Stratasys Ltd (SSYS) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the quarter three, 2015 Stratasys' earnings conference call. (Operator Instructions). As a reminder, this call is being recorded. I would like to turn the call over to Shane Glenn, Vice President of Investor Relations. Please proceed, sir.

Thank you Sheila. Good morning, everyone, and thank you for joining us to discuss our third 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.

We will begin by reminding everyone that certain statements in this press release are forward-looking statements within 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, Inc. and Objet Ltd. after their merger as well as MakerBot, Solid Concepts, and Harvest Technologies after their acquisitions, and to successfully put in 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; unexpected capital expenditures and changes in liquidity; unexpected changes in the Company's strategy; unexpected changes in government regulations and approvals; unexpected changes in customers' budgeting priorities; unexpected litigation and regulatory proceedings; further charges to non-cash goodwill and other intangible assets' impairment expenses; and those factors referred to under Risk Factors, Information on the Company, Operating and Financial Review and Prospects, and generally in the Company's annual report on Form 20-F for the year ended December 31, 2014, filed with the U.S. Securities and Exchange Commission, and in other reports that the Company has filed with or furnished to the SEC on or prior to 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 conference call 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, today's call will include non-GAAP financial measures. These non-GAAP financial measures should be read in combination with our GAAP metrics to evaluate our performance. We also note that we are not providing any pro forma financial results for acquisitions. Certain non-GAAP to GAAP reconciliations are provided in the table contained in our slide presentation and in today's press release.

Now I would like to turn the call over to our CEO, David Reis. David?

Good morning, everyone, and thank you for joining today's call. Our third-quarter results are a reflection of the difficult global macroeconomic environment that has impacted our performance across all regions, and for most of our product lines, throughout the year. We believe the current environment is primarily a result of a slowdown in capital equipment investment from customers within our target markets.

In addition, while we believe that the overall market penetration in the prototyping market remains low, the segment has matured to an extent that it provides our customers with a wider selection of technologies and services than ever before, resulting in a longer sales cycle and increased experimentation by our users. We also believe the situation has been worsened by the negative impact of excess capacity that followed the two-year period of extraordinary industry expansion that ended in 2014.

Reflecting the low visibility of the current market environment, expected orders did not materialize as expected at the end of the quarter. The near-term outlook remains difficult as we begin the fourth quarter. And we will respond to these challenges by implementing the adjustments to our cost and operating structure. We expect these adjustments to positively impact in 2016.

However, despite these near-term challenges, we remain committed to our plan that we believe will help unlock the significant potential within our markets. This includes our recently-announced initiative to transform our brand positioning and go-to-market strategies, as well as the ongoing development of new capabilities and business models that we believe could transform our markets.

I will return later in call to provide more details on recent developments and our strategy moving forward. But first, I will turn the call over to our CFO and COO, Erez Simha, who will review the details of our financial results. Erez.

Thank you, David, and good morning, everyone. As David mentioned, our performance during the third quarter is a reflection of the overall market weakness that has impacted our Company across most regions and business units throughout the year.

Total revenue in the third quarter decreased by 18% to $167.6m when compared to $203.6m for the same period last year. On an organic basis, which excludes the impact of acquisitions, revenue declined by 20% in the third quarter when compared to the same period last year, or approximately 16% when calculated on a constant-currency basis.

Our core business revenue, which excludes MakerBot and Stratasys Direct Manufacturing, declined by 14% in the third quarter over last year; or approximately 10% on a constant-currency basis. MakerBot product and service revenue declined by 55% in the third quarter over last year, driven by the overall market weakness, as well as by ongoing challenges associated with the restructuring of that business.

Non-GAAP net income for the third quarter was $0.7m, or $0.01 per diluted share, compared to non-GAAP net income of $30.1m, or $0.58 per diluted share, reported for the same period last year.

The Company updated the goodwill impairment analysis of all of its reporting units. On the basis of its preliminary analysis, the Company recognized a non-cash goodwill and other intangible assets impairment expense of $910m in the third quarter, primarily as a result of changes in the Company's near-term cash flows projections which reflect, among other things, the increased uncertainty in the 3D printing environment.

The impairment expense is subject to further adjustments, pursuant to conclusion of the preliminary impairment test, which is expected to be completed within the next week and disclosed in the Company's third-quarter financial statements to be filed on Form 6-K. Finalization of the impairment analysis is expected to occur later in the fourth quarter.

Although we remain confident in our long-term growth prospects, our visibility into our near-term performance remains limited as we begin the fourth quarter.

