Stratasys Ltd (SSYS) 2015 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the quarter-two 2015 Stratasys earnings conference call. My name is Cathy and I will be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions) As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Shane Glenn, Vice President of Investor Relations. Please proceed, Sir.

Thanks, Cathy. Good morning, everyone. Thank you for joining us to discuss our second-quarter 2015 financial results. On the call with us today are David Reis, CEO; and Erez Simha, CFO and COO of Stratasys.

I remind you that access to today's call, including the prepared slide presentation, is available online at the Web address provided in our press release. In addition, a replay of today's call, including access to the slide presentation, will also be available, and can be accessed through the Investor section of our website later today.

We will begin by reminding everyone that certain statements in this press release are forward-looking statements, with the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements are characterized by the use of forward-looking terminology such as will, expects, anticipates, continues, believes, should, intended, projected, guidance, preliminary, future, planned, committed, and other similar words.

These forward-looking statements include, but are not limited to, statements relating to the Company's objectives, plans, and strategies; statements of preliminary or projected results of operations or of financial condition, and all statements that address activities, events, or developments that the Company intends, expects, projects, believes, or anticipates will or may occur in the future. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties.

The Company has based these forward-looking statements on assumptions and assessments made by its management in light of their experience and their perception of historical trends, current conditions, expected future developments and other factors they believe to be appropriate. Important factors that could cause actual results, developments and business decisions to differ materially from those anticipated in these forward-looking statements include, among other things, the Company's ability to efficiently and successfully integrate the operations of Stratasys and Objet Limited after their merger, as well as MakerBot, Solid Concepts and Harvest Technologies after their acquisitions, and to successfully put into place and execute an effective post-merger integration plan; the overall global economic environment; the impact of competition and new technologies; general market, political, and economic conditions in the countries in which the Company operates; projected capital expenditures and liquidity; changes in the Company's strategy; government regulations and approvals; changes in customer's budgeting priorities; litigation and regulatory proceedings; the Company's ability to satisfy the financial covenants under its revolving credit facility; and those factors referred to under risk factors, information on the Company, operating and financial review and prospects, and generally the Company's Annual Report on Form 20-F for the year ended December 31, 2014 filed with the US Securities and Exchange Commission, or the SEC, and in other reports that the Company has filed with or furnished to the SEC on the date hereof.

Readers are urged to carefully review and consider the various disclosures made in the Company's SEC reports, which are designed to advise interested parties of the risks and factors that may affect its business, financial condition, results of operations and prospects. Any guidance and other forward-looking statements in this press release are made as of the date hereof, and the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

As in previous quarters, our focus on today's call will be on non-GAAP financial results. These non-GAAP financial measures should be read in combination with our GAAP metrics to evaluate our performance. We also note that we do not provide any pro forma financial results for acquisitions. Certain non-GAAP to GAAP reconciliations are provided in the table contained in this slide presentation and in our press release.

I'd now like to turn the call over to our CEO, David Reis. David?

Thank you, Shane, and good morning, everyone. Thank you for joining today's call to discuss our second quarter results. The second quarter represented a continuation of a challenging market environment we began to observe in the first quarter. We believe that during 2013 and 2014, our Company and the industry experienced an extraordinary period of growth, driven by the positive synergies that result from the merger between Stratasys and Objet in 2012, as well as by heightened level of mainstream media attention that the industry enjoyed during that period.

We believe that our industry is now transforming through a period of slower growth, as usual to digest the recent investment in 3-D printing and expense capacity utilization. Despite these headwinds, we are encouraged by areas of sequential improvement in our business, and remain confident -- sorry -- remain convinced of our long-term potential over our industry.

Supporting our view, we recently completed two events, including one with our channel partners in Europe and one with our Stratasys direct manufacturing customers in North America, where excitement around the industry future and the potential of our revolutionary products remain high. Additionally, sales within the channel remain strong and several of our high-end production systems have shown signs of improvement after a slow first quarter.

We are beginning to see tangible results, which reaffirm our strategy of developing target solutions within key market verticals, and recently announced a major collaboration for our Solidscape product line in China, which presents significant potential for our future expansion. Short-term, we'll continue to make adjustments to align expenses with current market conditions. However, we remain committed to our long-term growth initiative that includes enhancing vertical solutions capabilities, expanding customer support services, accelerating product development, and enhancing our sales and marketing infrastructure.

Later in the call, I will return to provide more detail on these developments and our strategy moving forward. But first, I would like to turn the call over to our CFO and COO, Erez Simha, who will review the detail of our financial results. Erez?

Thank you, David, and good morning, everyone. The growth experienced during the second quarter compared to Stratasys' historical growth rates is a reflection of the overall market weakness and a slowdown in sales across most regions and business units when compared to last year.

After analyzing the results from the first half of this year, we believe we are moving through a period of market stabilization that is marked by slower growth as user expense capacity and utilization. Total revenue in the second quarter increased by 2% to $182.3 million when compared to $178.5 million for the same period last year, and was up approximately 6% sequentially.

