Stratasys Ltd (SSYS) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Stratasys' Q2 2016 earnings call conference call. At this time all participants are in a listen-only mode. (Operator Instructions). I will now hand the presentation over to Shane Glenn, Vice President of Investor Relations. Sir, please proceed.

Thank you, Brian. Good morning, everyone and thank you for joining us to discuss our second quarter financial results. On the call with us today are Ilan Levin, 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 at the web address provided in our press release. In addition, a replay 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 made on the call, regarding Stratasys' strategy, and the statements regarding its future financial performance, including the financial guidance concerning the expected results for 2016 are forward-looking statements reflecting Management's current expectations and beliefs. These forward-looking statements are based on current information that is, by its nature, subject to rapid and even abrupt change. Due to the risks and uncertainties associated with Stratasys' business, actual results could differ materially from those projected or implied by these forward-looking statements.

These risks and uncertainties include, but are not limited to, any failure to efficiently and successfully integrate the operations of Stratasys, Inc. and (inaudible) Limited after their merger as well as MakerBot, Solid Concepts, Harvest, and GrabCAD; after their acquisition or to successfully establish and execute effective post-acquisition integration plans; changes in the overall global economic environment, the impact of competition in new technology, changes in the general market, political and economic conditions in the countries in which we operate; any estimates in capital expenditures and liquidity, changes in our strategy, changes in the applicable government relations and approvals, changes in customers' budgeting priorities; lower than expected demand for products and services; reduction in our profitability due to due to shifts in product mix into lower margin products and shifting in the revenue mix towards the added manufacturing service business; cost and potential liability relating to litigation and regulatory proceedings; and those factors referred to in Item 3.D Key Information Risk Factor, Item 4, Information on the Company and Item 5, Operating and Financial Review and Prospects in our 2015 annual report as well as in the 2015 annual report generally.

Readers are urged to carefully review and consider the various disclosures made throughout form 6K. that attaches to Stratasys' un-audited, condensed financial statements as of, and for the quarter and six months ending June 30, 2016 and its review of results for operations and financial conditions for the period which have been furnished to the SEC on or about the date hereof. Stratasys' 2015 annual report and in Stratasys' other reports filed with or furnished to the SEC, which are designed to advise interested parties of the risk factors that may affect our business, financial conditions, results of operations, and prospects.

Any guidance provided and any other forward-looking statements on this call are made of the day hereof and Stratasys undertakes no obligation to publicly update or revise any forward-looking statement, 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 GAAP and non-GAAP financial measures. The non-GAAP financial measures should be read in combination with our GAAP metrics to evaluate the performance. Certain non-GAAP to GAAP reconciliations are provided in the table contained in the slide presentation in today's press release. Now I would like to turn the call over to our CEO, Ilan Levin. Ilan?

Thank you, Shane. Good morning, and thank you for joining today's call. Having assumed the role of CEO on July 1, I would like to take a moment to thank our outgoing CEO David Rice for his contribution and leadership. David's tenure of CEO was defined by a year of significant growth for our Company, including the transformation of Stratasys into the industry's leading 3-D printing and additive manufacturing company. David will continue as member of the Board, and as an Executive Director.

I am excited and optimistic to continue that mission of growth and leadership. I believe our industry is maturing and evolving beyond general purpose 3-D printing for design applications. It is being transformed by the growing access to more affordable office and desktop printers and by the greater need for enhanced value for specific additive manufacturing applications within certain vertical industries. I believe SDM and PolyJet are mature, well qualified technologies with significant runway ahead for future growth.

We have targeted specific high-value industries such as Aerospace, Automotive, and Medical; which will rely on these technologies to enhance their businesses. We have a large install base target market and beyond that will form the basis for future collaboration and innovation to deliver value around additive manufacturing applications. These assets provide me with the confidence that we will continue to capitalize on the potential of additive manufacturing moving forward.

Looking at the second quarter, we were pleased to make additional progress in improving our financial performance in the quarter, driven by our successful efforts to control costs and improve operational efficiency. These initiatives help drive improvements in our margins and substantial increase in profitability compared to the first quarter. In addition, our margins benefited from strong sales of our higher-end systems, including our new J750, full-color, multi-material 3-D printer that removes technology barriers by enabling customers to achieve one-stop realism without post-processing.

We announced the launch of our new GrabCAD surface, GrabCAD Print, during the second quarter. The GrabCAD print services is an overall 3-D printing solution that provides the ability to share, organize, print, and analyze 3-D models. GrabCAD Print is currently available in free public BETA in North America. I will return later in the call to provide you more details on important initiatives and other key developments, 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, Ilan, good morning, everyone. We have made significant progress in improving our performance and are pleased with the pace of planned reductions in operating expenses. As a result, both our gross margin and operating margins saw improvement in the period and we enjoyed positive cash flow. Total revenue in the second quarter decreased by 6% to $172.1 million when compared to $182.3 million for the same period last year.