Product revenue in the third quarter decreased by 26% to $118.5m, as compared to the same period last year. Within product revenue, system revenue decreased by 37% over the same period last year, with the decline driven primarily by the overall market weakness we discussed previously.

Consumables revenue was flat when compared to the same period last year. Excluding MakerBot, core consumables revenue grew 3% over last year, or 8% on a constant-currency basis. We believe the slowdown in consumables sales is driven primarily by the recent weakness in hardware sales.

Service revenue in the third quarter increased by 13% to $49.1m, as compared to the same period last year. Within service revenue, customer support revenue, which includes the revenue generated mainly by maintenance contracts on our systems, increased by 16% compared to the same period last year.

The Company sold 5,467 3D printing and additive manufacturing systems during the third quarter, and has sold a total of 141,395 systems worldwide as of September 30, 2015, on a pro forma combined basis.

Unit sales in the third 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. Although systems sales were disappointing, we observed a sequential quarterly improvement in ASPs, as our product mix favors higher-cost systems.

Gross margin declined to 51% for the third quarter, compared to 58% for the same period last year. The decrease in gross margin over the last year was driven primarily by product mix, as sales of our higher-margin Connex systems were notably weaker during the period. In addition, gross margin was impacted by an increase in reserves related to slower moving inventory.

Product gross margin decreased by -- decreased to 59% in quarter, compared to 63% for the same period last year, reflecting the impact of lower demand.

Service gross margin decreased to 32% in the quarter, as compared to 40% for the same period last year, driven primarily by the inclusion of the Solid Concepts and Harvest Technology acquisitions, as well as an increase in reserves related to slower-moving service inventory.

Operating expenses increased by 9% to $95.2m for the third quarter, as compared to the same period last year. Compared to the second quarter of this year, operating expenses declined by 1%, reflecting the impact of lower reseller commissions and planned cost reductions, which were partially offset by higher investment in certain R&D projects, and the ramp-up of our Company-wide ERP implementation.

Net R&D expenses increased by 31% in the quarter to $25.1m over last year, driven by the inclusion of acquired GrabCAD expenses, and an increase in internal funding for certain product development projects.

SG&A expenses increased by 3% in the quarter to $70.1m over last year, but declined by 5% when compared to the second quarter of this year, reflecting the impact of lower reseller commissions and planned cost reductions.

Net income included a tax benefit of $11.3m, which resulted mainly from the impact of losses incurred in high-tax jurisdictions.

The following slides provide you a breakdown of our geographic sales for the quarter, which reflects the broad-based weakness we have outlined previously.

For our core products and services, which exclude MakerBot and SDM, all regions underperformed in the third quarter relative to our expectations. Our expectations for the remainder of the year are a continuation of these trends, as the challenging market conditions we have observed in 2015 persist.

Non-GAAP EBITDA for the third quarter amounted to a loss of $1.5m.

The Company used $17.9m in cash from operations during the third quarter, and currently holds approximately $262.4m in cash, cash equivalents, and short-term bank deposits. The decrease in cash, cash equivalents, and short-term bank deposits as compared to $502.6m at the end of the second quarter, is driven primarily by our recent repayment of our revolving credit facility, and $30.7m in capital expenditures used for the purchase of fixed assets, which includes payments for our new facility in Israel.

Inventory increased to $140.8m as compared to $137.4m at the end of the second quarter of 2015, as lower-than-expected hardware sales drove an increase in finished goods inventory.

Accounts receivable decreased to $130.7m, compared to $137m at the end of the first quarter -- at the end of the second quarter, while DSO on 12-months trailing revenue remained flat, at 64.

In summary, our third-quarter results did not meet our expectations, and we are disappointed with our performance. We believe our performance was impacted by weaker macroeconomic conditions that drove an overall slowdown in capital equipment spending.

Our near-term visibility remains low as we begin the first quarter -- the fourth quarter, as sales cycles have lengthened and pipeline conversion rates have declined when compared to historical levels.

We will make the adjustment to our operating expenses to align with the current market environment and to emphasize operational efficiency.

We believe we maintain a conservative balance sheet and sufficient capital to meet future requirements while weathering the current downturn.

And finally, we remain confident in the long-term growth prospects that we have identified in key verticals and applications. And we will remain committed to our growth initiatives and long-term investment plan.

I would like now 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. The Company has provided financial guidance for the fourth quarter of 2015 as follows. Total revenue in the range of $160m to $175m, with non-GAAP net loss in the range of $9m to $3m, or $0.17 to $0.06 per diluted share. GAAP net loss of $35.3m to $28.3m, or $0.68 to $0.54 per basic share.