On an organic basis, which excludes the impact of acquisitions, revenue growth was down 10% when compared to the same period last year or down approximately 5% on a constant currency basis. Our core business, excluding MakerBot and Stratasys direct manufacturing, was up 1.3% in the second quarter of the last year, and up approximately 8% when compared to the first quarter of this year, as we have begun to observe some recovery in our high-end production system sales.

The lower growth experienced in the second quarter was primarily due to the slowdown in hardware sales as well as negative growth in Asia-Pacific region and for MakerBot. MakerBot product and service revenue declined by 57% in the second quarter of last year, driven by the overall market weakness, as well as by ongoing challenges associated with the restructuring of this business.

Non-GAAP net income for the second quarter was $8 million or $0.15 per diluted share compared to non-GAAP net income of $28 million or $0.55 per diluted share reported for the same period last year. Product revenue in the second quarter decreased by 13% to $134.5 million as compared to the same period last year.

Within product revenue, system revenue decreased by 21% in the second quarter over the same period last year, with the decline driven primarily by weaker MakerBot system sales as well as overall market weakness, as discussed previously. Consumables revenue grew by 6% over the same period last year, [up] 13% on a constant currency basis, in line with our revised expectation for the year.

Services revenue in the second quarter increased by 96% to $47.8 million, as compared to the same period last year. The increase in services revenue was driven primarily by the revenue contribution of Solid Concepts and Harvest Technologies, which were acquired during the third quarter of 2014 and not included in the previous year's results. Within service revenue, customer support revenue, which includes the revenue generated mainly by maintenance contracts on our systems, increased by 17% compared to the same period last year.

The Company sold 6,731 3-D printing and additive manufacturing systems during the second quarter, and on a pro forma combined basis, has sold a total of approximately 136,000 systems worldwide as of June 30, 2015. Unit sales in the second quarter relative to prior periods were impacted by lower MakerBot unit sales, as well as the overall impact of the market factors we have outlined previously.

We are observing signs of recovery in our high-end production systems, led by sequential sales improvement in our Fortus line. This includes positive market reception for the new Fortus 450 MC, which performed ahead of plan in the second quarter. Additionally, we have seen sequential improvement for our recently introduced Connex line of column multi-material 3-D printing. Most notably sales of our Solidscape line of 3-D printers grew significantly during the quarter, driven by the initial orders of our recently announced collaboration in China, which David will discuss in more detail later in the call.

Non-GAAP gross margins declined to 54.7% for the second quarter compared to 59.8% in the same period last year. Non-GAAP gross margin expanded sequentially when compared to the first quarter gross margin of 54.1%. The decrease in gross margin over last year resulted primarily from the impact of inclusion of Solid Concepts and Harvest Technologies.

Gross margins for product revenue was flat in the second quarter compared to last year, and improved sequentially over the first quarter of this year, driven by a sales mix that favored our high-end systems. Operating expenses increased by 23% to $96.1 million as compared to the same period last year. Net R&D expenses increased by 28% to $22.5 million in the second quarter over last year's, driven by the inclusion of crowd card expenses, increased headcount, and an overall acceleration in system and material product development.

Compared to the first quarter of 2015, net R&D expenses declined 8%. SG&A expenses increased by 22% to $73.6 million in the second quarter over last year, primarily due to the inclusion of Solid Concepts and Harvest Technologies operating expenses. Sequentially, SG&A expenses increased 5% compared to the first quarter of 2015.

We will [save] the tax benefit of $4.8 million in the second quarter compared to effective tax rate of 3.8% for the same period last year. Our tax expenses were impacted by losses incurred in high tax jurisdictions that were offset by taxable income in low tax jurisdictions.

The following slides provide you a breakdown of our geographical sales for the quarter, which reflects an emerging new [travel returns] in North America. The outlook for the remainder of the third quarter of 2015 is for continued improvement in North America and Europe, with an expectation of continued market headwinds in Asia-Pacific/Japan region. driven by tough macroeconomic conditions.

Non-GAAP EBITDA for the second quarter amounted for $12.1 million. Company used $15.6 million in cash from operations during the second quarter and currently holds approximately $502.6 million in cash, cash equivalents and short-term bank deposits. Our cash balance includes cash from $175 million drawdown on the Company's revolving credit facility.

We incurred significant one-time cash and non-cash charges during the second quarter related to post-merger integration activities and Company reorganizations. Capital expenditures amounted to approximately $30.4 million in facility and equipment investment, primarily driven by new office facility in Israel.

Inventory increased to $137.4 million as compared to $131 million at the end of the first quarter of 2015, representing a 5% increase over the first quarter. [Account] a favorable decrease to $137 million, representing a 4% decrease as compared to $142.4 million at the end of the first quarter, while DSO and 12 months trailing revenue was $65 million compared to $67 million at the end of the first quarter.

