Stratasys Q1'16 Earnings Conference Call: Full Transcript

Operator:

Good day, ladies and gentlemen and welcome to the <b>Stratasys, Ltd.</b> SSYS First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require assistance please press star, then zero on your touch tone telephone. As a reminder this conference call is being recorded.

I would like to turn the conference over to Shane Glenn, Vice President of Investor Relations.

Shane Glenn:Vice President, Investor Relations:

Thanks, Otoya. Good morning, everyone and thank you for joining us to discuss our first quarter financial results. On the call with us today are David Reis, CEO, and Erez Simha, CFO and COO of Stratasys.

I'll 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 this 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 regarding Stratasys' beliefs and its comprehensive new strategy will help grow its markets and the statements regarding its projected future financial performance including under the heading Financial Guidance are forward-looking statements reflecting management's current expectations and beliefs. These forward-looking statements are based on current information that by its nature subject to rapid and even abrupt change.

Due to 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 continue to efficiently and successfully integrate the operations of Stratasys, Inc. and Objet Ltd. After their merger as well as MakerBot, Solid Concepts, Harvest, and RedEye after acquisitions, and to successfully establish and execute effective post-acquisition integration plans; changes in the overall economic environment; the impact of competition and new technologies; changes in the general market, political and economic conditions in the countries in which we operate; any underestimates and projected capital expenditures and liquidity; changes in our strategy; changes in applicable government regulations and approvals; changes in customers' budgeting priorities; lower than expected demand for our products and services, reduction or profitability due to shifts in our proudct mix into lower margin products or shifts in our revenue mix significantly towards in manufacturing services businesses, cost and potential liability related to litigation and regulatory proceedings; and those factors referred to an item in 3D key information Risk Factors, item 4, Information on the Company, and item 5, Operating and Financial Review and Prospects, and our 2015 Annual Report as well as the 2015 report.

Readers are urged to carefully review and consider the various disclosures made through the Form 6-K, 2015 end reports, filed with or furnished to the SEC which are readers near to advice interest parties of the risk factors that may effect your business, financial conditions, results of operation and prospects.

Any guidance and other forward-looking statements in this press release are made as of the date hereof and Stratasys undertakes no obligation to publicly update or revise any forward-looking statements whether as 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 measure 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 today's press release.

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

David Reis:Chief Executive Officer:

Good morning everyone and thank you for joining today's call. We made significant progress and improving our operating efficiency during the first quarter. The help drive favorable trends in operated profit and cash generating during the period despite the market environment that remain challenging. We're also encourage to see sequential improvement in MakerBot performance during the quarter as we begin to recognize some positive results from the recent restructuring of that business.

MakerBot is the best of category presumable to long-term opportunity and challenge for us. As customers increasingly choose desktop systems over high-end systems to address the constant modeling needs and in some cases also the peoples needs. We believe we are well positioned to capitalize in this opportunity and trend as we are the leader in both the professional industrial segment - like markets. In addition, our position is supported by our growing install base of systems and online 3D printing community sides both the largest in our industry.

We're pleased with the initial reception of the Stratasys J750 which we launched during the first quarter which we believe provides the market with unmatched color and multi-material printing capabilities. Initial orders of this innovative system has exceeded our expectations. Marketing condition driven positively by the weaker global manufacturing environment remain challenging and we are committed to further improving our financial performance by aggressively managing our expenses and drive additional operational efficiencies.

At the same time, we will invest aggressively a wrong initiative which helped us to maintain our leadership position in prototyping and that support our effort to develop a solution based business model to target applications for tooling and end response within key vertical markets. I will return later in the call to provide you more detail on these important initiatives and other key developments, but first I would like to turn the call over to our CFO and COO, Erez Simha who will review the details of our financial results. Eriz?

Erez Simha:Chief Operations Officer and Chief Financial Officer:

Thank you, David and good morning everyone. As David mentioned we continue to observe a challenging business environment during the first quarter, but we are pleased with our ongoing efforts to control cost and improve our working capital management. This is rather than improved gross margin as well as growth in operating income and significant improvement in cash flow from operations during the period.