Non-GAAP earnings guidance excludes $17m of projected amortization of intangible assets, $7m to $7.5m of share-based compensation expense, $2.5m in non-recurring expenses related to acquisitions, $4m to $5m in reorganization and other related costs, and includes $5.2m to $5.7m in tax expenses related to non-GAAP adjustments.

Finally, at this time we are reviewing our long-term operating model, and will provide an update when we begin to observe improved market visibility.

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 these non-GAAP financial measures.

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

Thank you, Shane. Our recent performance has not met expectations. We are facing a challenging market environment that requires us to adapt and refocus our strategy as our industry transitions and matures. Despite near-term challenges, we continue to observe significant potential within our markets, and remain confident in the long-term growth opportunity.

I would like to take a moment to highlight some initiatives that we believe will reinforce our leadership position in the 3D printing and additive manufacturing industry, and ensure that Stratasys is prepared for the future growth opportunities we see ahead.

To strengthen our position, we recently launched a new branding initiative that reintroduces Stratasys to the market. The goal of our branding initiative is threefold; to take ownership of what our customers, partners, and employees already know, that Stratasys is the industry leader by many metrics, including installed base, intellectual property, R&D investment, new product development, and innovation.

Secondly, to clearly communicate to the market that Stratasys will provide a total ecosystem of solutions, including hardware, materials, services, and software, with the customer at the center.

And, finally, that Stratasys is a 3D printing Solutions Company, and that we will work hard to adapt and evolve our organization to take advantage of future growth opportunities within a market that requires a solution-driven approach.

We are very proud of the work we do at Stratasys. We truly shape lives by revolutionizing the way things are made, and we believe our new branding strategy reflects this position.

We have identified several market trends that we believe support our long-term optimism and future growth prospects within the prototyping and advanced manufacturing markets.

First, we believe that a significant opportunity remains for rapid prototyping applications. Earlier this year we conducted an extensive market analysis that included the data from 845 respondents to an industry survey that targeted product developers. Based on our research and that survey, we believe prototyping applications remain a significant opportunity. We estimate the global prototyping market to be a $10b to $15b opportunity, with only 23% of that opportunity currently addressed by additive manufacturing.

Second, we recently released the results of an in-depth industry survey completed by our Stratasys Direct Manufacturing organization. The report is based on an independent analysis of 700 designers, engineers and executives, 40% of whom are employed by companies with over $50m in revenue. The goal was to uncover common themes among companies who are looking to adopt and integrate 3D printing into their manufacturing processes.

Some of the survey findings include a belief that end-use parts will be increasingly designed for additive manufacturing over the next three years. Additionally, the respondents anticipated the applications with the highest levels of growth for additive manufacturing are, tooling and patterns, trial and bridge-production parts, and end-use parts. Also encouraging was the belief by a majority of respondents that, regardless of their company's in-house additive manufacturing resources, they recognize a value in partnering with a service provider to augment internal capabilities.

We believe we are well-positioned to capitalize on these emerging trends, given our comprehensive portfolio of current and future products. Our product and service offerings are evolving rapidly, as we seek to better position the Company to provide a complete portfolio of solutions within the design and manufacturing value chain.

Building this comprehensive ecosystem takes time. And over the past several quarters, we have completed several transactions that support this effort, including our acquisition of GrabCAD and Econolyst. In addition, we have entered strategic partnerships, such as those we recently announced, with PTC and Adobe.

Our ecosystem, combined with our new branding strategy, will be on full display at the Formnext 2015 exhibition later this month. For the first time, we will showcase a combined range of solutions, including industrial PolyJet and FDM 3D printers, along with MakerBot desktop 3D printers and Solidscape professional systems.

The growing Stratasys ecosystem features design-to-print workflows, 3D printing curriculum, and consultancy offerings through Stratasys Professional Services and Strategic Consulting.

Over the course of 2015, we have made significant changes to our go-to-market strategy. In April, we welcomed Josh Claman to the newly created role of Chief Business Officer, where he oversees the Company's marketing, sales, service, and channel organization. Josh is focused on driving commercial and go-to-market synergies across the Company's different business units.

More recently, we further strengthened our leadership team with the appointment of John Gould, formerly of Dell, as President of North America go-to-market operations. He will play a critical role in defining our North American expansion strategy by improving both the customer and channel partner experience. This includes our more recent initiative to build out dedicated inside sales team to work with our partners to pursue cross-selling and up-selling opportunities, as well as executing specific sales campaigns designed to acquire new accounts.

