Stratasys Ltd (SSYS) 2011 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the first quarter 2011 Stratasys earnings conference call. My name is Carissa, 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's callMr. Shane Glenn, Director of Investor Relations. Please proceed.

Thanks Carissa. Good morning. Welcome to the Stratasys conference call to discuss our first quarter financial results. Representing Stratasys' executive management on the conference call today is 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, anticipates, 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 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 Dimension and uPrint printers, and our Fortus 3D production systems, particularly for use in direct digital manufacturing. Our agreement with HP to expand distribution and sales of our 3D printers, our Wavewash support removal system, the demand for our proprietary consumables, the expansion of 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 growth rates experienced in this and preceding quarters, our ability to introduce, produce, and market new materials 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 recent R&D initiative to expand the DDM capabilities of our core FDM technology, our ability to successfully integrate and market Solidscape products, our ability to retain Solidscape management, and our ability to protect and defend Solidscape intellectual property, and the success of our RedEye on demand and other paid parts services.

Actual results may different from those expressed or implied in 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 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 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 operations and comparative performance, primarily the identification and exclusion of expenses associated with impairment charge restructuring expense, and expenses associated with stock-based compensation.

The Company uses these non-GAAP financial measures for evaluating 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 first quarter financial results. We're very pleased with our record performance which reflects a continuation of the positive trends we have observed during the past year. Total revenues expanded to a record $34 million, Fortus system grew by an impressive 60% from last year, benefiting from the growing demand for direct manufacturing applications. Consumable revenue grew by 36% to an all-time record level, driven by the acceleration of customer usage and our expanding system installed base.

We continue to make incremental progress in our game-changing collaboration with HP during the quarter. In the five markets currently served by HP, unit sales of HP Designjet 3D printers were up significantly compared to the sales that generated within those same markets last year. Gross margin improved both sequentially and year-over-year during the quarter, driven by the strong sales of our higher margin products. The strong revenue growth combined with our improved margins drove a 46% increase in non-GAAP operating profits during the first quarter over last year.

We are excited about our acquisition of Solidscape, a leading provider of 3D printers targeting investment casting and mold making applications. Solidscape operates within a business model that is similar to Stratasys, with reoccurring stream of high margin consumable revenue. We expect Solidscape will add modestly to earnings this year, but more importantly we expect the acquisition will bolster our long term DDM strategy going forward.

While we are off to a great start here in 2011, I will return later to update you on some of our initiatives, but first I would 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 $34.3 million for the first quarter, a 23% increase over the non-GAAP revenue of $28 million reported for the same period last year. For purposes of comparison, we have excluded the $5 million one-time noncash charge against revenue taken during the first quarter of last year. The charge against revenue represented the fair value of a warrant issued to HP for 500,000 shares of Stratasys common stock, in connection with the distribution agreement signed in January 2010.

The Company shipped 567 units during the first quarter versus 610 last year. Units shipped of our Fortus 3D production systems were strong in the first quarter expanding by 40% over last year. Unit shipments of our 3D printers were down 11% during the first quarter. Two factors are worth noting when evaluating our 3D printer unit shipments. First, a significant number of uPrints were sold at our annual reseller meeting in the first quarter of 2010 during the promotional launch of uPrint Plus. The first quarter of 2010 also benefited from a significant backlog of 3D printers that carried over from the prior period.

The first quarter of this year benefited from a more modest backlog of 3D printers and had no new product or promotional program associated with 3D printing. These factors made for a difficult year-over-year comparison in 3D printing. Second, we believe our channel in non-HP markets have been focused more on upselling to Dimension and Fortus systems, in anticipation of HP expanding into the region with Designjet. This may be costing us some sales of uPrints.

As you may recall when we initially introduced uPrint we expected to develop an additional layer of resellers focused exclusively on the uPrint product line. Before we embarked on that strategy we entered into an agreement with HP that essentially made HP our master distributor for the uPrint category of 3D printers within markets they serve. With HP, you have to expand into several markets, our distribution network remains underdeveloped for the uPrint class. And our channel partners have spent more effort on upselling to Dimension and Fortus. Scott will talk later on some steps we are currently taking to address this gap, especially in the US.

The impact HP can have on the market was again evident in the first quarter. While total 3D printer unit volume declined by 11% during the first period,3D printer unit volume and the markets served by HP grew by 49%. This growth includes a 27% increase in our Stratasys brand 3D printer. In addition, sales of HP Designjet 3D printers increased 78% over the comparable products sold in those same markets last year. This continues a positive trend we have observed over the past year that provides strong evidence of HP's positive impact within the markets they serve.