We continue to see weak market demand and longer sale cycles, resulting in slow hardware sales across all regions and business units. (Inaudible) with product and service revenue was essentially flat, declining 2% in the second quarter over last year, but increased sequentially by 8%, driven by the positive impact of ongoing reorganization of the business and the trends towards des top systems for modeling operations. GAAP operating loss for the second quarter was $17.1 million.

Non-GAAP operating income improved both year over year and sequentially to $10.2 million compared to $3.7 million for the same period last year, and $4 million in the first quarter of 2016. GAAP net loss for the second quarter was $18.5 million, a $0.36 per diluted share. Non-GAAP net income for the second quarter was $6.2 million or $0.12 a diluted share, compared to non-GAAP net income of $8 million or $0.15 a diluted share, deposit for the same period last year. Non-GAAP income a tax expense of $5.1 million, a tax rate of 45.4%, which is from the noncash valuation allowance from assets related to our US subsidiaries.

It should be noted that the deferred tax assets have expiry dates many years into the future, and we do anticipate being able to recognize their value to offset prospective tax liabilities. Product revenue in the second quarter decreased by 8% to $123.8 million as compared to the same period last year. Within product revenue, system revenue declined by 19% over the same period last year we discussed previously, driven primarily by the ongoing market weakness we discussed previously. We were pleased to see system utilization remains strong.

Consumable revenue for the quarter increased 11% compared to the same period last year, an improvement in year-over-year consumable revenue growth for the second straight quarter compared to the flat growth we observed in the second half of 2015. What also impacted by the overall market slowdown, consumable revenue growth is more a function of our install base and represented the revenue stream that is less affected by the decline in systems serves within any given quarter. Stratasys' revenue in the second quarter increased by 1% to $48.3 million as compared to the same period last year. Within service revenue, customer support revenue in the quarter, including the revenue generated by maintenance contract on our systems, increased by 11% compared to the same period last year, driven primarily by growth in our install base of systems. We are pleased by the growth and the revenue generated by our install base systems.

GAAP gross margins improved to 46.2% for the second quarter compared to 45.5% for the second quarter, compared to 45.5% same period last year. Non-GAAP improved slightly to 55.9% for the second quarter compared to 54.7% for the same period last year. Product gross margin improved driven by the sales mix that favors higher margin systems as well as aggressive cost control efforts in operations that reduced the level of production in efficiencies that we experienced in prior quarters. Service gross margin also improved compared to the same period last year helped by the cost control efforts. We again realize significant reduction in our operating expenses and have proven in operating (inaudible) during the second quarter.

GAAP operating expenses declined by 17% to $96.7 million for the second quarter, as compared to the same period last year. Non-GAAP operating expenses declined by 10% to $86 million for the second quarter, as compared to the second period last year. In addition, non-GAAP operating expenses in the quarter declined by 3% sequentially when compared to the first quarter of 2016. These favorable trends over the last two quarters reflect a positive impact of our operational initiative, and an overall focus on improving our operational efficiencies and reducing our direct and indirect spending.

SG&A expenses declined significantly over the same period last year, reflecting the cost reductions, lower (inaudible) expenses related to the Company-wide roll out; as well as the impact of (inaudible) sales commission. We should know that the planned post reductions do not impact our long-term initiatives, and in some instances we have actually increased investments in areas as we view as strategically important for long-term growth. The following slides provide you with the breakdown of our geographic sales for the quarter, which reflects the broad-base (inaudible) we outlined previously.

Our original results are consistent with the trends we have observed in recent quarters. GAAP EBITDA for the second quarter amounted to $6.9 million. Non-GAAP EBITDA for the second quarter amounted for $90.5 million compared to $12.6 million in Q1 2016 and $12.1 million for the same period last year. The Company generated $6.9 million in cash operations in the second quarter and currently holds approximately $253.9 million in cash and cash equivalent.

At the end of the second quarter increased slightly to $125.7 million as compared to $124.5 million at the end of the first quarter. We continue to focus aggressively on managing (inaudible) levels. Accounts receivable increased slightly to $113.3 million, compared to $109.1 million at the end of first quarter. DSO, on 12-months trailing revenue increased slightly to $61 million compared to $58 million in previous quarter.

In summary, we are pleased with our improved operational performance and positive cash flow driven by the progress we have made in controlling expenses and improving operations. We are pleased with the positive trend in both operating and gross margins supported by our operating initiative as well as favorable (inaudible) mix. Going forward, we remain focused on managing expenses and driving operational improvement.

Finally, we believe we maintain a strong balance sheet with sufficient capital to invest for the future and capitalize on emerging opportunities. I would like now to turn the call over to our VP of Investor Relations, Shane Glenn, who will provide you with greater details on our 2016 financial guidance. Shane?

Thank you, Erez. Our guidance for 2016 remains as follows; total revenue in the range of $700 million to $730 million, with non-GAAP net income in the range of $9 million to $23 million or $0.17 to $0.43 per diluted share. GAAP net loss is $84 million to $67 million or $1.60 to $1.28 per basic share. Non-GAAP earnings guidance excludes $59 million of projected amortization of intangible assets, $25 million to $27 million of share-based compensation expenses, $7 million in merger and acquisition-related expenses, $4 million to $5 million in re-orgainzation and other related costs, and includes $5 million in tax expenses related to non-GAAP adjustments.