We will continue to collaborate with our current channel partners, with the expectation that they will play a valuable role in helping nurture and grow new customers. This will include a more effective structure of covering the market, which involves enhancing our ability to support key channel partners through training, certification, sales enablement and joint sales efforts.

Additionally, we continue to pursue our strategic accounts management and vertical business unit initiatives, which are developing new growth opportunities across large organizations, and are targeting markets where our disruptive solutions can unlock value within the manufacturing process. Many of these changes to our go-to-market approach are underway. And we intend on moving forward with expansion over the next few quarters.

Most importantly, we already observe results from some of these initiatives. For example, within the strategic management accounts initiative in North America, sales grew by 137% in the third quarter compared to the same period last year. Although the growth is compared to a small base, we believe the performance is impressive considering the challenging macroeconomic environment we observed during the quarter.

We recently initiated additional organizational enhancements and operational improvements at MakerBot. This includes the reorganization and reduction of staff to become more operationally efficient; enhancement to our leadership team, including the hiring of key executives; consolidation of facilities and reductions in overhead cost, including the centralization of staff; and the outsourcing of production for legacy fourth-generation products to contract manufacturers, which we believe will significantly reduce costs and allow for greater focus on the development of the next-generation products. We are confident the structural changes will help improve the performance of MakerBot reporting unit beginning of 2016.

In addition to the restructuring at MakerBot, we are currently evaluating additional adjustments to our costs and operating structure to better align with our current market environment -- with the current market environment.

In summary, despite our near-term challenges, we continue to observe significant market potential, and remain confident in our long-term growth prospects.

We have re-launched our brand to reflect our leadership position as a 3D printing solutions company, and look forward to presenting our comprehensive ecosystem to the market.

We are augmenting our go-to-market infrastructure with key hires and a vertical-market focused approach, to better serve our customers' additive manufacturing needs.

In light of the current market environment, we are making adjustments to better align expenses with current market conditions, including ongoing restructuring at MakerBot, and an overall emphasis on productivity and efficiency across the entire organization.

And finally, although we expect market conditions will remain challenging over the near term, we remain committed to our long-term investment plan and growth strategy that focuses on vertical markets and manufacturing-related applications. Operator, please open the call for questions.

(Operator Instructions). Patrick Newton, Stifel.

Yes, thank you. Good morning, David and Erez. I guess, just diving in, I really wanted to focus on gross margin as that metric is bouncing around four-year lows. And I guess, just digging beyond the mix and lower Connex sale headwinds that you touched on in your prepared remarks, are you seeing any pricing competition creep up across the portfolio as the industry is pressured by lower sales? Or have you used any discounting tactics in an attempt to re-accelerate pipeline conversion rates? Or are you starting to see any pricing pressure at all across the materials side of your business?

Hi, good morning. It's Erez. The decline in gross margin is only due to the change in product mix that we observed during the last few quarters and the decline in Connex mix. We don't see any ASP pressure. I think that ASP went up. We don't see any change in competitive landscape in the market in the verticals we operate; not at all.

All right, that's very helpful. And then just focusing on the MakerBot operational improvements, I guess, given the demand trends as they stand and the lack of visibility, and also the current cost structure of that entity, in what timeframe do you think you can get MakerBot to operational breakeven? And perhaps if you could help us quantify the current loss generated.

And then also, is there any reason, given the macro challenges, that the organizational enhancements that you're applying to the MakerBot division are only targeted at MakerBot and are not more broad and Company-wide?

Okay, so I -- it was a long one, I hope I remember everything. But I'll start with the MakerBot. We didn't provide any numbers regarding the profitability of MakerBot. What I can tell you that we expect a significant improvement in profitability in MakerBot results in 2016 compared to 2015, based on the ongoing and evolving plan that we have in place.

As of cost measurement in other places, we are dealing now, in the entire Company, with productivity and cost efficiency and adjusting cost structure to what we see today outside in the market. It will have no impact on 2015, because it is in the make. Some of it is medium term, some of them is short term. And I think that once we come out into the beginning of 2016 we will be able to discuss it in detail.

Great. Thank you for taking my questions. Good luck.

Thanks Patrick.

Troy Jensen, Piper Jaffray.

The first question here is for David. David, I agree with your thesis regarding excess capacity and industrial CapEx issues, but how do we know this isn't competition? And I know specifically there's really no competitor to Fortus, and I'm not talking about MakerBot, but just on the industrial side here, just the knowledge of future competition with the print suppliers, is that impacting business at all?