First quarter product revenue was $27.8 million, a 28% increase over the $21.8 million reported for the same period last year, which excludes the warrant charge. Two factors drove our product revenue growth during the quarter. First, Fortus system revenue increased an impressive 60% when compared to the same period last year. Fortus sales have continued their strong positive momentum driven by the rising demand from customers using their systems for new DDM applications. Second, consumables revenue increased by an equally impressive 36% over last year, consumable revenue is being driven by a significant acceleration in customer usage, as well as from our growing installed base of systems. 3D printer revenue was flat during the first quarter for the reasons we discussed earlier.

First quarter service revenue was $6.5 million, which was up 4% compared to the same period last year. Our maintenance revenue increased 9% for the first quarter. We experienced an improvement in maintenance revenue growth during the first quarter, which reflects the waning impact of an extension in the warranty period that we implemented in 2009 for most of our systems. We are now beyond the one year anniversary of that change, and we expect maintenance revenue will resume a more favorable growth trend going forward.

Revenue in our RedEye paid parts business declined by 5% in the first quarter compared to last year. We witnessed a very slow start to the year domestically as bookings in RedEye for January and February were down 16% versus last year. However, business began to rebound significantly in March. In addition, bookings in April were up over 15% compared to last year within RedEye. Domestic sales grew by 21% during the first quarter over last year, and represented $18.8 million or 55% of total revenue. International sales grew by 25% to $15.5 million representing 45% of revenue.

Gross profit was $18.3 million for the first quarter of 2011, a 27% increase over the $14.4 million reported for the same period last year, which excludes the warrant charge. Gross profit as a percentage of sales was 53.2%, which was up significantly when compared to the 51.5% for the same period last year, and up significantly when compared to the 50.9% we reported in the fourth quarter of 2010.

The strong growth in our higher margin products, especially consumables, contributed to the significant increase in gross margin both sequentially and year-over-year. Operating profit was $6.5 million for the first quarter 2011. A 43% increase over the $4.5 million reported for the same period last year, which excludes discrete items and stock-based compensation expense.

Operating expenses increased by 19% during the first quarter over last year. The biggest impact on operating expenses was a 40% increase in R&D expense, and a 30% increase in G&A expense. The higher G&A expense was driven by a combination of several factors, including increased travel, professional fees, as well as employee related costs. The higher R&D expense was driven by the 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 $131,000 for the first quarter, versus $263,000 for the same period last year. This compares to $351,000 for the fourth quarter 2010. We expect this R&D collaboration will continue in 2011.

SG&A expense in the first quarter included $147,000 in stock-based compensation expense net of tax, or $0.01 per share, compared to $150,000 net of tax, or $0.01 per share for the same period last year. Other income for the first quarter included a $698,000 one-time gain net of tax, associated with a recent sale of an investment we maintained in an independent on lines parts quoting service company. Our initial investment allowed us to evaluate the synergistic opportunities of the service with our own online quoting service RedEye. More importantly, the investment allowed us to secure a perpetual royalty free license agreement on intellectual property controlled by that company, that we viewed as strategic to our RedEye business. The sale of our interest in that company had no impact on the ongoing intellectual property license.

Income tax expense amounted to $2.6 million for the first quarter, or an effective rate of 34.6%. Net income was $5 million for the first quarter, or $0.23 per share, compared to a loss of $443,000, or $0.02 per share for the same period last year. Non-GAAP net income of $4.4 million, or $0.21 per share increased by 53% when compared to the $2.9 million, or $0.14 per share for the same period last year.

Items excluded from non-GAAP net income include the one-time gain net of tax associated with the sale of the sale of the investment during the first quarter of 2011, the impact from the HP warrant charge net of tax taken in the first quarter of 2010, as well as stock-based compensation expense net of tax in both periods. A table provided within our press release provides the itemized detail surrounding non-GAAP incurred during both periods. We generated %5.3 million in cash from operations, or $0.25 per share during the first quarter. We finished the quarter with $98 million in cash and investments. We should know with the acquisition of Solidscape which closed yesterday, consumed approximately $38 million in cash from our quarter ending balance. We still maintain a very healthy balance sheet even with the acquisition.