Additionally, we are providing the following estimates regarding the potential performance and strategic plan for 2016. Based on revenue trends in the first half of the year, we believe that we will end 2016 at the low-end of our revenue guidance; with gross margins in the range of 54% to 55%, operating margins of 3% to 5%, tax expense of $15 million to $17 million, which includes the negative impact of the (inaudible) county treatments for tax valuation allowance, and capital expenditures projected at $60 million to $70 million, with approximately $45 million designated for completing the new facility in Israel.

As previously discussed, our relatively high estimated non-GAAP tax rate for 2016 is a function of the ongoing noncash valuation allowance and deferred tax assets we expect to record throughout the year. As Erez mentioned, those deferred tax assets have expiration dates many years in the future and we do anticipate being able to ultimately recognize their value to offset prospective tax liability. The Company believes it could achieve significant improvement in its operating structure in 2016. which could translate into improving operating profit compared to the prior year.

Given the expected ongoing negative impact of not recording a tax benefit on US tax losses on our net income loss, the Company believes that non-GAAP operating is the best measure of performance in 2016. Appropriate reconciliations between GAAP and non-GAAP are provided at a table in the end of the press release and slide presentation, with itemized details of the non-GAAP financial measures. Now I would like to turn the call back over to our CEO, Ilan. Ilan?

Thank you, Shane. We were pleased with the improvement of our financial performance during the period and we remain on track to meet our goals for improved financial performance for the year. As our industry matures and expands beyond traditional design and engineering applications, we expect the development of advanced solutions that target specific customer applications with enhanced value will drive an exciting new phase of growth for our industry. We are fortunate to have at our disposal a broad set capabilities; ranging from high-end production systems, to entry level 3-D printers, as well as services that include professional consulting and Stratasys direct manufacturing.

For example, we recently announced a professional services and consulting offering that leverages the expertise of both our tradition hardware and materials business as well as the deep manufacturing knowledge from Stratasys' direct manufacturing. The new service assists customers to implement 3-D printing solutions for applications that range from prototyping to production parts, using a technology-agnostic approach. We are focused on bringing value to our customers with a comprehensive ecosystem of solutions and believe our unmatched technological capability and customer reach represent invaluable assets with significant potential for future -- for further development.

The development of the J750, the industry's first and only full-color multi-material 3-D printer and its recent success in the marketplace, demonstrates our ability to bring enhanced value to our customers. The transformative new system enables full-color 3-D color printing, combined with unprecedented material offerings to help users streamline their workflow process and speed product delivery cycles. The J750 enables near instantaneous decision making, by streamlining the way products are designed, evaluated, and brought to market. The system is expected to improve total cost of ownership by eliminating many of the tradition complex processes, time, and resources required to create product matching prototypes in full color.

We successfully launched the J750 earlier this year with early success driven by applications for consumer products, medical devices, service bureaus, and education. For example, Otter Box, the leading smart phone case company in the US, required realistic prototypes and fast new product design iterations. The J750 removed costly and time-consuming post processing from their work flow allowing for a single, full color, and multi-material prototype with a 30-minute print time, to replace what used to be a nearly three-day process.

Otter Box is now completing product development cycles in eight weeks compared to 26 weeks when they adopted the J750.

We view software as a critical component of our overall strategy that supports a integrated infrastructure of hardware, material, and service offerings. Accessibility and ease of use remain significant barriers within our industry, and we believe that our GrabCAD service -- software as a service platform can help customers with tools that lower those barriers and ultimately unlock greater value for 3-D printing.

In May, we announced the public beta of GrabCAD Print. The first product released as part of the strategy. It is a cloud-based printing application with native CAD support that provides the ability to share, organize, analyze, and print 3-D models on supported professional printers. Access to this functionality is readily available online and locally-installed clients and securely managed through the GrabCAD platform. The tool incorporates the universal, open architecture that makes 3-D designed to print workflow that makes 3-D printing significantly easier, more intuitive, and actionable.

We are committed to an open and partner-friendly ecosystem; and industry-leading CAD solution providers, such as PCT, Cisco Systems SolidworksSand Siemens PLN software will be collaborating with Stratasys to further simplify key functions for the CAD to 3-D print work flow. In addition to preparing and printing jobs from their native CAD environment, users will be able to analyze designs for 3-D printability and access Stratasys' other 3-D printing solutions. The overall GrabCAD platform now includes GrabCAD Community, a vibrant community of millions of engineers, designers, and students sharing CAD content, how to tutorials, and participating in publicly-sponsored design challenges; GrabCAD workbench, a software as a surface product for design teams to securely manage and collaborate on product design projects; And GrabCAD Print. Simplified CAD to print work flow to make professional 3-D printing easier and more accessible. With GrabCAD and MakerBot (inaudible) we believe we maintain the large effort community of end users in our industry, providing a unique ability to interact and communicate directly with customers who can recognize value from our solutions.