Total revenue in the first quarter decreased by 2% to 3% to $157.9 million when compared to $172.7 for the same last year. MakerBot products and service revenue declined by 23% in the first quarter from the last year, but increase sequentially by 27% driven by -- an impact of ongoing reorganization of that business. Non-GAAP operating income improved both year-over-year and sequentially to $4 million compared to an operating loss of $0.8 million for the same period last year and the loss of and then also $8.9 million in the fourth quarter of last year. Non-GAAP net income for the first quarter was $0.6 million or $0.01 per diluted share compared to non-GAAP net income of $2 million or $0.04 a diluted share, reported for the same period last year.

Net income included a tax expense of $3.6 million which is rather from the non casual which resulted from the non casual ---- against deferred tax assets derived from ----- in the US.

Product revenue in the first quarter decreased by 6% to $118.6 million as compared to the same period last year. Within product revenue; system revenue for the quarter declined by 14% over the same period last year driven primarily by the overall market weakness we discussed. Consumer revenue for the quarter increased 6% compared to the same period last year.

Service revenue includes about 7% to $49.3 million as compared to the same period last year. Within service revenue, customer support revenue during the quarter which includes the revenue generated mainly by maintenance contract on our systems increased by 11% compared to the same period last year driven primarily by growing our installed base of systesm. We are pleased to see an improvement in yield in consumables and service revenue growth, compared to the flat growth in consumable --- second half of 2016 and the flat growth in service revenue in the fourth quarter of last year.

The Company sold 5,125 3D printing additive manufacturing systems during the first quarter and has sold a total of 161,149 systems worldwide as of March 31,2016 on a pro-forma combined base. Unit sales in the first quarter increased sequentially by 11% driven by higher MakerBot unit sales. Gross margin improved sequentially to 55.1% for the first quarter compared to 54.1% for the same period last year. Sequentially gross margin percentage increased by 7 point -- by the one time item that negatively impacted gross margin to fourth quarter of last year as well as the operational cost control measures that help mitigate production to latest inefficiencies.

Product gross margin improved to 61.1% in the first quarter compared to 58.6% for the same period last year, driven by sales mix of several higher margin system and ---- consumables as of percentage of total product revenue and improved production efficiency. Service gross margin decreased slightly to 40.4% in the quarter as compare to the 41.7% for the same period of last year.

Sequentially service gross margin increased by4 points in the first quarter held by our cost control effort and the product sales mix direct manufacturing that stables higher margin offerings.
We are pleased to recognize significant reduction in our operating expenses and increasing operating profit during the first quarter. This 12% reflect a positive impact of our operational initiative included reduction in headcount, subcontractors, facility consolidation and an overall focus on reducing our direct and indirect spend.

Operating expenses declined by 6% to $88.5 million for the first quarter as compare to the same period last year. In addition operating expenses in the quarter declined by 4% sequentially when compared to fourth quarter of 2015. Net R&D expenses decreased by 7% in the quarter to $22.8 million over the same period last year driven by our overall cost reduction efforts. SG&A expenses decreased by 6% in the quarter of $65.6 million over the same period last year reflecting the cost reduction as well as an impact of lower reseller commissions.

We should note that this planned cost reduction do not impact our long term strategic initiative and in some instances we have actually increased investment in area we view is strategically important for the long term growth.

Net income included the tax spend $3.6 million, which is resulted from the non-cash valuation allowance against deferred tax assets derived -- in the US compared to a tax benefit of $7.8 million for the same period last year. It should be noticed that this the deferred tax assets have expiry date many years into the future and we do anticipate being able to recognize our value to offset prospective tax liabilities. The following slide provide you with the greater --geographic serves for the quarter which reflects the broad based weakness we have outlined previously. Our regional results were consistent with trend we have observed in recent quarters.

Non-GAAP EBITDA for the first quarter amounted to $12.6 million. The company generated $31.6 million in cash from operations during the first quarter driven by the -- cost initiative and improvement in local capital management. The company currently hold approximately $280.2 million in cash and cash equivalent and shorter terms back deposits.

Inventory at the end of the first quarter increased slightly to $124.5 million as compared to $123.7 million at the end of the fourth quarter as we continue to focus aggressively on managing inventory level. Accounts receivable decreased by 11% to $109.1 million compared to $123.2 million at the end of the fourth quarter. As a result significant efforts to improve our cash position. DSO on 12 months trailing revenue decreased to 58 compared to 65 in previous quarter.

In summary, our first quarter results are in line with our expectations for the year and reflected continuation of the challenging market environment we have observed over the past several quarters. We have encouraged with the positive trend in gross margin that was driven by manufacturing efficiency and product mix. We are pleased with the operational improvement we have achieved which contributed to improved profitability and cash flow from operations.