Inventory balances were $18.8 million at the end of the first quarter, which is up modestly from the $17.9 million at the end of the fourth quarter. Inventories have risen to match the strong order flow and forecast for both systems and consumables. Accounts Receivable was $21.9 million at the end of the first quarter. Day Sales Outstanding, or DSO, was 59 days compared to 55 days at the end of the fourth quarter, compared to 63 days at the end of the first quarter last year.

I would like to take a few minutes and review some of the financial details of our acquisition of Solidscape. The Solidscape business model is similar to the Stratasys model. The company sells proprietary systems at a favorable margin, which then generate a reoccurring stream of high margin consumable revenue. The company generates gross margin in the 60% range, and has operating expenses that amount to approximately 45% of revenue. Solidscape's revenue for calendar 2010 was $13.4 million. EBITDA for that period was approximately $4.3 million.

Based on the level of intangibles and goodwills that we expect post-acquisition, we estimate the company will generate approximately $1.3 million in pretax profit for the balance of 2011. Not counted in those projections is approximately $500,000 to $600,000 in one-time nonrecurring charges we will recognize in the second quarter that are related to closing the acquisition. Excluding the effect of these nonrecurring charges, for the remaining eight months of 2011, we expect Solidscape will contribute approximately $1.3 million of pretax profit in 2011, or $0.04 per share net after tax.

Overall, we are pleased with our financial performance during the first quarter and the continued improvement in our markets. I would now like to turn it 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 positive trends in our markets and we are optimistic about the coming quarters. We continue to evaluate the various scenarios for our collaboration with HP, all of which have various affects on our financial performance in the coming months. This combined with our recent acquisition of Solidscape continue to make giving specific revenue and earnings guidance difficult. Consequently, we will not give specific revenue and earnings guidance at this time.

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

Thank you, Shane. We are pleased with our first quarter performance which was driven by a continuation of the positive trends that we have observed over the past year. As we mentioned earlier, we continue to observe incremental progress in our game-changing collaboration with HP. Sales of HP's Designjet 3D printers increased significantly during the first quarter over the comparable sales from last year. HP's presence is also having a greater than expected positive impact on our Stratasys brand products, as sales of our higher-priced Dimension brand 3D printers increased significantly within the HP market.

While HP's entry into the market is creating positive results, remember that their involvement currently remains limited to only two products in five countries. They have made modest investments in marketing and channel development thus far, and we believe their roll out will remain a gradual process over time. Their short term goal remains to better understand the 3D printing market, and we find their strategy, both in the mechanical and architectural spaces. We are working on a plan with HP that would further expand them into four to five European countries later this year.

In addition, Stratasys expects to be collaborating with HP over the next few months to add 10 to 15 new HP resellers in the US that will be selling our uPrint brand of 3D printers. However, as we have said before, this is really dependent on HP and their marketing plans. We continue to work with HP on developing that plan, but the timing and the location of the additional expansion remains dependent on their own internal plan.

Big companies don't always move quickly, don't always move predictably in dealing with a company our size. So I don't think that we necessarily have certainty as to those plans at this point in time. However, our recent work with HP has strengthened our view that our proprietary FDM technology is the best platform to address this significant market opportunity, and we remain confident that HP's distribution capabilities, combined with their brand and marketing muscle, can drive increased adoption of our proprietary 3D printers. We look forward to growing the 3D printing market with HP.

The growth in our Fortus 3D production system revenue was particularly strong during the first quarter, expanding by 60% over last year. New DDM applications are driving this significant acceleration in growth. The DDM applications that continue to drive growth include the production of fabrication tools to aid in manufacturing, as well as aircraft repair and maintenance. We bolstered our long term DDM strategy this week with the acquisition of Solidscape, a leading provider of 3D printers targeting applications for investment casting and mold making.

Solidscape is a highly profitable company with strong product margins, and a dominant competitive position within their core market. Their printers are marketed worldwide and are known for the production of wax and parts with ultra-fine feature detail, and a smooth surface finish that are highly castable. Their product line will further expand Stratasys into new DDM markets, including jewelry, in terms of jewelry manufacturing, dental, and precision industrial casting applications. While Solidscape is the leader in providing systems for jewelry manufacturing today, we see significant opportunities to expand their products beyond their core market.

Solidscape will operate as a wholly owned subsidiary from their base operations in Merrimack, New Hampshire, and their management will stay on with the company. Our combined team will collaborate to identify and implement strategic growth opportunities and investments in their technology. And additional information on the Solidscape acquisition can be found by accessing the link provided at the end of our first quarter press release.