In summary, we are pleased with our improved financial performance that has resulted from the continuous improvement and impact of ongoing actions to reduce operating expenses. We are also pleased with the initial success of the new J750, as well as interesting GrabCAD Print and our overall software strategy to make 3-D printing significantly more intuitive and highly accessible for our customers.

As our industry matures, our focus will be on our customers' needs, and how Stratasys can provide a clear value proposition by leveraging our core assets and cultivating new capabilities. This approach includes investing aggressively to develop an advanced ecosystem of applications and solutions that bring enhanced value for customers within key vertical markets. And finally, although we are not observing any change in the near-term market environment, we remain committed to these strategic initiatives and we are excited about our Company's future. Operator, please open the call for questions.

Yes, sir. (Operator Instructions). Our first question from the line of Wamsi Mohan with Bank of America Merrill Lynch. Please proceed.

Yes, thank you. Ilan, congratulations on the new role. So given that you have just recently resumed the role of CEO, can you provide us some color on how you view the market opportunity and the direction you would like to see this Company moving forward and any changes you intend to bring to the strategy for the near- and long-term, and I have a follow-up for Erez.

Thank you. As I highlighted in the written statement before, I believe that the 3-D printing additive manufacturing market is transforming and evolving over the years. I think there is two very clear trends. One of which is to more affordable office and desktop printers, and the other trend is toward more enhanced value around specific additive manufacturing applications.

And to that extent, I think we have two very strong core technologies within Stratasys; both SDM and PolyJet are very mature technologies, very well-qualified, and have been certified by many customers and are beginning to be placed in process applications with many of our customers. Which leads me to believe that we have a significant runway with both of those technologies. While we may add further technologies as we go along, we provide other technologies through our Stratasys direct manufacturing business, I believe that SDM and PolyJet are very strong legs that we can rely upon for our future growth.

We have also targeted very specific industries where we believe high-added value applications, with respective to additive manufacturing, are very strong; including Aerospace, Automotive, and Medical. And so with all that, I think that as we move forward we will continue to rely on resources internally as we have in the past. Maybe even with a stronger focus towards those elements I just mentioned, using both of our core technologies as well as augmenting elements in the future; through either parts business as I said, or other technologies that we may bring to market.

Okay. Thanks, thanks Ilan. And Erez, on the trajectory for SG&A there was a big decline in the quarter; how far along are we on implementing the cost-saving initiatives? Your guidance suggests that revenue will be up modestly second half versus first half this year. How should we think about OpEx second half versus first half? Thanks.

Good morning, Wamsi. I must say we are very happy with the progress we are making with the operating expenses and the cost-deduction initiative that we are taking. I think that looks into Q2 and its embedded in the guidance, you should expect slightly higher operating expenses; which particularly represents seasonality in operating expenses between the quarters and increasing operating expenses. We intend to continue and maintain and push operating expenses as much as possible, down, while investing and continuing to invest in the long-term initiatives that we discussed in previous quarters.

Thanks.

Thanks, Wamsi.

Thanks.

Thank you. Our next question comes from Troy Jensen with Piper Jaffray. Please proceed.

Thanks for taking my question and congratulations on a better profitability, gentlemen.

Thanks, Troy.

So maybe first for Erez, here. If I look at the revenue guidance is unchanged, the operating margins guidance is unchanged, but you raised the taxes from I think you said $10 million to $11 million to $15 million to $17 million, but you did not lower your EPS guidance. Can you just explain kind of the dynamics that allow you to keep EPS unchanged here?

Good morning, Troy. What we tried to communicate in the guidance is we are guiding you towards the lower end of our revenue guidance. So within range, we think we will end the year at the lower range of our revenue guidance.

However, having said that, I think its operating margins will be better, not on the low-end of the range, resulted with the higher taxable income and provision for taxes. And we still believe that we would meet the range of EPS. It is kind of a mixed trend; revenue will be on the lower end.

The operating margins will be in the range but not on the low range of the guidance. This will result in higher taxable income and tax expenses. And we maintain the range of EPS as we provided.

All right. Understood. Maybe one for Ilan here, and congratulations on the new role. We talked to a lot of your channel partners and there is a lot of interest in the retailer base in the HP product. Several of them are contemplating partnering with HP; so I would just love to get an update if you have exclusivity with most of your big-channel partners, how can you kind of prevent them from bringing on the HP product line?

Troy, hi, I will take it, yes. For the channels itself, we do have exclusivity globally so work with (inaudible). In their agreement, they have the option to work with the processes only around 3-D printing. We do not see yet significant impact of HP activity in the market. I would not say it is no noise at all, but we would not say significant activity of HP in the market.

We do have channels that are working with us for 20 years, and went with us a long way. I think that our profit offering around SDM, or PolyJet is attractive, or very attractive to the channels compared to the other alternatives in markets today. And structurally (inaudible) today we did not see any channels giving us. Ilan?