Going forward we'll continue to aggressively manage our expenses and rose towards additional operational improvements and finally, we believe we will maintain strong balance sheet and sufficient capital to invest for the future and capitalize on emerging --.

I'd like now to turn the call over to our VP of Investor Relations Shane Glenn who will provide you greater details on our 2016 financial guidance.

Shane Glenn:Vice President, Investor Relations:

Thank you, Erez. As Erez mentioned our visibility is the timing of magnitude where market recovery remains limited. The some certainties reflected in our revenue projections and operating budget which assuming no significant market improvements throughout 2016.

Our guidance for 2016 remains as follows, total revenue in a range $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 of $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 expense, $7 million in merger and acquisition related expenses, $4 million to $5 million in reorganization and other related costs and includes $5 million in tax expense relates to non-GAAP adjustments.

Additionally, we are providing the following information regarding our company's future performance and strategic plans for 2016. Gross margins to improve modestly to range of 54% to 55% operating margins of 3% to 5%, tax expense of $10 million to $11 million which includes the negative impact of the planned accounting treatment for deferred tax asset valuation allowance. Capital expenditures are projected at $60 million to $70 million, with approximately $45 million designated for completing the company's new facility in Israel.

Our tax expense guidance and relatively high estimated non-GAAP tax rate for 2016 is a function of the ongoing non-cash valuation allowance against deferred tax assets, we expect to record throughout the year. As Erez mentioned, these deferred tax assets have expiration date many years into the future, and we do anticipate being able to ultimately recognize our value to offset prospective tax liabilities. The company believes that it can achieve a significant improvement in its operating structure in 2016, which can translate into improved operating profit compared to the prior year. Given the expected impact, our net income of the planned accounting treatment for tax valuation, the company believes operating profit growth would be the best measure of performance in 2016.

Appropriate reconciliations between GAAP and non-GAAP financial measures are provided in the table at the end of our press release and slide presentation with itemized detail of the non-GAAP financial measures.

Now I would like to turn the Call back over to David Reis. David.

David Reis:Chief Executive Officer:

Thank you Shane. As previously noted we observed no significant change in market environment from last quarter however we are pleased with the progress of our --- restructuring and cost cutting initiatives and believe that we are on track to meet our goals to improving financial performance in 2016. In addition, the business transformation that we discussed on our last call is proceeding as planned. As outlined previously our goal is to maintain our leadership position in prototyping by developing a solution based business model the target key vertical markets and emerging applications for tools and end use ---.

This include investment in R&D and go-to-market initiatives to support the many gross opportunities we have already identified. As well as incremental investment in our strategic accounts vertical business units, MakerBot, GrabCAD software and IT infrastructure that will position us for long-term growth.

I would like to highlight some of the opportunities and unique challenges we faced within the prototyping segment of our industry. As we have observed the price to performance position of desktop 3D printer has improved dramatically in recent years.

Anything drives increase penetration and rapid adoption of 3d printing technology. This trend is supported by recent industry survey we conducted which founded between 60% to 70% of designers and engineers that have adopted 3D printing technology using desktop units proportion of their prototyping application.

In a separate survey, we found it's over half of our customers it's on go strategy professional in desktop systems. Then on purchasing additional desktop units over the next year is over 30% planning on multiple units. We believe that this trend will continue and represents an attractive opportunity for Stratasys and our industry leading line of MakerBot desktop printers.

First quarter revenue at MakerBot increased sequentially by approximately 27% despite weak season sales trends that our typical during this period. We believe the renewed focus on quality customer service and improve go to market is beginning to have positive impact. We are also focus on efficiency as MakerBot and believe our recent announcement to transition all production MakerBot product ---- one of the largest contract manufacturing in the world will allow to greater manufacturing flexibility and help drive incremental operational saving going forward.

In addition we see significant opportunities for cross and upselling within our large installed base of desktop users as those customers expands the use of 3D printing to application which require functionality not offer as view the best of within the desktop markets.

However, the rapid development of the category is led to dynamic competitive environment as the market absorbs the large number of competitive products that the low cost but also limited functionality to end users. We're also observe you growing utilization of desktop systems for basic concept model application. This is impact to sales of higher end system that have historically being purchased partially for the same purpose. As transit will likely pursue as functionality of desktop systems continue to improve.