In RedEye, we made several improvements to our sales program in Q1, including launching our strategic account management program in early March, which added two incremental salespeople. These new positions will focus on our Top 50 customers proved by the vertical, including automotive, aerospace, and the medical products. we have also taking a dedicated approach operationally by assigning two sales engineers to drive quality and deliver with those key accounts.

Revenue from consumables our highest margin product grew by 36% during the first quarter over last year. This growth was the fastest quarterly growth rate for consumables in over four years, and is being driven by a significant acceleration in customer usage and our growing installed base of systems. We are optimistic that this momentum can be sustained given the positive trends within our markets, as well as our expectation of a significant growth in our installed base of systems going forward. Okay.

In summary, we continue to experience positive sales momentum and a strong pipeline of opportunities. The HP collaboration remains a central focus of our 3D printing expansion strategy, and we believe HP is excited about 3D printing and we are excited about being their partner. While we expect the acquisition of Solidscape will have a modest near term positive impact on earnings, we are more excited about the longer term potential of adding their product line, and developing their technology for new DDM applications.

We maintain a healthy balance sheet even with the acquisition of Solidscape, and we continue to generate significant cash from operations. We are hard at work on new products, and we believe that these will further expand 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 and our core markets. Okay.

I 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). Your first question comes from the line of Troy Jensen of Piper Jaffray. Please proceed.

Hey, congratulations on the nice quarter, gentlemen

Thanks, Troy.

So a lot of commentary here about Fortus and consumable pipeline strong. I guess I am curious to know if you think the gross margin level here is sustainable?

Troy, I know you followed us for a number of years, and you watched us go high and low on our gross margin. I would say we had a very favorable mix during the quarter, and probably won't sustain necessarily at that high a point.

Alright. Fair. Can Scott, can you just go over Solidscape technology? I am just kind of curious, maybe who they compete with most often, are their consumable levels less than yours, given they typically make smaller parts, any insight on the underlying technology would be helpful?

Sure. They are highly focused on the casting side of jewelry manufacturing, providing highly precision ultra-fine feature detail, at this point about 10 times higher feature detail than the core Stratasys FDM parts, to put that into perspective. In terms of competitors, there are really two minor competitors at this point, and that is Digital Wax and Envision Tech with their UV polymer plastic output to be casted. And it is always more difficult, in some cases not possible, to cast the plastic whereas it is always possible to cast wax, and it is the preferred method worldwide to build, well for jewelry, gold, silver, but for the investment casting area, which I am also very excited about, wax is also a preferred method for the separate parts.

Troy, on the consumables side, we are looking about $1,500 to $2,000 in consumables per machine per year, that includes the actual build and support materials, as well as they do have replacement parts that are also consumables that are involved with the system. I think the opportunity that we see longer term is that today there is a more narrow focus as far as markets are concerned with the product, and we see an opportunity to take that technology, and expand that out and look for new opportunities outside of their core market.

And let me do just one follow-up on it. The $13.4 million in revenues, that was a 2010 number, correct?I'm curious if you can give us any direction on 2011?

Yes. That was calendar 2010.

Yes. And to go into 2011 would really go into guidance. We are going to have growth after that number. But we are not sure of that level of growth at this point in time.

But no reason to believe it won't grow with market rates, correct?

It will grow, yes.

Okay. Thanks, guys. Keep up the good work.

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

Thank you. Good morning.

Good morning, Jim.

Question with respect to uPrint. It sounds like you did have some tough comparisons. And I am wondering if we, would it be possible for you to maybe give us a sense just in terms of the unit growth you saw in Dimension separate from uPrint. Just trying to get a sense as to how the overall units might have grown in that part of the business?

Yes. What we saw from our unit mix standpoint, was probably last year our uPrints represented probably 49% of our overall unit volume. The uPrints represented 31% of the unit volume this year. So 69% of our units in the current quarter were either 1200s, Elites, or uPrint Plus. As I said on my comments, that we really see our channel focused on non-HP markets is trying to upsell our products as much as possible to the uPrint Plus and the Dimension product line, as well as Fortus because they are expecting HP to come into those marketplaces, and have a more competitive place. And as I said, HP really hasn't expanded their territory.

So in short term, that is very positive.

In the short term, Yes. It is positive and it is part of the things that are driving gross margin. The other part to that within the quarters, we really saw a weakness in Asia. As you know, Japan is a strong market for us, and with the tsunami there, we saw a downturn in our business in Asia during the quarter.

Any sense as to how much that was down, and then I just have a follow-up on Solidscape if I could?