In summary, we observed some sign of sequential improvements versus the first quarter of 2015, although our second-quarter results were lower than expected across most geographies and industries, compared to growth level experienced historically. We are observing signs of recovery in certain regions and are cautiously optimistic about sustained improvement in North America and Europe. However, we expect the Asia-Pacific region as well as sales at MakerBot to remain a headwind for the duration of the third quarter.

We will continue to make adjustment to our operating expense and to align with changes in current market environment. Longer-term, however, we remain committed to our growth initiative and investment plan.

We remain well-positioned to respond to an acceleration in demand while improvements in overall market conditions. We believe that we have a strong balance sheet and are making the appropriate investments in strategic initiatives, and building infrastructure to help accelerate our growth moving forward, and that we are on the leading edge of our exciting industry.

I would now like to turn the call over to our VP of Investor Relations, Shane Glenn, who will provide you greater details on our updated 2015 financial guidance. Shane?

Thank you, Erez. Due to the Company's limited visibility regarding the timing of improvements in growth, the company Has withdrawn its previously delivered financial guidance and, instead, is providing financial guidance for the third quarter of 2015 as follows.

Total revenue in the range of $175 million to $190 million, with non-GAAP net income in the range of $1.5 million to $7 million or $0.03 to $0.13 per diluted share; GAAP net loss of $27 million to $22.5 million or $0.52 to $0.43 per share. Non-GAAP earnings guidance excludes $18 million of projected amortization of intangible assets, $9.5 million to $10 million of share-based compensation expense, $7 million to $8 million in nonrecurring expenses related to acquisitions, and includes $6 million to $6.5 million in tax expenses related to non-GAAP adjustments.

Finally, at this time, we are not modifying the following long-term goals for the Company's operating model, which include annual organic revenue growth of at least 25%, non-GAAP operating income as a percentage of sales at 18% to 23%, non-GAAP effective tax rate of 10% to 15%, non-GAAP net income as a percentage of sales of 16% to 21%. Appropriate reconciliations between GAAP and non-GAAP financial measures are provided in a table at the end of our press release, providing an itemized detail of the non-GAAP financial measures.

Now I'd like to turn the call back over to David Reis. David?

Thank you, Shane. As I mentioned in my opening remarks, we believe that the extraordinary growth that Stratasys and our industry enjoyed during 2015 and 2014 was driven in part by the synergies that result from the Stratasys and Objet merger in 2012, as well as from heightened level of media attention observed during the period. During this period, our customers' capacity went through a dramatic expansion.

Now, the industry near-term growth is likely being impacted as end markets digest capacity and increase their utilization. Despite these near-term challenges, we see no indication of fundamental change in the attractive market opportunity within our industry, and we are encouraged by the sequential improvement we are observing in the areas of our business. We continue to believe that our industry is poised to transform manufacturing, engineering, and design processes across a wide range of spectrums, and will be driven by vertical solution development and further penetration into advanced manufacturing applications.

With our strong pipeline of potential future opportunities and our position of leadership within the industry, we believe we are well-positioned to capitalize on these opportunities as they will develop. As mentioned earlier, we are committed to our strategic investment plans that we unveiled early this year, which is designed to support the future growth of our business and sustain our leadership position.

The multiyear investment plan, focused on enhanced vertical industry solutions, extended customer support services, building enhanced sales and marketing infrastructure, and accelerated product development. all designed to support potential annual revenue of $3 billion in 2020. To reiterate, we see no change in the long-term opportunity for our industry, and observing enthusiasm and interest from both our channel partners and customers.

We recently host 239 of our Stratasys direct manufacturing customers in Nashville, Tennessee at the first SDN Summit to introduce the combined SDN organization as a total solution provider that focuses on application from prototyping to production. At the event, strategy manufacturing experts from our SDN group conducted seminars, workshops and one-on-one meetings with key accounts. Additionally, a recent EM channel partner event -- sorry, channel partner event -- was attended by CEOs and sales executives from 41 Stratasys European resellers.

The event was the first channel partner meeting at our new Stratasys EMEA headquarters in Germany that features workshops sharing best practice for vertical market marketing and growing the material and service businesses. Most of those events were well-attended, and the feedback from customers and channel partners was positive, reinforcing our optimistic long-term outlook.

We made multiple enhancement to our overall channel and go-to-market strategy during the quarter -- strengthening our presence in Germany, Switzerland, and Austria through the acquisition of the key German channel partner, RTC Rapid Technologies; making enhancement to our North America channel for Stratasys product line with addition of W.D. Distributing and with WYNIT.

For MakerBot, we announced the expansion of the central breaker presence to over 600 stores following the successful pilot program; recognized the MakerBot channel in Europe -- sorry, reorganized the MakerBot channel in Europe and Asia to better leverage the existing Stratasys go-to-market infrastructure within those regions. And finally, recently FISHER/UNITECH, a top Stratasys reseller, announced it is now carrying our MakerBot brands of products.

In addition to those go-to-market developments we are beginning to see tangible results with new customers and applications. The Chinese government has a multi-decade plan for growing and employing high skilled workforce, and has committed publicly to promoting 3-D printing as a driver force in China future manufacturing development.