To the best of my knowledge and what we hear from the market, Troy, this is not a factor in the slowdown in this point of time. We don't have such an indication, is the only thing I can say. We are -- we're obviously concerned about the same issue. We asked it many times. We don't get this indication.

Alright. That's fair. And then maybe just my follow-up for Erez. With all the OpEx cuts coming here and the change in the gross margins, what do you think the revenue levels going to be needed to reach a breakeven with the new cost structure? How much OpEx are you planning on taking out?

So, Troy, indirectly, you're asking about 2016, which I cannot comment on just now. But what I can tell is that we are taking very seriously the change in business volume that we see in front of us. And we are dealing with adjusting the cost structure of the Company, the entire cost structure of the Company, not only MakerBot, to fit to what we see today in the market in term of customer demand.

We are dealing with the medium- to long-term activities, such as production efficiency and outsourcing of production and optimization of production. And some of them are short-term activity that we are implementing as we go. Again, once we come closer to 2016 and the plan is nailed down, we will be able to discuss the details.

(Multiple speakers).

Okay. So the plan in any case, Troy, the plan in any case is this activity to -- will lead to and will have effect in 2016.

2016. Okay. Good look in Q4, gentlemen.

Thanks, Troy.

Thanks.

Ken Wong, Citigroup.

Hey, guys. So maybe shifting gears a little bit away from the printer business, do you envision a scenario where the services business could potentially decline year over year? And I guess not so much the services -- the parts plus the maintenance. Stripping off the maintenance, if we were just looking at the parts business, is that a business that could face similar weakness?

I'll take this one. The service, the maintenance part of it, its growth is related to the increase in the install base, one part of it. So obviously if the slowdown that we see will continue, we will see less growth in the service part of it. On the other hand, we are doing, over time, a better and better job in signing customers to service contracts, which is mitigating part of this potential decrease.

And -- or I guess -- not so much the maintenance support piece, and yes, I figured that attaches to hardware. But what about the parts business, is that a business that you would expect to see similar type of weakness going forward? Is that something that could possibly decline down the line?

Going back to my prepared notes, we are -- we indicated in the prepared notes that we did go through I think a quite detailed survey, I think it was two quarters ago, serving customers, quite a lot of customers that have potential to buy parts. And the overall indication that we have is that the requirement and the demand for parts should grow. So I don't think we should see a slowdown in this part of this business. We don't have such indications.

And again, if you go back to the prepared notes, you see that there is an indication that people are saying that despite the fact that they have machines, they understand the value and need for parts. And in specific verticals within the parts markets, people say specifically that they expect, over time, to buy more and to adjust the design processes for future adaptive manufacturing parts production. So we don't have such indications.

Nevertheless, Erez, I think, said earlier, the overall visibility is quite low. But I'm reasonably optimistic about this part of our business.

Got it. And then one -- and then a question for Erez. How should we think about gross margins in Q4? With your guide, it looks like OpEx might be roughly flat, but I guess that largely does depend on whether or not gross margins improve in Q4, like they typically do. Or do you continue to see pressure there?

No. I think that you should assume same level of gross margin in Q4 as we saw in Q3. No significant change.

Okay. Got it. Thanks a lot, guys.

Thanks, Ken.

Wamsi Mohan, Bank of America.

Hi. Yes. Thank you. You said the near term is challenging. Is it reasonable to think of any organic growth in 2016? And directionally, if you have growth, then will you still adjust the OpEx downward or do you think that you will redouble on investment? And can you talk about the seasonality heading into Q1 as well? And I will follow up.

I think that maybe I'll take the first part of it. First of all, I will state very clearly, and we said it a few times the last few months, the visibility is low. I think we'll be able to give indication about 2016 later in the year and after we've finish the planning. At this point of time it's very difficult to predict. Visibility is low, but I think that as we are progressing into Q4 and as we are getting closer to next year, I hope visibility will improve and we'll be able to give a better indication.

Erez, you want to add something here?

I think that the part that we control looking forward is the cost structure, or control almost completely the cost structure. And we intend to deal with the cost structure now regardless of the revenue growth or not growth that will happen next year. Again, we do see that it is a challenging market environment, very low visibility and predictability. And we intend to adjust the cost structure.

Okay. Thanks, Erez; thanks, David. Also, just as my follow-up, can you talk about if your R&D priorities are changing here based on what you've found around your survey? Is there going to be a slightly different focus around the different product lines or where your R&D investments are going to go? Thank you.