Well, on a quarter over quarter basis, Asia was actually down 18% overall for all of our business combined.

Okay. I haven't had a chance to look at the link that you provided on Solidscape. But I am wondering if you can give us a sense, my impression was that their installed base is below 3,000 systems. Is it around 2,500 or so, and what kind of ASPs do they get on the equipment?

Well, they shipped over 3,000 units to date and coming out of the recession, I am not sure at this point exactly how many of those are active. But they have shipped around 3,000 total systems.

And we can come back and give more color in terms of what the install base is of active systems at the end of next quarter, from an ASP standpoint, they have an ASP going from $31,000 to as high as $57,000.

And Jim, one thing I want to follow on with your question and Troy's question earlier, the thing we stress here is that we don't compete or we did not compete with Solidscape prior to this acquisition. I mean if you look at where they sell products and the applications that they go after, we do not serve those at all with our legacy products at the Dimension, uPrint and Fortus line.

Got it. Thanks very much.

Thanks, Jim.

And your next question comes from the line of Brian Drab of William Blair. Please proceed.

Good morning

Good morning, Brian.

Could you just go over some of the details around what created the difficult comparison again, the first quarter of 2010 the 3D printer units, the reseller meeting, and just the timing. The uPrint itself was introduced in the first quarter of 2009, right, and was it the uPrint Plus that was the first quarter of 2010?

Right. Yes. So going into the first quarter of 2010, we had a strong backlog from 12/31/09 that created strong sales in the first quarter of 2010 for our uPrints. And then in terms of talking about unit volume overall, we also noted that the uPrint Plus was introduced in the first quarter of 2010, and we had a reseller meeting there where we do promotional sales with uPrint. It doesn't mean that we are discounting them, but we are trying to get our resellers when we have them in a meeting to buy systems. So both of those things contributed to a high sales in the first quarter of 2010.

And did you have an annual reseller meeting in the first quarter of 2011?

No, we did not.

Okay. Okay. And then I just want to make sure that I am looking at comparable figures here. When you say that you had 49% growth in HP markets in this quarter, is that comparable to the 123% growth that you saw in the fourth quarter of 2010?

Yes.

Okay. And have you said yet how you are planning to fund the acquisition of Solidscape?

It was cash, it was $38 million in cash. We paid for it, we had $98 million in cash and investments at the end of March 31st, and we funded it out of that.

Okay. With cash in hand, thanks.

Yes

Okay. Thanks very much.

Your next question comes from the line of Ian Kell of Northland Capital Market. Please proceed.

Thanks for taking the call. Quick clarification here. What was international up in the quarter?

Give us a second here. International was up 25% in the quarter and domestically we were up 21%.

Okay. And then can you get a little granular in terms of how much Europe represents of international?

Yes. So out of the international, Europe was up 50%, while the Far East was down 18%, [Asian] is not a big part of our overall market, but it was up 43%. But it is a nominal amount relative to both European and the Far East.

Alright. And just quick on Solidscape, any sense of the split between units and consumables in terms of revenue? Can you give any color there?

Yes. We don't have a breakdown. Similar to what we don't do in our currents. We will lump those both within products as we go forward, and we won't give any specifics as to the breakdown of those going forward.

Okay. Alright.

One other comment on that, Solidscape from the prior questions, one of the things that I am excited about in the jewelry area is that we believe that there are approximately 60,000 jewelry manufacturers in addition to the custom retail side. And we believe that only 9% or 10% of those have adopted 3D CAD. And that is growing. We think that is growing at over 15% annually. So within the jewelry area, there is some very good upside for us, and there is about an equal upside in the mid term/long term with the expansion into precision investment casting, which is a market that we know, and we know how to market and sell into, as well.

Yes, sure. Alright. And then just quickly, you said the resellers here domestically anyway, are obviously looking to upsell at this point given the HP possibility there. What are you guys doing now to manage that, and just given that it may take HP some time to actually truly hit here in the US. So what are you doing with that?

Well, I think that is a very fair comment. One of the things that we are trying to introduce along with HP is we are trying to expand within the US to include 10 to 15 HP channel partners that would sell the uPrint product within the United States within the next few months. So we are trying to work with HP on a collaboration to do just that, which would then expand the uPrint sales within the domestic markets here.

But you are not, I was thinking more along the lines of your current reseller base, in terms of just how you are working with them?

Yes. Those guys are there to make a living, and it is impossible for us to really expand for people just to the uPrints themselves, because of the implications of HP potentially coming into the marketplace. And our current resellers are doing the best things they can to make a living. And part of that is generating a greater sales of Fortus which is a great benefit to us too.