This initiative represents a significant opportunity for Stratasys. And we are pleased to have recently announced the collaboration for our Solidscape product line with the Kangshuo Group in China to provide Solidscape 3-D printers for application relating primarily to custom jewelry manufacturing. This agreement provides Stratasys with opportunity to play a major role in creating the largest network of service bureaus and innovative center in China that would target application from custom jewelry manufacturing using our Solidscape brand of products.

Our Solidscape line of high precision 3-D printers product produce wax patterns that are ideal for those wax investment casting and mold-making applications. These patents meet high standards in surface finish, accuracy, and material castability, while eliminating the need for significant postprocessing. The multiyear collaboration includes providing up to 1,000 Solidscape high precision 3-D printers to equip multiple new service bureaus and innovate expenses within China, as well as opening of manufacturing facility by Kangshuo for the family of Solidscape 3-D printers for the domestic Chinese market.

Also included in the agreement is a plan to supply China 3-D printing education initiative with significant quantities of Solidscape 3-D printers. We believe this marks the most comprehensive 3-D printing collaboration to date in China, and will help drive significant (technical difficulty) education utilizing our Solidscape product lines.

Another area of recent success within -- is within the dental market, where we are observing growing adoption that we believe validates our strategy to focus on this exciting vertical. Our customer, a leading manufacturer of clear orthodontic liners, recently announced a 30% expansion of its fleet of Objet Eden500V 3-D printers, and now prints 100% of its custom-made orthodontic aligners utilizing Stratasys PolyJet 3-D printers in several dental fields.

Our PolyJet technology provides our customers with the ability to efficiently manufacture custom aligners on that scale with optimized workflow, faster production and shorter lead-times. We believe that our customer adoption of 3-D printing technology is indicative of potential significant expansion within dental verticals, including the other adoption of our Stratasys PolyJet-based solution for reduction of custom-made orthodontic products.

Our vertical business unit strategy is designed to capture these opportunities. And we made significant operational enhancement, including key personnel additions, during the second quarter, as we believe we further enhance our ability to address dental application and provide solutions to this vertical moving forward.

In summary, while we are disappointed with our second-quarter results, at this time, we see no indication of a change in the fundamental growth drivers for additive manufacturing, and we believe the long-term opportunities remain very promising. We are encouraged by areas of sequential improvement in our business and remain optimistic about our long-term growth prospects.

We believe our industry is transitioning through a period of slower growth as users digest their investment in 3-D printers and expand the utilization of recently acquired capacity. While we remain confident in our long-term market perspective in light of the current growth environment, we're making adjustments to better align expenses with current market conditions.

Finally, we are confident that our investment plan and our growth strategy will enable us to put greater focus on long-term vertical and manufacturing related applications, such as dental and the recently announced Solidscape collaboration, which further positions the Company to capitalize on future growth opportunities, and helps solidify our leading position in additive manufacturing and 3-D printing.

Operator, please open the call for questions.

(Operator Instructions) Sherri Scribner, Deutsche Bank.

Maybe you could talk about the guidance for the third quarter? It looks like revenue guidance is flat sequentially. EPS comes down a bit. Are you expecting OpEx to be high? Or how should we think about that, given the weak demand environment? And also can you give us a little more detail on what's going on with MakerBot? Thanks.

Sherri, good morning. It's Erez. We do not expect a significant increase in operating expenses in Q3. However, the lower EPS is due to some one-time benefit that we recorded in Q2 around taxes that will not happen again in Q3. And, as of MakerBot, I think also in Q3, we do not expect our MakerBot to perform differently than Q2.

The Company is going through a reorganization, aligning the go-to-market within Stratasys. And I think the performance of market expectations for the performance of MakerBot in Q3 combine into our guidance for Q3.

Is there any visibility on when MakerBot will be a benefit?

We expect a tough 2013 for MakerBot. We do not expect MakerBot to contribute -- to gain benefit in 2015. And again, the plan is that as of 2016, MakerBot will come back to a higher growth than we saw in 2015 and will contribute to the bottom line of the Company.

Thank you.

Bobby Burleson, Canaccord.

Just curious about the SDN business. What type of competition are you seeing out there in North America and Europe as other guys build out capacity? And how meaningfully have you guys invested in metal capacity up to this point? Thanks.

Good morning. We -- I think concluded -- or we were in the final stages of concluding the integration between RedEye, Solid Concepts and Harvest. I think the event that took place two weeks ago kind of was an effort to mark the conclusion of this, I think, very intensive PMI effort. And I think we are now well-positioned to put a lot of attention going to market.

Specific to your question, we don't feel increased competition compared to, let's say, what we saw or the Company saw a year and two years ago.

And you are making investments in metal capacity. Have those been substantial?

We made investments in increased capacity in the past. I think it was what -- two quarters, three quarters. I think, to date, we have one of the kind of larger, I think, infrastructure to support the metal application as a service provider.

Thank you.

Troy Jensen, Piper.

