, but in terms of where they -- where they go, and when they go, is really within their own internal marketing plan. And big companies don't always move quickly, and don't always move predictably in dealing with a Company our size. So I don't think we have certainty, as to those plans at this point in time.

Okay. And then obviously with respect to guidance, I realize the hesitancy given that the different potential outcomes with HP, but what about guiding kind of non-HP business, kind of the core business, so that we can kind of get a feel for how you're thinking about the rest of the business for the next quarter or year?

I think that is really difficult to do, when you look at initiatives that we're doing within R&D, things that we are doing in terms of facilities expansion, and et cetera. I think a lot of it overlaps within our business, and it is difficult to give anything meaningful to our shareholders, I think.

Okay. All right. Thanks, guys.

Thanks, Steve.

Your next question is a follow-up question from Jim Ricchiuti, Needham & Company.

Yes, the strength that you saw in Fortus, the 39% increase in Q4, is there -- is there some budget flush aspect to the growth you typically see for Fortus in Q4?

No -- I think we're going to see a continued percentage growth trend with Fortus, mostly driven by DDM. If you recall, we saw that -- let's say -- 2007 all the way through the end of 2008. So I think it's more dependent on all of the new applications that we've expanded in DDM, and work that we did in the last year or two, putting in benchmarks that now -- that now come out.

Jim, I do think that we did see some budget flush in there in the fourth quarter, which is a little bit different than Scott's view, but I would say that you probably would have seen that same phenomenon in 2009.

Okay. And then, normally you have some seasonality in Q1. Last year's Q1, I think it's probably fair to say your end markets were still in a recovery mode, and you actually showed sequential growth. But I wonder if you could give us some sense, as to how we might think about Q1, just from the standpoint of the normal seasonality you've experienced in recent years? Is there a change here?

I don't think we -- as much as I'd like to, I don't think we can predict that. Clearly, it had been -- a seasonal quarter, weaker last year. We think we started to see the recovery in Q4 of last year, and that carried some momentum into Q1. We, obviously, seen recovery in Q4 of this year, and we hope that some of that carries into Q1.

I think the other thing, Jim, is that you certainly with the first quarter of 2010, we did begin to see some -- some definite momentum in the markets, which certainly contributed to a really strong first quarter.

Okay. Thank you.

Thanks, Jim.

Gina, I think we have time for one more question.

Okay. Your final question comes from the line of follow-up, Andy Schopick of Nutmeg Securities. Please go ahead.

Again, as a follow-up to Jim's question, you haven't commented about the year-end backlog. Do you care to just give us how that ended?

Sure, Bob, you want to handle that one?

I don't have the backlog number right in front of me. As you can tell, I'm turning pages in there. Backlog -- system backlog at the end of the year was about $8.7 million.

$8.7 million, system backlog. And couple of other ones here. Scott, with the pressure that the states and municipalities are still under, I'm just curious to ask you how you feel about the potential effects, or impact on the business, especially in the educational area, going forward here into the new year? Do you have any general comment that you care to share about that?

Well, there are federal initiatives that will probably have a bigger effect, a bigger positive effect on Stratasys for 2011. But remember, this is a global market for education, about roughly half and half, and it goes private, all the way through public. And I think we can say that private funding, certainly for 2011, is stronger than the public. But there is -- it is a big world, very under-penetrated, and I don't think that states like California are going to have a meaningful negative effect from a public standpoint on our revenue, since it is a big under-penetrated global market.

All right. That's it for me.

Okay. Thanks, Andy.

That concludes the Q&A session. I would now like to turn the call back to Mr. Scott Crump for closing statements.

Okay. In closing, I would like to thank you for your interest in Stratasys. We look forward to speaking with you again next quarter. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.