Sure. Sure. Okay. Thanks, guys. Nice quarter.

Thanks.

And your next question comes from the line of Steve Dyer of Craig-Hallum, please proceed.

Good morning Most of mine have been answered real quickly I guess some of your domestic resellers have correctly anticipated that you are going to have some HP expansion here and have sort of started to react by upselling. What has sort of been their feedback, is the relationship with them still good? Any color around sort of what the resellers are telling you?

Oh, absolutely. We have a very positive relationship with all of our resellers, not just domestic but globally. We did not have, as Bob mentioned, any big program, or big tent as we call it in Q1, but we did in fact, in fact I did, meet with all of the resellers over a day and a half period of time, and I think it is probably the relationship is probably best ever in our history. And that reseller history goes back a long way.

Okay. Will the HP relationship be exclusive with the 10 to 15 resellers in the US?

Details of what we are working out with anything we work out with HP is still in the negotiation phase so it is hard to put any more color on it today.

Okay. And then, both with your acquisition as well as just kind of general commentary, there seems to be a little bit more of an emphasis on DDM than maybe I have heard in the past. Is there kind of a subtle shift there, or how do you think about that versus the 3D CAD?

Well, let's see, if you look at it, I see what you are saying. If you look at it from the 3D printing side, you would, of course, look at prototyping, rapid prototyping for design engineers the expansion of that into architectural would also be prototyping. But, no, we have had a strong continuous focus on our Fortus DDM applications, which has expanded over actually a bit of time to over 30% of all of the Fortus business.

And I expect that to continue to grow with both the efforts that we have to expand applications, but also there is a strong customer base expansion as well, because over 40% of the usage of our installed base of systems, of any system for Fortus, over 40% of those are in fact used for DDM. So we have a six-year strategy that every year has steadily grown in these new applications for using our additive manufacturing for direct digital manufacturing. And it just looks like it is going to continue to grow very strongly. The other exciting part about direct digital manufacturing is the higher than let's say printer higher than prototype level of consumable usage, typically maybe double to triple. Shane, do you want to comment on that?

Yes. I was going to say we have seen some of the Fortus systems, the 900mcs, we had a couple instances where it was $50,000 a year in consumable usage. I think there has been a tendency, understandably, for everyone to focus in on what is going on with HP, and that is a huge opportunity for us. But oftentimes kind of missed in that is this Fortus business that continues to do very well. There is a lot of attention being paid to these technologies for transforming the way products are manufactured. I think we all saw the article in The Economist Magazine regarding that, and some of the focus there. And the other thing that is helping that for us is the change in our channel strategy there a few years ago. When we went from a direct to an indirect channel and we have really been able to leverage our channel partners in helping to expand that business.

Okay. That is helpful. Thank you.

Thanks, Steve.

Thanks, Steve.

And your next question comes from the line of Chuck Murphy of Sidoti & Company. Please proceed.

Good morning, guys.

Good morning Chuck.

Just wondering, for the HP-related sales and I guess HP markets, what would those unit sales be like sequentially? I know you said 49% year-over year. What about sequentially?

Yes. We don't have the sequential numbers in front of us on an overall unit basis.

We are not releasing them anyway, it is HP.

Scott is right. We have never given the individual HP numbers separately.

Yes. I meant more the growth?

Yes. And like I said, I don't have the numbers.

Yes we don't have them in front of us.

Alright. My other question was with regard to Solidscape, could you kind of explain the difference of when you would use a Solidscape system, in kind of a casting process versus when you would use a Stratasys system, and I guess you would call it additive manufacturing?

Sure. With additive manufacturing there are a lot of different applications. But to your question, when you are building a prototype, let's say a designer wants to do fit, form or function of a prototype, an excellent product technology there is our FDM, Stratasys FDM technology. When a metal part, let's say specifically a titanium cobalt chrome for the industrial precision application needs to be produced, then a wax master can be produced in that casting process, and in that form or that pattern, then is filled with the metal to create the part.

In the case of jewelry, to make let's say a gold or a silver piece of jewelry or ring, the part would be ideally built in wax, which is what comes out of a Solidscape system with high precision, builds the case. The wax is actually poured out, as opposed to burned out. And then the cavity is filled with the metal gold in order to, lets say build the ring. So clearly, for the casting or in this category, small casting applications, wax is definitely the preferred method. With, by the way, automatic support removal, so destroy or damage the part when you are removing the build supports. And just to summarize, for traditional prototypes, the FDM process is widely used, and we have at Stratasys the greatest number of systems worldwide for that application in prototyping.