How about one for David here? I was hoping you could touch on the RTC acquisition? Curious to know if the intention here is to go more direct in Europe? I know you've done similar deals in Asia. Or were you just really acquiring local talent to beef up system integrators and channel managers and stuff like that?

No, our basic channel is -- our basic strategy is a channel strategy and this is not changing. The acquisition of RTC was intended to create a stronger base in Germany while operating with our many channel partners in Germany in coordination. It was the same way we did it in Japan successfully and Korea and in other places.

So it's not in any way or any intent to replace the channel. It's to create a strong base in Germany and to allow us in the future to expand, for example, our SAM activity, our strategic account activity and such.

That's perfect. And maybe just a follow-up for Erez. I know you have rescinded the full-year guidance. But traditionally, Q4 is a very seasonally strong quarter; I think historically it's gone up 10-plus-percent on a sequential basis. Any reason to believe that we would see the same type of strength there out this year?

Troy, we are providing guidance for Q3, and we do not provide guidance for H2. The visibility into H2 growth has not improved. The potential additive variability in our performance for the remainder of the year makes giving full-year guidance very difficult. I don't know how -- exactly how long their weakness will persist. We are doing what we can do to improve performance, including managing cost structure and continuing to invest in growth opportunities. However, we remain focused on our current strategy to drive sales growth and adoption, and are committed to our multiyear investment plan.

All right. Understood, guys. Good luck in the second half.

Wamsi Mohan, Bank of America.

So David, your long-term growth objective still remains at 25% for organic growth. But if we just step back and look at what -- how that has played out, in 2014, you increased that target to 25% from 20% when you saw the growth each quarter in 2014 between 31% to 36%. But your comments today around capacity digestion would imply that that 30% growth was temporary. So why should we not think that the long-term growth profile is lower than -- definitely lower than 25% but might be even quite a bit lower than that?

I'll tell you a little bit about my perspective with it. We said both in the PR and on the call that we did experience, I think, extraordinary growth rates during 2013 and 2014. We gave the reasons. It had a lot to do with the merger, I think, in Objet and Stratasys. A lot of interest was created by the media, which pushed the growth rate to a higher level than historical ones.

If you go backwards to 2010, 2011, and 2012, prior to the merger -- and I do appreciate the fact that the industry was substantially smaller, historical growth rates were not low. I mean many years since this time, growth rates in both Stratasys and Objet were over 20% year-over-year. So, we are just kind of exiting at accelerated growth period.

And because when we meet the market and we meet a lot of customers and partners, we do not see -- I don't know how to convey this message. We really don't see any long-term changes the perspective of the industry, relevance of the technology for many applications across many, many industries. We -- it's difficult at this point to either change the long-term perspective or refine it.

I think we need to wait a little bit more time and look even backwards for the years before 2013 and 2014 to get the right perspective. I think that within a relatively short period of time, a few quarters, we will get a better understanding whether those numbers are really in line with the long-term perspective. But there is no indication today which is saying that long-term, the numbers are going to be different. And again, when you go back to 2010, 2011, and 2012, this is our view at this point in time.

Okay, thanks David. And if I could just follow up, consumables revenue growth sharply decelerated. Last quarter, that was still quite strong, even though you saw strong unit deceleration last quarter. So can you help put that in the little bit of perspective? Where did you see that deceleration play out? Was it very specific to a few verticals? Was it very broad-based? Any particular geographies that drove that consumables growth rate so much lower sequentially? Thanks.

It's Erez. I think the first part David will continue, but the growth in consumables is composed of many parameters. If you take out what happened in MakerBot and you look only on the core business, the growth in consumables was close to 20%. And in --

In fixed currencies.

-- in fixed currencies. And I think that slower growth throughout the time will generate -- solid growth in hardware will generate slower growth in consumables. And consumables will not continue to grow forever. And the fact that they grew without (inaudible) growth but still consumables perform, and I think in line with our expectation this quarter.

I would like to add to it that when again just to repeat that if you think consumable part in MakerBot is -- growth year-over-year was in constant currency was 19%, which I think is impressive. And if you dive in and you look internally on the consumption per machine, which is a very difficult analysis that we are trying to do because some of our sales of consumables are not done directly by us.

In general, the overall feeling is that consumption per machine did not go down and in some areas of the market weren't even up. So there is an increased adoption. And I think this is, by the way, a very good sign to where the industry is going. It's not a negative sign.

Great. Thank you for that clarification. That's very helpful.

Paul Coster, JPMorgan.

Erez, you acknowledged that in prior quarters, there was a few methodological flaws in forecasting, particularly around those sort of -- some of the issues you had with some of the MakerBot machines. So, when you talk of limited visibility now, I assume it's not to do with method. It's actually the end market. What is the -- is that correct, first of all?

And secondly, what is it that you look at -- confident measures that you look at to sort of draw that conclusion?

So yes, for us, this is correcting -- when we look today and we're talking about visibility, we are talking about the end market and the demand that is generated by -- through different parameters. Different parameters is the pipeline that we have for leads and opportunities, and the translation of those leads and opportunities into transactions.