I would just add, Troy. Hi. Thanks, and good morning. Just to add to Erez. I think what we are offering are mature-valuated, very well-articulated technologies with a clear value proposition that are well-known to the market in general and to our resellers. So, despite any competition that might be entering into the market, I think we are very well-positioned.

All right, understood. Good luck in the second half gentlemen.

Thanks Troy.

Thank you.

Thank you. Our next question from the line of Jim [Ratucci] with (inaudible). Please proceed.

Hi thank you. Good morning. A question on the SDM business, what was the decline on the business in the quarter?

Jim, good morning it is Erez. We did not provide any specific information around SDM. What I can say is that it is according to our plan. We are satisfied with the result. It is, a business in the 3-D printing market. So they see the same phenomena that we see in the other businesses, in the other business, which is in slightly weak demand. In any case, it is not unusual or a surprise for us. And they are running according to our plan.

Okay. And looking at --

I would --

Yes, go ahead.

I would just add to that. It is Ilan. I would just add to that that we believe that it is a very strategic asset for us, in the context of moving towards higher-added value applications, relationships with key customer accounts, we view the SDM business as very complimentary to what we are trying to do going forward.

Okay. Thanks. One other question. Just as it relates to full-year guidance. Even at the low-end of the revenue range for the full year, you are still looking for some nice sequential improvement in the back half of the year. Is that going to be weighted, do you think, more towards Q4 just given the normal seasonality; and I am wondering what is giving you even that confidence, given the market environment?

Jim, this is Shane. Good morning. We would expect to see the same type of seasonality trends we have seen in the past. As you know, Q3 is typically a weaker quarter for us based on some of the seasonal trends, especially in Europe. Some of the capital equipment purchasing trends typically will drive a very strong fourth quarter. I think it is safe to say we would expect to see similar types of trend this is year.

Okay. Thank you.

Thanks, Jim.

Thank you. Our next question comes from the line of Kenneth Wong with Citi. Please proceed.

Hey, guys. I think one area where it did look like things improved was in the MakerBot business. Would you say that this is an area that has stabilized? Should we see this kind of sequential growth going forward?

I can hardly hear you. And I will try to repeat the question; you asked about MakerBot (inaudible) this business has stabilized, correct?

Correct. And should we --

The answer is absolutely, yes. I think that we went through a very significant reorganization and restructuring in the MakerBot business and we started to see the results. Also, on the financial side of MakerBot (inaudible) we saw a nice, sequential growth in revenue this quarter, and we think that MakerBot position and brand will help us to play in the market of desktop printers in the future.

Got you. And then for Ilan, I am not sure if you had a chance to really think through what the longer-term profit levels could be for this business, but, I guess when you guys return to a normal state, is 20% EBIT margin achievable, something below that, any thoughts from your side?

So I will take it. I think that, again, the long-term model, we did not yet release a long-term model. And we will do it once we feel comfortable both with the market trend and market behavior and advisability that we have. And it is too early to talk now about the longer-term business model; the market is changing, visibility is relatively low for a period of two to three years, and we prefer to wait a little bit more before we release our long-term guidance.

That is fair. Thank you, Erez.

Thank you.

Thank you. Our next question comes from Sherri Scribner with Deutsche Bank. Please proceed.

Hi, thank you. I was hoping to get a little more detail on the decline in the system of sales down about 19% year-over-year. Can you provide us with detail on mix and how much of the year-over-year decline is attributable to the MakerBot business?

Yes, Sherri, good morning. It is Erez. I think that, the year-over-year decline in units; although we did not provide too much color, is coming from the low-end market. So the small unit. We actually saw a very clear shift this quarter towards high-end product, mainly around the J750, which resulted in a very nice gross margin and operating results. But once you count the units you do not see it.

Okay. Thinking about the GrabCAD business. Does that sit in your services segment? So, would we see that in services margins and how should we think about margins for that business? Thanks.

The output today, the cost center; it is a part of the R&D expenses.

Okay. Thanks.

Thank you. Our next question comes from Paul Coster with JPMorgan. Please proceed.

Thanks for taking my questions, I have got two, actually. The first one relates to materials, and obviously you have seen gross there off (inaudible) base; but to what extent is it volume driven versus mix versus pricing? And then the second question just goes back to the price strategy of having these vertical teams that would develop the application specific to the needs of customers and industries. Are you retaining that strategy? Is the timeline to delivering still sort of 18 months, generally, on one of those projects, and how you are sort of managing the risks there? Thank you.

Hi, Paul, good morning, this is Erez. I will take the first one. Ilan will talk the second one. Material growth of 11% this quarter is mostly not autofeatures increase in incremental install base, and not the result of changes in prices. It is actual growth, both in units and in dollar that had impact and created an 11% growth in the quarter.

Hi, Paul. It is Ilan. So with respect to the vertical industries that we have identified; specifically we can mention Aerospace, Automotive, and Medical. We are already providing solutions specific to those industries and applications already. Many times, these applications that we are already providing or that we will provide in the future are made up of different parts of what we own internally. Whether it is the hardware elements, materials, part of our service business. So it is a lot of mix and matching within that, and perhaps adding some additional layer of technology or business layer around that.