Again, obviously and unfortunately I cannot go into a detailed R&D plan. We are using this quarter-on-quarter opportunity to re-examine a lot of our activities. In general, I can say that the -- our initial and previous roadmap I think is valid today, as it was before.

Nevertheless, in part of the planning to 2016 and even further years, obviously we're going to re-examine it. I don't expect to see big changes. I think we are doing the right things. We're spending in new products, exciting new technologies. I don't see a dramatic change there. Nevertheless, again, the situation is bringing us to refocus, to look carefully on every expense and every investment, and this we are doing.

Thank you.

Thanks, Wamsi.

Jason North, Jefferies.

Hi. Looking at the survey and the internal analysis you did, did the results indicate what prototyping year-over-year growth could return to once the excess capacity is worked through?

Can you repeat the question? Sorry.

Looking at your survey and the internal analysis, did the results indicate what the prototyping year-over-year growth could return to once you work through this excess inventory that you're currently seeing the low visibility?

No. We don't have -- the survey did not look for this number and we -- I don't have a clear indication today because of the low visibility. What was very clear in the survey, and I want to emphasize this, is we found a lot of very interesting data. Obviously we're just giving one data point that the penetration is low. We also found out that -- in places that rapid prototyping is used, it's become a dominant technology in the rapid prototyping processes of the organizations. We were happy with those results because we see that the potential is still very, very big.

And therefore, by the way, from our internal planning, we -- our intention is to continue to be or to lead this market while extending our penetration into manufacturing. So we were very happy to see the results of this research, because the low visibility and slowdown of the market might make some people worried about issues like saturation or stuff like this. And this survey, also done internally and not to huge scale, give us a reasonably good indication that the market has a very low -- relatively low penetration, relatively low penetration. 23% I think is the number we mentioned, and it still means that we have a long way to go.

Okay. And a follow-up here on the services gross margin, saying that's going to be relatively flat because it's down this quarter despite revenues being up sequentially. And it seems like part of that was due to higher inventory reserves, but why is that -- it still seems like that's lower than it would be. Surprised it's flat sequentially, so any thoughts there would be helpful.

Jason, it's mainly because of the accounting reserves that we took this quarter as a result of really uncertain things in future demand that we see in front of us.

Then why won't that rebound in Q4 then?

It's is one time. It's a one-time reserve. Jason?

Yes. Thank you very much.

Thanks, Jason.

Sherri Scribner, Deutsche Bank.

Hi. Thank you. I had a bigger-picture question. Considering the weak environment that we're seeing, have you guys in the past ever seen an environment that has been this weak, considering you guys have been doing this for a while? I'm just trying to understand if there's a precedent for this and how long it typically takes.

And then as a follow-up to that, thinking about this glut of inventory that we have or glut of machines that we have that's taken basically two years to build up, does that suggest that it's going to take two years for us to work down the amount of machines that the industry has?

Sure. It's David. For your first question, I think the only time I recall a significant drop in hardware sales was I think in Q1, Q2 2009. I don't recall the exact numbers, but the drop in hardware was very, very significant. But the recovery was relatively fast. I think it recovered within a few quarters. This is the only time I recall something like this probably in the last 10 years, both for Stratasys and for Objet.

The question about the recovery time, again, the visibility is very long. I really can't comment on it. Like we said many times, if you look on the fundamental of the markets, the overall interest in 3D printing, the new applications that we are developing, the new products that we are bringing to market, the low penetration in rapid prototyping is indication that it will recover in one point of time. But to ask me to give you a date, it's very difficult in this point of time.

Thank you.

Thanks, Sherri.

Thanks, Sherri.

Shannon Cross, Cross Research Group.

Thank you very much. Can you just talk a bit about, on the OpEx side, how you're -- where you're finding some of these cost reductions? Because you're in an expansion period from the standpoint of building your back office and obviously the branding campaign and that. So I'm just trying to think of where you might be cutting within the core business and how you're finding some of these cost reductions and how you're incenting some of your employees to try to come up with improvements.

So it's a long process that we are going through. And actually the high-level rationale behind it is we are keeping the long-term strategic investment and compart of the Company in place. And as a result of lower revenue than we expected, and the 2015 year-to-date results are speaking for themselves, we are adjusting first what is related to revenue generating. And it's around marketing and leads and all this kind of activity that was supposed to generate higher level of revenue. And today, they are not in line with the level of revenue that we see in front of us.