And again, the leads and opportunities in Stratasys are still in line with what we expect those to be. However, we do see the migration from opportunities to deals and perform a little bit different than it used to be in previous quarters. And this translated into relatively longer sales cycle that has impact on our revenue, and again in customer behavior that we could not focus today as we used to do in previous quarters.

Okay. And the sort of reset to the method that the salespeople use in qualifying leads?

There is no change in the way that we treat leads or generate leads or invest in leads or translate leads into opportunities. However, the ratio of the conversion between opportunities into transactions which has -- which reflects on the market behavior is different than what we used to have in the last few years. And by the way, we used to have a very accurate forecasting system based on those pile of leads and opportunities.

Okay, got it. And my last question is -- I assume, as the volumes decline in MakerBot, that the certain fixed cost in that segment that weigh on the segment margins. But can you kind of give us a sense of the degree to which we're talking about our variable costs versus the fixed cost operation there?

Paul, I don't want to get into the details of fixed versus variable in MakerBot. The Company is going through a significant reorganization which includes all parts of the Company. By the way, we touched both variable, fixed, long-term operating expenses as much as we can. I think that we have relatively high flexibility to adopt operating expenses there to the level of business that we expect. And I think that in 2015, we provide MakerBot with the tools to build the infrastructure for ramp-up business in 2016.

Right, thank you.

Ananda Baruah, Brean Capital.

I guess really what I wanted to ask was in conversations with your customers, what is the sense you get that would be the right confluence of dynamics, or I should say the appropriate -- that really gets them to sort of kick in the next adoption cycle? How much of it -- is it macro-related? Is it a matter of innovation? Sort of recent new applications, price, those kinds of dynamics. And anything else that they might be saying. Thanks.

Maybe I will go back to the statement Erez made earlier or Shane made earlier about the lower visibility that we have today is. The behavior pattern of customers today is a combination of a lot of things, and it is varying by geography and is impacted by local macro events. The general notion is that customers are slower compared to previous years in making bad decisions.

As Erez indicated from the number of leads that we see, the level of interest is high and in many places is growing. The interaction with customers is getting tighter, and we have a lot of discussions with a lot of companies about how additive manufacturing would become part of their strategic future.

So like I said -- and we are repeating ourselves. We don't see a decrease in the interest. We don't see a decrease in the inquiries. We don't see a change in the way people view additive manufacturing, and the way people believe that it will become part of their strategy and strategic way of operating in the future. This is not changing.

On the specific buy decision, this slowness which is coming mainly from capacity that was purchased in the last two years, and customers have the opportunity to increase the utilization of this capacity before placing more orders. But again, the fundamentals -- the interest is there. And therefore, we are cautiously optimistic, although in the short-term, the visibility is low because the pattern that we were used to in the last five or seven years. And we are all aware of it was very, very different.

So, we believe that it's temporary and the market will come back to some growth patterns. It might be a little bit different from what we were used to, but the growth patterns in the future.

And Erez, in that context, how are you thinking about -- regarding your comments on cost structure, where is it that you are actually managing costs away right now? Where is it that you are still investing for the long-term in that context? Thanks.

We didn't change anything in our approach. And we continue to invest in long-term initiative that we believe are crucial for the growth of the Company in the future. And it's around R&D projects, and it's around go-to-market, and CPU and SAM, and customer interface activity. We did not change anything in this approach.

We are scaling down some of the, I would say, revenue-related activities, as we see that revenues is lower than what we expected. And we are scaling down the equivalent relevant operating expenses to fit into lower level of business in the short-term.

Got it. Thanks a lot, guys.

Steve Milunovich, UBS.

A question about your existing and potential new customers. For existing customers, what is the satisfaction level? Do you measure that? Are they to some degree running into issues and using 3-D printing?

And then for new customers, I can buy that some of your existing customers may be digesting capacity. But your penetration of the market is miniscule. So there is something wrong with adoption and I would think it's probably around technology. I mean, there are distribution issues. But I would think it's things that HP talks about -- speed, quality, sufficient variety of materials.

Would you agree with that view? And when do you kind of see some of those improvements over time intersecting with customer needs, such that adoption increases? Are we a year away? Are we three years away?

First of all to your first question. I think that the overall -- and I'm talking about the core Stratasys today -- the level of perception of customers around the world is good, in many areas, good. People -- and you can see it in the consumable consumption -- people are using the machine and producing with the machine.

I do agree with your statement that our penetration in this market is very, very small. I think that in the rapid prototyping market, we are dealing with some issues of capacity. We are dealing with issues of go-to-market and expanding our reach to new customers, which you know did not experience hands-on the technology.

On the manufacturing side of it, I think the market and we are doing a huge effort on this direction is adopting the technology slowly. And here, technology breakthroughs will accelerate adoption. But it's mainly related to manufacturing. I don't think it's a true statement for rapid prototyping, which is basically the core of our business for the last many, many years.