If I am kind of comparing Fortus to Solidscape, Fortus would be more plastic parts, Solidscape would be helping to make metal parts via casting?

Yes if you really want to refine what the differentials are, the Solidscape system is slower than a Stratasys system, so it's good for smaller parts, and also, but it's great at the fine feature detail. And then exactly what you said, plastic versus metal parts, metal castings.

Got you. Okay. Thank you.

And your next question comes from the line of Ryan Thibodeaux of Maple Leaf Partners. Please proceed.

Hey good morning.

Good morning Ryan

Good morning. Since we launched uPrint, I think you guys have averaged between about 46% of all 3D units sold have been uPrint, and you said that they were 31% in the first quarter. I am just trying to understand why the significant dropoff in the run rate from what we have seen over the last nine quarters?

And Ryan, I think that goes very much, or at least I attempted to answer in the call. When you look at the quarter-over-quarter comparison, again we went into 2010 with a strong backlog which generated sales in the first quarter of last year. We had the promotional sale at the Resellers' Meetings last year, and then we really have done nothing with channel expansion on that. And quite the contrary, our channel is in the last year has really focused on upselling in anticipation of additional competition within their marketplaces

But doesn't that 31% include the HP units, as well?

It does, and we hit good growth in those markets. But if I look at domestically, for example, our resellers are really focused on selling uPrint Pluses, but mostly Dimension products, and then we did the expansion two years ago, where a lot of our resellers within the US get to sell our Fortus products, and it's the focus of those resellers and Dimension and Fortus that is generating great sales in Fortus. But at the detriment of the uPrint product itself. So we have a gap in our channel today.

So is it fair to say that almost all of the uPrint unit sales are coming from HP now?

No. No. We're --

Not all, but I mean a significant majority?

No. Because they are still only in five countries within the world, so I wouldn't call it a majority at all.

Okay. And then the other question I had is that for the last, this is really for Scott. For the last 15 months we have been talking about how significant this HP relationship could be for Stratasys. So I am just having some trouble understanding the strategy behind going out and acquiring this smaller business, granted it is better margins and profitable, but just for this critical time for Stratasys, why go out and distract themselves with an acquisition of a company across the country, and at the same time trying to roll out new markets for HP?

Well, of course, we have three elements to our business. We have DDM, we have 3D printing, and services with our RedEye brand, as we expand, we realized that two years ago, as we expand with HP, we actually need to bolster more of our high margin DDM area. That is why we made some pretty significant investments, as well as worked with our Fortune 500 partner to expand more into the high margin DDM area in addition to 3D printing, so that we stay balanced and a more healthy company as we go forward.

So it is not about one element, right? It is about three synergistic elements that make up Stratasys today. We have been involved in other companies' acquisitions, and they can be a distraction. But we believe that we are now, what five months into the thinking process of this, we believe that we will be strategically positive, and not a short-term, midterm, or long term distraction.

Yes. Just to tag onto what Scott had to say I think it is really important Ryan that we have always had the DDM strategy, it has been very much a part of who Stratasys is, Solidscape fits very well as a DDM application, and as we said in our comments, the management team and the employees of Solidscape has been a very well run company, and the management will be coming with us and be part of our team.

Is the management team under contract for any certain period of time?

No. The cultures of two companies are very similar. We didn't feel that there was a need to put any golden handcuffs on people, and we are really excited to work together as a team, and we have gotten a chance to know each other over the last four months and we feel confident management will stay and help us grow together.

Lastly are there any earnouts associated with the transaction?

No.

Okay.

Thanks Ryan.

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

On R&D, your R&D levels are up quite a bit year over year as well as sequentially. And Bob I am just wondering should we assume this kind of rate going forward, and then if you factor in Solidscape, just trying to get a sense at to what your R&D levels could look like?

We will be able to give more color as it relates to, with the Solidscape that had been there when we get to the next quarter. What we said in that previous quarter's conference call is we expected to see R&D levels over the course of the year to grow at a similar level to what our revenue growth would be, and that is still what we would expect for the year right now. One of the things that is impacting the R&D growth rate is the amount of reimbursement that we had from our Fortune 500 partner

Got it. Okay. Thanks.

And your next question comes from the line of Jeff Bernstein of AH LaFonte. Please proceed.

My question was answered. Thank you.