We are dealing with, I would say, back-office productivity and efficiency and trying to look for synergies in the back office in the different regions, in the same regions as we, in the last two to three years, grew dramatically in terms of those infrastructures. We are looking on operations and on production and production efficiency, on sourcing and outsourcing and purchasing and suppliers. And I would say that the entire process is mainly looking into the Company area that can be -- can regenerate significant cost efficiency in the short and long -- short and medium term for the Company.

But again, the high-level rationale behind it is to adjust the cost structure to a different revenue outlook that we see in front of us while keeping the long-term investment and the investment in R&D and review in IT infrastructure in place to allow us to get stronger and more efficient from this period when it happened.

Thank you. And then I just had a second question on cash flow and capital allocation. Clearly your cash flow's under pressure, but how should we think about how you're contemplating capital allocation? And then I was just curious. You repaid your revolver during the quarter. Was that just related to timing of cash flow or what led to that? Thank you.

No. We paid the revolver for two main reasons. A, we don't need the cash, that -- and we are looking at cost items in the Company, this has cost, we did -- we choose to give up for now. And again, once we discuss 2016 and 2016 overview, we will be able to discuss also cash flow and free cash flow for 2016. And again, among other things, we have to be very tight on capital, so in order to improve free cash flow in 2016.

Thank you.

Thanks, Shannon.

Ben Hearnsberger, Stephens.

Hey. Thanks for taking my question. I wanted to get your comment on a couple of statements in the press release. You mentioned prototyping business is mature but also underpenetrated. I guess can you help us reconcile these statements? And then I guess the real question is do you consider prototyping a growth business going forward?

So I will start from the -- from your last question. Yes. We consider prototyping to be a future growth engine to this Company, in parallel of us extending into manufacturing, which is a totally different arena with different requirements. So yes, we believe that there's a long way to go in rapid prototyping.

The word relatively low penetration, and we are indicating 22%, 23%. With the word mature, it has to do with I think market -- understanding market knowledge of the technology and the availability of different technologies, availability of product. So the mature is relating to this, and the low penetration is relating to our survey.

Okay. And then I had a question on GrabCAD. Is it generating revenue now? And if not, can you give us a sense for the potential business model for GrabCAD?

Again, GrabCAD -- again, I don't want to go into GrabCAD's financials at this point of time. But GrabCAD was purchased as a very important pillar in our strategy going forward. We believe that GrabCAD has the tools to help us even faster convert ourselves into a company which provides solutions to our customers, not just products, which I think is going to be fundamental for the -- for our future and the future of the industry.

And like I think it's saying in the [pre-read] paper, GrabCAD products and the strategies will come to market in the, I would say, medium term. And then we'll be able to talk about it more openly. But it's -- GrabCAD is a substantial pillar in our future go to market and the way we see our position within the market and our effort to convert our self from being a product -- great product and hardware consumable provider to total solution provider, which I think is very required by our customers, both, by the way, in rapid prototyping and, more importantly, in manufacturing.

Okay. Thank you.

Ananda Baruah, Brean Capital.

Good morning, guys. Thanks for taking the question. Just one from me and then a quick follow-up. Based on -- based -- guys, based on the reported metrics, your organic growth, it seems, at least at a higher level, to suggest that potentially the softness -- the soft dynamics could be becoming more pronounced as we move through the year. And I just wanted to get your thoughts on that. Would you agree with that? And then any context you could put around how you guys view the softness and the dynamic manifesting would be helpful. And then I have a follow-up. Thanks.

Hey, Ananda, it's Erez. I think that it's really, really difficult to discuss a trend looking forward as visibility is extremely low. If you judge upon the performance of the last two quarters, I suggest that what you say makes sense. But again, I think, A, it's too early, B, low visibility, no predictability. I wouldn't hurry and jump into such conclusion now.

I want to -- I just want to add something to what Erez said. We are talking about -- a lot about market condition. And there's doubt -- and I think -- I hope everybody on the line agrees that we do see a serious slowdown and we try, to the best of our knowledge, to explain it.

I want to emphasize the fact that we in Stratasys, myself and all the management team it includes, we are not sitting in -- we are not laying back on our chairs and waiting until the market is recovered. Even with this -- those conditions I think we can do a lot, with the difficulties, to improve our situation. And we mentioned a lot of activities that we are doing. Now, not all of them are going to give fruit in two days or one quarter, but if you go and read what we said earlier, we're doing a lot of things that, within this tough market condition, we believe are going to improve our situation.