Regardless also opportunity or challenge we believe Stratasys is well positioned to continue to lead the prototyping given. Our leadership position in both the professional and desktop segments within industry largest install-based system worldwide.

Our market leading brands and eco systems including the largest online 3D printing community sides in the industry for both professional and semi professional markets. The market opportunities it remains relatively un penetrated and our demonstrated ability to drive innovation. A great example of our committed to innovation is the recently announce Stratasys J750 printer. The new system technology barriers full color 3D printing combined within unprecedented range of materials ranging from rigid to flexible from -- transparent.

The systems helps users to streamline their work flow process and speed product delivery cycle but eliminate time consuming painting and assembly processes with a normally required to create through to life prototypes.

The system maintenance capacity of 6 material cartages allowing customer to keep frequent users frequent use materials loaded at all times which reduce a down time associated with material change overs. The multi purpose system can produce production tools, manufacturing moulds, teaching aids as well as surgical guide the visual modems. We believe the J750 is well positioned to address the emerging market for medical models giving the system ability to print high detail models in full color with material focus that can vary within each box.

We believe the J750 represents the ultimate 3D printing solution for trans prototyping application, we're pleased with the strong initial orders for this products. We also made good progress implementing our vertical market strategy during the first quarter. Also early in its development, our vertical business units or the VBU outperformed the non-verticals areas of our business, highlighted by strong contribution from aerospace and medical.

We view aerospace is a key future market from manufacturing application which new opportunities to address aircraft interiors and long-term opportunities or secondary structures that have higher technical requirements. In the first quarter our aerospace vertical grew by estimated 40% year-over-year. Aerospace is a vertical with simplification requirement within manufacturing, but OEMs are moving quickly to evaluate in technology giving it's potential cost savings. We believe that the manufacturing validation both owned by the broader adoption within aerospace would be invaluable across multiple other industries.

We are also observing positive trends in our medical vertical we have estimated 22% year-over-year growth. Medical is other market characterize by early adoption and street manufacturing requirements recently announced an agreement with the New York based Jacobin situation to create the center of excellence with the goal of advancing views of 3D printing for variety of medical applications.

Research and the Jacobs institute will leverage Stratasys 3D printing technology to develop and test new medical devices. The center will also serve as the referral center for hospitals and medical research organization with the considering implementing 3D printing labs.

We believe that this application develop through this collaboration was apply to a broader medical audience and can support future growth opportunities within our medical vertical business units.

In summary, our first quarter results reflected continuation of challenging market environment we observed in 2015. However, we are pleased with our improved financial performance and operational efficiency. We will observe the shift deposit by the market which includes accelerated adoption desktop units we used in concept modeling application, creating both an opportunity and challenge for the company which we are preferring to address. We remained focus on maintaining our leadership position prototyping and our pleased with our positive trend in MakerBot and strong early demand for our new, advanced J750.

We continue to develop key vertical markets in the emerging application for tools and end used spots. We will continue to focus additional operational efficiency while investing aggressively in initiatives to support long term growth. And finally, also we expect the mark and market economic environment will remain challenging into '16. We remain excited about the company future.

Operator please open the call for questions.

Question & Answer

Operator:

Thank you. Ladies and gentlemen if you have question at this time please press the star then one key on your touch tone telephone. If your question has been answered or you wish to remove to yourself from the queue you may press the pound key. We accept to limit yourself to one question and one follow up and get back in the queue.

Our first question is from Wamsi Mohan Bank of America. Your line is open.

Wamsi Mohan:Bank of America/Merrill Lynch:

Yes. Thank you good morning. David can you elaborate on your comments on desktops being used for prototyping and do you read us as a net opportunity or threat in the long run and especially given that the desktop spaces is more competitive than higher in machines and does this happening in some specific verticals and regions or is it pretty broad based and I have a follow up for rest.

David Reis:

I think its in the specifically the natural trend just to printing is advancing printers in this segment becoming better overtime and they given a good solution with A4 concept modeling. Historically, people did wanted to get in to 3D printing both higher, typical higher in printers also for concept. So basically we believe the market in both areas will grow on one hand is that the option desktop printing will accelerated and we see it and you are familiar on few with the numbers. At the same time people which adopting desktop printing a soon after it will have also need for more advanced rapid prototyping which have -- so we hope we will going to push our historical core business even further and like I said we've script I think that the strategy is very well positioned, I mean we are I think on this creative leader in a rapid prototyping and behind and MakerBot is number one brand and the leader in desktop.