Good morning Jeff, thanks.

Your next question comes from the line of [Thomas Picariello] of Commercial One Financial. Please proceed

Good morning. Thank you for taking my question. My question was in terms of revenue. What percentage of your revenue comes from 3D printing versus RedEye versus service?

Yes. We don't actually break that out specifically. We don't give specific numbers.

Okay. Within the 3D printing segment, what about, it seems as though you say consumables is your highest margin. How much of the revenue within 3D printing came from consumables and specific printer sales?

Yes. We pretty much lumped things within the product category. We have given some broad categories historically that said about one-third of our sales came from systems and about one-third from our services.

Yes. If you look what we characterize as kind of the recurring components of the business which would be the consumables and maintenance revenue, you are looking at about one-third, around one-third of revenue for those two components. And obviously the consumables include both consumables from 3D printers as well as the Fortus 3D production systems. Generally a general guide as we sit here today, about half or little less than half of our revenue is system related, and that would include obviously both 3D printers and Fortus. The balance is going to be we have the RedEye business, we have some spare parts and some spares, we also have some other service revenue that would be thrown in there.

Okay. And just a quick follow-up. It seems as though the consumables, a lot of that comes from the build materials. You said something around $1,500 to $2,000 a year per machine. How are the barriers to entry for that market as far as keeping a potential competitor from selling ABS plastic, or whatever bill of materials they wanted to use to your existing customers that already have your systems?

Yes. I mean we have some pretty significant barriers in place that tried to, we try to maintain the supplier, to be the supplier, sole supplier of that material. It is very critical that we maintain the quality and we want our customers to use our material. And we have a lot of trade secrets. We have a chip on board with the cartridges that -- Smart chip.

A smart chip that the systems must read to recognize it as a Stratasys material, and then we have some patents as well, associated with the manufacture of the material.

Now you had mentioned the $1,500 to $2,000, you were referencing the Solidscape materials. Solidscape in particular, has a really proprietary formula for their materials, and one of the things we didn't mention earlier as it relates to Solidscape, is one of their big value propositions for customers is the castability of their materials. There is really nothing out in the industry today that compares to their proprietary material when it comes to being able to cast that, which is critical, which is an essential step for the process when you are making the wax patterns, the wax products from their systems

Definitely Best in Class.

Oh, that sounds great. My last question was just in terms of the HP agreement, is there any date where that distribution agreement ends?

The agreement was really set up to be an evergreening agreement. Officially it ended September 30th, 2011, but it was written where we expect it to be an annually renewing contract.

That is how we have all of our reseller contracts globally. We can stop them, but they go on long term, some of them, Germany and Japan now have gone on for 18 years, I believe at this point.

Okay. It just seems as though you are relying on HP heavily in your future strategies as far as your sales, and you want to focus more on the manufacturing side?

Well, Yes. The development and design, manufacturing with HP covering the marketing muscle and sales channel.

Great. Sounds good. Thank you very much.

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

You have a follow-up question from the line of Jim Ricchiuti from Needham & Company. Please proceed

Scott can you talk a little more flavor in terms of what is driving the DDM unit growth for Fortus, new applications maybe what kinds, are you getting more customers, or just greater recognition of the technology?

I think it is the combination. It has taken five, six years now of awareness, marketing, marketing of specific new applications to through referrals. We have a group that is only focused on the DDM area. So we are seeing the expansion not just in aerospace, which is a huge opportunity, but also in medical, both based on manufacturing tools. So our strategy has been to expand and invest heavily over these past four years in manufacturing tools, like for instance, making the fixtures that are needed to build a car, that need to be done prior to the car, the first car being made. All of those fixtures are a good, strong growth area, and that same thing is of course true in the aerospace area.

We also have invested and refined our fast track training, which includes a big component of expanding into direct digital manufacturing areas. And as you probably have seen on our website, we have expanded our application stories significantly, especially in the last couple of years. So I think it is a combination of many items that have created the momentum. We had a very strong momentum, by the way, before we hit the 2009 kind of Great Recession, some months growing 25%, 27%, 30% per quarter, on a quarter-over-quarter sequentially. And I believe that we have picked that same momentum back up as we started in 2010, and we clearly are seeing that here in 2011. Not just with revenue and sales orders, but also through what we call the pipeline of prospect coming up.

Okay. Thank you. Congratulations.

Okay. Thanks, Jim. Okay. Well, operator.

There are no further questions at this time. Would I like to turn the call back over to Scott Crump for closing remarks.

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

Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.