Now, obviously if market condition will improve we're going to be in even a better position, even a great position. But we are not counting and saying -- life is tough and we are just waiting. We are doing a lot and we're going to do even more, and very aggressively, in the coming months, regardless of the low visibility.

So if you're asking if it's going to get worse, it's very difficult to say. Like Erez said, the visibility is low. We are trying to do a lot of things internally within this environment, which is tough, to bring us to a better situation, both on the revenue side and, as Erez discussed, the OpEx and cost side. So just rest assured that we are not waiting for the market to improve and we are actually extremely active. We're going to become even more active in the coming weeks and months to make sure that we do the best within those conditions.

David, appreciate the incremental context. And we look forward to seeing how those things impact the Company as we move through 2016. Just a quick follow-up from me. Based on my model -- this is really more of a clarification -- it would seem to suggest that the implied December Q revenue guide implies flattish organic growth. I just wanted to check that with you guys. Is that accurate? And that's it. Thanks.

Ananda, I can come back to you offline. I don't have the number on hand here.

Okay. Great. I'll follow up with you guys. Thanks a lot.

Rob Stone, Cowen and Company.

Good morning, gentlemen. I wanted to ask about facilities. You mentioned consolidating some space for MakerBot. I wonder if you could comment on where you see your facilities and fixed assets and utilization for the rest of the Company in terms of where you have space, where you might need space, things like that.

Yes. So our facility for the entire Company without MakerBot serve us in two places. The first one is an ongoing business serving the corporate unit and go-to-market unit. And in those places I don't think that we have excess of capacity of excess of space that we have to deal with. It might be excess, but not a significant one.

The second part of our facility is for production purposes, and also there, there is no significant excess of capacity. And actually we are dealing with optimizing and manufacturing based on geographical location and some tax leverage that we can do moving production around the world, and moving more and more to outsourcing of some of the components, so key components of the Company, in order to allow us to deal better with the fluctuation in the business and to move faster to a variable or better variable versus fixed cost in manufacturing.

Great. And my follow-up question is on capital expenditures. I know you're still working on the plan for next year. Could you say what you expect for CapEx in Q4? And is there some minimum amount in 2016, for instance things to which you're already committed that might represent, say, a floor for CapEx next year? Thanks.

So I think that CapEx in Q4 will be $20m to $30m. And we have some obligation for 2016, which is around building in Israel. And again, this depends on the time we move forward. I'm not sure it will take place, everything, in 2016. It might be that partially it will be 2017. Or we do it in low scale. And we will refer to the numbers once we discuss 2016.

All right. Thanks for taking my question.

Brian Drab, William Blair.

Hi. Just still sorting through the model here and I want to see if you can help me with this. So with the 4Q guide, mid-point of the revenue guide is around $170m, and the mid-point of the EPS guide, around negative $0.10. Is that the sort of run rate and EPS that we would expect going forward on that level of revenue, given that it sounds like there is a one-time item in the third quarter and there is not a one-time item in the fourth quarter?

Again, I go back to what we discussed previously in the call. We are now dealing with adjusting the cost structure. I don't think that the EPS in Q4 represents any run rate that you can assume looking forward. There will be actually very low impact on 2015 from all the activity that we are taking now, but those will impact 2016. And again, once we discuss 2016 and we finalize the plan and discuss 2016, we'll discuss in detail what did we do and what will be the EPS run rate for 2016.

Yes. I didn't ask the question exactly how I wanted to. What I'm trying to get at is, in the fourth quarter, were there any unusual items that would cause some disconnect between that level of revenue and that level of EPS today? And would you need to cut costs to get that negative $0.10 or so up? And what I'm getting at, because in 2016 it implies that we would need to cut -- it looks like something in the $15m to $20m range or maybe a little more than $20m range just to get to breakeven in terms of EPS if the revenue run rate doesn't move up from there. So were there any one-time items in the fourth quarter or, without cost cutting, is $170m in revenue tied pretty closely to negative $0.10 in EPS?

Yes. So the $170m represents also a specific product mix that generates a specific gross margin, which is I think -- can be different looking forward. But there is no any specific one-time element in the guidance that we provided for Q4. And again, the cost structure, also the cost alignment results are not [developing].

Okay. And then are there new products being introduced at Formnext or is it more the ecosystem that you're showcasing?

It the ecosystem. It's all around the ecosystem.

Okay. Thanks very much.

Yes.

Thank you. I would now like to turn the call over to David Reis for closing remarks.

Thank you for joining today's call. We look forward to speaking with you again next quarter. Goodbye and thank you.

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