As we go forward we will continue to do that. We believe it is a big opportunity for us. We will be doing it, I think, with greater collaboration and partnership with several select customers from each of those industries. I think you have seen some of the press releases over the perhaps 12 months, and I think you will continue seeing that going forward as well.

All right. Thank you.

Thanks, Paul.

Thank you. Our next question comes from the line of Anada Baruah with Brean Capital. Please proceed.

Hey, thanks guys. Good morning. Ilan, congratulations on the new appointment, and good morning Erez, Shane, and Cody. Two for me if I could. I guess the first, going back to the rev guide. It is just more context, basically, if you guys could. Shane, if you do normal seasonality of the last couple few years, what my model shows is that you actually would not achieve even the low-end of the guide. You need a flat in September, like a mid-teens sequential in December putting you below the 700, because you have kind of done mid-single to high single digits the last two years in December. And so what occurs to me is number one is that mix is helping you. Maybe it pushes it up some in the second half this year relative to the last couple years. But it still seems that you need to at least want some sequential growth in the second quarter as well, in June, to put yourselves in a solid position to do that low-end of the guide. So I would love to get more context around that, and even consider the normal seasonality, and then I have a follow-up. Thanks a lot.

Good morning. It is Shane. We do not want to get down into providing specific guidance around Q3 and Q4 although I do understand your question. I think if you look at the guidance we provided, we are still within the margin of error of the numbers that we provided with also the addition of the comments we said around revenue being at the low-end of the range and to Erez's comments about improvements in the operating expenses and the successes that we have had there; which are essentially offsetting what we are seeing on the tax side. Beyond that, I do not want to go into any additional details. I think that if you run the numbers, we are, -- you would still find we are in the margin of error, still within those ranges.

Okay. Okay. I mean as long as you guys are comfortable with it. Okay. And then the follow-up for me, Ilan, I would love some context around the language that you used around aggressive investment with regards to some of the key strategic areas. I do not want to read too much into it, but clearly there is stuff that you see that you want to have energy behind, so I would love to hear about what some of those areas are. In the extent that you can talk about being able to fund those from some of these cost savings relative to having to put like new investment dollars behind that. That be would great. Thanks.

A lot of it is reallocation of resourcers internally. As we go back to the internal markets that we have identified, not that we are exclusively focused on those, but if we took that as an example. We have begun to identify together with key customers areas where the technology can be applied in an in-process application.

We then pulled in sometimes jointly funded, but certainly putting our heads together around how to get to the application and bring those to market. That is a lot of those kinds of investments. We have already started much of those investments and I anticipate that we will continue to make those investments, usually in response to specific applications that customers are putting in front of us, after having see our technology and how it can help them.

Got it. That is very helpful. Thanks a lot guys.

Thank you.

Our next question comes from the line of Patrick Newton with Stifel. Please proceed.

Good morning. Ilan, congratulations on the new position and good morning, Erez. I wanted to jump into the gross margin guide. I asked a similar question last quarter, but we have had two consecutive quarters above the high end the full end of full year guidance range. Can you walk us through what needs to happen in order to get back into the 44% to 45% range for the full year. Help us to understand, new products, mixed tailwinds and ongoing benefits from operation improvements, and profit efficiencies; why gross margins would be stepping down in the back half.

Yes, hey, good morning. It is Erez. To your comments. The first half was unusual in terms of product mix as well as impacted significantly by introduction of J750 that carried very high gross margin. I am not sure that this product mix looking forward will stay the same. I am sure it will not.

The second reason, is there are some outsourcing of activities in a specific part of the Company that the cost impact of it will have an impact on gross margin in Q3 and Q4. We do not see it in H1 but we see it in H2. We kept the gross margin as guided in knowing that H2 would probably be lower than H1.

Great. Thank you. And then for Ilan or Erez, you spend quite a bit of time discussing GrabCAD, and if we look at GrabCAD communication work bench and print, can you help us understand how the products will be monetized and walk through your go-to market strategy, and given that you already commented, this is a cost center, how should we think about timing to GrabCAD contributing to the PNL?

I think GrabCAD and the offering to customers goes way beyond a specific profit center or revenue line for Stratasys. It is part of the whole entire ecosystem we are providing. We think that software in genera, GrabCAD specifically, can enhance the user experience when combined with hardware materials, service offering, and anything else we can offer.

I see it more as a strategic play that is the glue between everything that we provide, and enhancing a customer experience. How and at what timing that we may monetize specific elements of our offering are less integral than to what the GrabCAD is all about.

Great. Thanks for taking my questions. Good luck.

Thank you.

Thanks Patrick.

Thank you. Our next question comes from the line of Shannon Cross with Cross Research. Please proceed.

Thank you very much for taking my question. I am curious about the trends you saw last quarter versus what you saw this quarter. Clearly, the J750 drove upside in terms of the mix, but are you still seeing and hearing from people about more of an indication of moving to the lower end in the midrange, or is that something that is sort of a one quarter phenomena; and then also can you give an idea of the backlog of demand you see for the J750?