Okay, that does make sense. And can you talk a bit more about the decline in MakerBot sales? I mean they've really fallen off. Is it a problem because of the extruder quality issue? Or -- because it seems like in the press you still read about 3-D. So there's still, for the consumer, a little bit of buzz. I'm just trying to understand why the significant follow-up and what you're doing in terms of changing management and so forth?

Like Erez mentioned earlier, we are in the process of reorganizing and restructuring MakerBot. I think that Stratasys and the MakerBot team strongly believe in the future of this market. Nevertheless, we need to get reorganized. We need to adapt the way our operations with the way the market is developing.

You know, our focus today is mainly on the professional uses and education. And the drop in sales in MakerBot is -- can be partially attributed to any issues we had in the past, and some of which also could be attributed to headwinds we have in the overall market. MakerBot is not separated from status to us to this respect. So they see whatever we see and, therefore, have a significant drop in sales compared to last year.

Okay, thank you.

Ken Wong, Citigroup.

You guys have talked a bit about realigning costs. And then as I look into Q3, it looks like your OpEx will be roughly flat. I guess how should we think about where OpEx goes in the future? And then you guys had talked about 46% to 47% in the past. I assume that that's no longer a good metric to model off of?

Again, we provide guidance only for Q3, and you can assume operating expenses without any significant change in Q3. However, the measurement that we are taking now in aligning the revenue-related or revenue-related expenses, I think that we'll have a higher impact in Q4, and because of the time it takes us to perform and execute here, and our flexibility within adopting our cost structure and scaling it down. Again, 47% -- 46%, 47% was correct for the entire year. We do not see today 46%, 47% as a parameter that is still viable.

I want to -- just another, I think, important comment here that -- and again, we don't -- because we strongly believe that the fundamental of the markets are not changing. And the future -- and the growth in the future will return in some shape or form. In areas that we cut costs, some of the cost-cutting is not going to be reflected in our profitability, because we are going to move this money into long-term investments.

So we are not cutting in those areas. And in some areas, we are even increasing investments, driven by the belief that again fundamentally did not change, the market did not change dramatically. Demand is there and it's going to return. So money is being moved from different OpEx MMM's into the investment areas that we highlighted both in the presentation and in the PR.

Got you. And then maybe another cost follow-up. What about the CapEx outlook that you guys have in the past? Should we hold you guys to that still? Or is that also an area where you guys are looking to cut back?

No, the reduced CapEx plan that we announced at the end of last quarter is still in place.

Okay, got you.

Rob Stone, Cowen and Company.

I had a couple of questions related to gross margins. If you can provide a little more color, please. One is on the sequential trend in services gross margin, which was down from the level it had been for a few quarters. And then the other is within products, consumables were up and systems down, and yet product margins were flat. So any comments would be helpful. Thanks.

If you compare gross margin this year to previous years, you have to remember that in previous year, we did not consolidate SDM into the financial statements. So, the current Q3, Q2 results include solid SDM gross margins and performance, which has impact on the overall gross margins of the Company. The SDM has a different business model -- lower gross margins compared to the average gross margins of the Company.

And if you look at Q2 compared to Q1, you see sequential improvement. And in Q1, it was included. You see sequential improvement in gross margin mainly because of mix that was more weighted to high net -- a higher net product this quarter compared to previous quarters.

And one follow-up, if I may. So, working capital actually improved sequentially. So what prompted you to draw on the revolver?

It's mainly shorter needs of financing some CapEx and other activity in Stratasys. The amount that we withdraw will not be at the same level. It will be at lower levels at the end of the year.

Thank you very much.

Patrick Newton, Stifel.

Thanks for taking my questions. I guess diving into the longer-term targets, you reiterate the long-term growth target of 25% or greater. And I think, Erez, in some answers to questions, you talked about aligning costs on a short-term basis.

David, you responded that demand will return. Can you help us understand your expectation? Realizing you don't have a crystal ball, but on this return to growth or return to demand for the industry, is this a couple of quarters? Is this measured in years, plural? I mean as you sit here today, when do you think this phase of slow growth will end?

Actually, I think the reason we are seeing the visibility is low is because we don't have a clear expectation about this question. Okay? You know we do know -- again, and by talking with customers and talking with channels, that the interest is there. You know, we see the use cases. We know the penetration in general in many areas of activity is relatively low. But it's impossible for us to indicate the timeframe.

Okay. And I guess just shifting gears to the consumer market, you did talk about the reorganization and you did talk about a focus on professional educational markets. But I guess given MakerBot results and elevated competition in that market, and what appears to be somewhat of a race to the bottom there, how core is being in the consumer market to Stratasys? And if it is core, can you help us understand what the current margin profile is of your consumer business, and where you see it progressing long-term post-this reorganization?

I'm not sure I'm clear of the question. But when we talk about MakerBot and MakerBot target markets today, consumer, the way I think you define it, is a small part of our activity. As I said earlier, our focus is on the education segment and the desktop professional market. Of course, there are consumers which are buying those products, but it's not a target market at this point of time.