Yes, hi, good morning. I will start with the latter part of the question. I can say that the introduction was a very successful introduction of the J750 in the market. Well-perceived by the customers with the bookings that were greater than our planned expectation. However, I do not think it presents kind of a trend that will continue for long-term, looking forward.

It is typical for introduction of new product to see such a reaction of the market. And practically if you look at the customer behavior today, we do not see a different trend if you ignore the J750, in the behavior today, behavior train. Still a longer cycle. There is still ongoing effort for the next sell. Again, I do not think that the market has changed at all, compared to previous quarters.

Okay. Thank you. And Ilan --

I hope I answered --

Yes, you did, thank you. Ilan, can you talk a bit about what you are seeing in the pipeline? You are doing the event in August, in terms of announcing something, and I am just kind of curious as to your thoughts on sort of how technology will progress within this industry and you know what kind of, I do not know, surprises or holes you see within what Stratasys has planned for the next couple of yeas; within the scope of what can you talk about publicly at this point. Thanks.

So as I mentioned earlier in the call, there are several trends that are happening with respected to added manufacturing market and its maturing nature. One of those trends is building, using technology, and building around specific high-value added applications. And I think key industries that we have identified play a very central role in that.

I think you will see going forward is a lot of technologies, and perhaps even full solutions, that are wrapped around technology in general that we have. I think SDM and and PolyJet are great starting points in that respect, and customers are enthused of how we can take the technologies and move them beyond the specific printers we are doing today and perhaps thinking in a much different way, broader way, of adding elements into the materials in a broader sense. Just sort of opening our minds over what we can do around SDM and PolyJet, to get full solutions that can either be used for manufacturing tools or for end-use parts specifically in the industries that we have identified.

That is what excites me. I think there is a lot of opportunity moving forward. Which leads me to believe that we have a very long runway with our base technologies as they stand today.

Thank you.

Thank you. Our next question comes from Rob Stone with Cowen and Company. Please proceed.

Hi guys, thanks for taking my questions. The first one is on the tax rate. I know you are not in a position yet to provide guidance for next year, but assuming hypothetically that business trends continue with sort of flattish revenue and some improvement in the operating expenses. If you have ongoing GAAP losses, would you expect to see the same kind of trend in the non-GAAP taxes in 2017?

Yes, hi, good morning. It is Erez. Yes, absolutely. I do not think you would see a change looking forward for the next few quarters. And the impact of tax expenses on the P&L. We explained it in the past. It is coming from the situations, the specific area, and actually in the US. Cumulative losses that we cannot recognize tax benefit accounting-wise, and we have to meet certain criteria in order to come back and recognize those tax benefits. And looking forward, I think that in the next three to four quarters I do not think we will be able to recognize it.

Okay. That is very helpful. And then with respect to the guidance, can you comment at all on what you are assuming for weighted average shares?

About what? Sorry?

You have a range of non-GAAP EPS guidance for the year. I am wondering what you are assuming for the share count.

Okay. We assume almost no change in the share count, and we will send you later on the number of shares that we calculated.

Great. Thank you.

Thanks, Rob.

Thank you. Our next question comes from the line of Brian Drab with William Blair. Please proceed.

Hi. Just another question on the 750. I am wondering if -- it sounds like this had significant impact on margins in the second quarter. What percentage of those machines are being sold through resellers versus direct; and if a large portion is being sold through a reseller, was it sort of the case right after the introduction of the machine that we put several of these machines or many of these machines with resellers and still have not seen the sell through on some of those?

Hi, good morning. It is Erez. In general our go-to market is indirect, and the J750 is not different. If are you asking about the channel inventory, the answer is absolutely not. There is no sale -- almost no selling without (inaudible). We did sell demo machines for a reseller that is needed to run the business, but outgoing trend and ongoing phenomena that we do every quarter. And, again, as for the inventory, and this is your question, if I understand you correctly, the answer is absolutely not.

Okay. So no meaningful impact from just placing them at re-sellers --

Right.

-- this is representing the initial wave of demand.

Right.

Can you comment further, just under your recent introduction of the direct manufacturing, consulting service, and how significant of a revenue stream you think that could be in the future?

So, yes. We now see it as a one of our additional tools to try and accelerate adaptation of 3-D printing with our customers, specifically large customers. We have a very professional team. Part of it is acquisition that we made last year with people that -- this is their bread and butter.

I do not expect, and the business model it is not, to become a Company that generates significant amount of revenue out of it; absolutely not. The rationale behind it is more non-quantified and to try to enhance and improve penetration within existing customers and new customers, bringing the knowledge that we have and using the technology that we have into specific customers across (inaudible).

Thank you very much.

Thanks, Brian.

Thank you. Our next question comes from Weston Twigg with Pacific Crest Secutities. Please proceed.