And as far as the margin structure, Erez, on that -- on the MakerBot side, how is it standing today? And post the reorg, how should it look?

So, the MakerBot margins today are lower than the core average gross margin of the Company for many reasons, by the way. There are -- there was issues of lower [served] that has impact on capacity that had impact on gross margin. We do expect gross margin of MakerBot as business will improve. And to get better, we do not expect gross margin of MakerBot to come to a level of Stratasys' average gross margin in general. But we do expect gross margin to be better as we fulfill more capacity and business is getting better, so that are stable today with less issues in production and looking forward.

Thank you.

Andrea James, Dougherty & Company.

Does it concern you that you need technology breakthroughs to accelerate manufacturing adoptions? And I guess just to that point, which verticals do you think you are going to see those breakthroughs first?

Let me again repeat what I said earlier. We have today good technology, and when we are doing good steady progress into manufacturing, I think it accelerated. The adoption would depend on advancing the technology. And we are seeing, I think, over the last many quarters, that the progress in manufacturing will depend, of course, on the go-to-market and development of applications, but also on our ability to build printers which are even more suitable to manufacturing from the point of view of material properties and end-use path properties, as the robustness of the equipment itself is the suitability to manufacturing environments. So this is an ongoing process.

We said also in the past that Stratasys is investing a lot of money and energy in developing such projects. All of those projects are usually long-term projects, but we are very focused on it. And this does not mean that in the short-term the Company is not progressing into the manufacturing arena. We are progressing every day. But accelerated penetration will depend, among other things, also on advancing technology, which again, we are investing a lot in.

And then, I think it's kind of exciting what you've been doing in aerospace. I'm just wondering, do you need to develop or acquire metal printing capabilities to really leverage the aerospace opportunity?

Metal is one of the technologies which is required by aerospace. Today we are addressing it via SDM. I mentioned earlier on the call that from the point of view of service bureau and ability to provide solutions, I think we are one of the strongest in the market today. With respect to Stratasys itself, we said all the time, we are saying it -- that we are looking on the space, and we might move to it if the right opportunity will appear.

And I think also that the Airbus deal that came out is a good example of for the current technology of Stratasys, mainly SDM to be a good -- to service a good solution and for the aerospace arena.

Is it correct to assume that you have other partnerships besides Airbus that are unannounced?

It's difficult to discuss unannounced transactions, but I think that we are working with -- in the aerospace with multiples and customers. It's a long-term journey. It's not a short-term journey. It's a different industry. It has to go from significant qualification processes. And once we have something to announce, we will announce, I'm sure.

Thank you.

Holden Lewis, Oppenheimer.

The -- you know, you've given the long-term sort of guidance parameters. Can you give a little bit of sense about what kind -- once you begin to see revenues expand again, what kind of incremental margin can we kind of expect on those revenues? Is there something that you've experienced historically? Or do you have kind of a framework to work off of, given your knowledge of your expenses and that sort of thing?

Holden, we didn't provide any medium-term outlook. I can tell you just that the cost structure of our Stratasys today is built off a significant part, which is variable cost, and provide us with the flexibility to adapt our operating expenses, by the way, scaling up and scaling down in both directions relatively fast. And again, it depends on the time of this event to happen, the situation of the Company.

There are areas of investment which are long-term, and it's a long-term journey that we invest. And we do not touch and we do not reduce, because we believe they are crucial for the success of the Company in the future. And it's -- I would say it will be fair to say that when and if -- when revenue will grow, the equivalent revenue-related expenses will have to take place, like lead generation activity and marketing, and other sales expenses in the Company.

Okay. And then sort of I was also interested in your comment earlier about the people basically looking to utilize their machine. It strikes me that you know where all of your machines are. You have a very high capture rate on the materials. As you see the materials grow and you keep track of that, does that give you any insights into the utilization of the machines that are in the field, just sort of tracking that revenue to sort of machine relationships and when you think that might be?

We have a lot of this kind of data. We typically don't disclose it. It's varying in a very significant way, both by industry and by geography. But to your question, yes, we do have a lot of this data. Not all of it is in our possession just because of the way we are structuring our distribution. But we do this -- we do know this information. And like I said earlier, we do not see a decreasing utilization. And in some areas, we even see increasing utilization of machines.

You are seeing an increasing utilization of the machines?

In some areas, yes.

Okay, but are you able to sort of track sort of the difference between your machines and sort of the utilization, and track how that's proceeding over time, and get a sense of where it's utilized enough to spark demand again?

Yes. And again, in the areas that we distribute consumables directly or the relationship with channel, provided we have this information, and I think it will be one of the indicators about potential recovery.

And that's why I'm asking what the status of that information is today.

At this point, you know, it's not statistically significant enough for us to give a prediction in respect to it.

Okay. All right, guys.

I would now like to turn the call back to David Reis for closing remarks.

Thank you all for joining today's call. We look forward to speak with you again next quarter. Thank you very much and goodbye.

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