Thanks, just wanted to touch on the J750 again. Because, it seems like the way you describe the platform, it is a lot of the limitation associated with past printers and you had good demand on the initial launch. And I would expect demand to remain high through the rest of the year given the way the project has been described, but you indicated that you are tracking to the low-end of the annual revenue guidance. Can you help us understand the disconnect and whether the J750 could drive some additional upside in second-half sales.

I do not want to refer to specific numbers, but as I said, the phenomena we saw in Q2 around the J750 does not represent an ongoing trend that we can rely on for a long time. And it has nothing to do with the impact on the guidance of the revenue. We did J750, if you look at the number, and you look at H1 and you look at what is going on in the market, you understand that we are heading towards the low-end part of the revenue guidance.

Okay. The other question I had was on product gross margin. It improved in the quarter. You said it was partly based on cost controls. So I am wondering within that, how much of that was related to MakerBot changes -- recent MakerBot changes -- versus other segments and if there is more room to improve the gross margin, if that demand remains soft for several more quarters?

So most of it was coming not from the MakerBot business, but from the other businesses. It is the result of J750, as we said, and some cost initiative that we took in production to eliminate the inefficiency in production. And looking forward, again, I said, and we maintain, the gross margin for the year. We do expect H2 to be a little bit lower than H1. And they are to come into the range of what we provided them on.

All right. Thank you.

Thanks.

Thank you. Our next question from the line of Ben Hearnsberger with Stephens. Please proceed.

Thank you for taking my question. I have a question on GrabCAD and R&D spend. Can you give us the percent of R&D spend associated with the GrabCAD platform, and give a sense for how the level is trending now that you have released some of the beta products.

We did not provide specific information. I would say it is a significant amount of R&D. But strategic investment that we believe that we have to do for the long-term in order to maintain leadership in the market but we did not provide any breakdown on the R&D investment between the different part of the business.

Is the expectation that you will be generating revenue off that platform in the out-year, fiscal year 2017, if so, it will sit in the services line?

Currently, and I think that Ilan discussed it, the GrabCAD is more than just generating revenue. I do not think it will be at all significant revenue in 2017, and yes, it will be part of the service, if it will be.

Thanks, Ben.

Thank you. Our next question comes from the line of Joe Wittine with Longbow Research. Please proceed.

Hi, good morning. Can you give an update on how big prototyping is today as a percentage of the Company; and maybe more importantly how long from where you sit today do you expect mix down, the lower-price desktop and office products to persist? How long until you think we can reach a quote unquote equilibrium that will provide stability to ASPs? Thanks.

I did not hear the first part of your question. Can you please repeat it?

I was asking if you would offer a quick update on roughly how big prototyping is today as a percentage of the Company.

So I think that without quantify the numbers, a significant part of the Company business is still prototyping, although we are heading with incremental business towards end use and manufacturing with our new application. We do see trend of -- we call it more for less, or desktop (inaudible) providing more offering for better previous quarters. It does have impact unit-wise in our home market. Do not forget we have access to this market with a very strong brand for MakerBot.

Understood. Maybe the second half of the question, how long you expect the mix down to desktop and office to persist? Is it essentially over here, does it last two or three more years, or how long before you reach a quote unquote equilibrium in your quarterly mix?

I would be very careful providing any kind of time schedule here. The market is developing. It is a really young market. And I really do not want to provide any timeline there.

Okay. Understood. Thanks.

Thank you. Our next question comes from the line of Hendi Susanto with Gabelli & Company. Please proceed.

Good morning. And all of the best for Ilan's leadership, first of all. May I inquire inside into your service segment? Customer support revenue grew 11% while the overall surface revenue grew 1%, what offset the double digit growth in customer service? Do you see weaknesses in your printing services? And I think it would be helpful if you show how other rep eye solid concepts and how first technologies perform and what your expectation on additive manufacturing service business.

Yes, it was a bunch of questions. I hope I remember everything. The service revenue includes both service contract and what we call SDM, Stratasys Direct Manufacturing business. We provided colors on the service contract, which recur on revenue generated by the installed and we are happy to see an increase of 11% year-over-year in service revenue.

This naturally was offset by a slight, slight reduction, a slight decrease, in the SDM business. And I said earlier, SDM is running according to our plan. There are no surprises there. The message here was that the install base of Stratasys, which is a very large install base, is generating stream of recurring revenue for consumables and service contracts and this is part of the business model.

And one additional question. How do you characterized longer presale cycle now versus in the past?

I think that it practically what we see as we take us more time to close deals. It is coming from, I think, if you reason, not one reason. The availability of offering in the market in front of our customer, different solutions that we see. And the trend that we see, at the end of the day, longer-term cycle that has an impact on our ability to consume and grow.

Got it. Thank you.

Thank you. Ladies and gentlemen, this is all the time we have for questions today. I would now turn the call back to Ilan Levin for closing comments and remarks.

Thank you for joining us on today's call. We look forward to speaking with you again next quarter. Thank you and good-bye.

Ladies and gentlemen, thank you for your participation on today's program; this does conclude the program and you may all disconnect. Everybody have a wonderful day.