So we need to manage those two trends, but the things is you can general it's a positive move of the markets.

Wamsi Mohan:

Thanks David and Erez the cash flow was pretty strong in the quarter there was a significant benefit from receivables. Can you talk about the linearity in the quarter and how you're willing to sustainability if cash flow through the course of the year? Thanks.

Erez Simha:

Yes, -- good morning, you're liking your comment that part of the positive cash flow that to replace in Q1 was due to significant efforts to reduce accounts receivable in the quarter I thing that as long as we progress throughout the year we will continue way to try and manage our cost structure and CapEx investment in order to support and improve positive cash flow and I don't think that significant reduction in can't receivables is starting to face again future the quarter. We are focusing our cellphone managing our eventually only ----- to try and reduce and even reduce significantly deliver of inventory that we have today on our balance sheet.

Operator:

Thank you. The next question is from Troy Jensen of Piper. Your line is opened.

Troy Jensen:Piper Jaffray:

Yes thanks for taking my question maybe to start of with David. I want to take a dive a little bit into aerospace and medical and what are you doing in those verticals that working well or is that just the states kind of seems that a lot of declined of those two verticals.

David Reis:

I think both medical and aerospace are a good example for industries which are very well suited for added even a factory -- in the way in the state of their technology today and in the future typically short run, high level of customization. So naturally those two industries are very good fit. Specifically in stock -- we talked about it in previous calls we established already I think 2, 2.5 years ago a very strong team within Stratasys which is dealing specifically with vertical market such as aerospace and medical and I thinka very that was done there pushed sales and like I said in both markets that we have experienced growth year-over-year as a result of those efforts. More specifically only few just one more point about aerospace I think the opportunity for aerospace is very- very big I think I currently think our current technology is very suited for lot of applications specifically it within a application and manufacturing and putting all these together there is a reason for the success and continues success in those segments.

Troy Jensen:

Alright understood. Then follow up for Erez here. Just on the gross margin side you guys did a great job this quarter you get the gross margins up you already kind of already about your range for the year. If I look back historically you guys have been in the high 50s low 60% gross margins, so just curious the mix at the cost structure -- cost reductions it help drive upside to the gross margins about this 54% to 55% range as well.

Erez Simha:

Joy good morning. The gross margin that we finish this quarter as a result of few issues; the first one up absolutely different product mix and little bit higher consumables revenue compared to the mix that we faces in the past. As --- that we are doing in production floor I know that driving improved efficiency as in production and optimize productions activity, moving forward into 2016 I wouldn't change the range I think that the move for outsourcing which we started to make both but we are doing in the other part of the company will result in better gross margin over the towards the end of the yield beginning in 2017 it will take time and meanwhile it will costs us a little bit of money and so I would keep the overall range of gross margin for 2016 as it is keeping in mind that we are doing better and we production, efficiencies and capacity and which is somehow offset -- we are doing trying to a move outside some of the productions.

Troy Jensen:

Alright. Understood guys. Good luck.

David Reis:

Thanks, Troy.

Operator:

Thank you. Our next question is from Ben Hearnsberger of Stephens, Inc. Your line is open.

Brandon Wright:Stephens, Inc.:

Hey thanks for taking my question. This is Brandon in for Ben just little quick on the quarter revenue growth. Kind of what kind of assumptions are backed into the guidance what your outlook here for core growth. Thanks.

Shane Glenn:

Ben this is Shane. We don't break it out between the core growth being other revenue excluding MakerBot and SDM So I think it's generally speaking comments we've made around the business clearly apply to all of our components of our business. Obviously we saw some as we mentioned in the call we saw some improvements in MakerBot in the quarter but we don't really break out the two segments.

Brandon Wright:

Got it. And then just a quick follow up on MakerBot given your outsourcing to build kind of any changes in cost structure what internal run rate I guess -- we guess trying to hit to kind of get your margin target from that line. Thanks.

David Reis:

Again we didn't provide us interim revenue guidance to MakerBot but the move is more strategic one and longer term rather than the short term impact on next quarters. It provide us flexibility, it shift the cost structure both fixed cost to variable cost. It will probably provide lower cost of operation and higher quality of product once we finalize the move.

Brandon Wright:

Got it Thank you much

David Reis:

Thanks, Ben.

Operator:

Thank you. The next question is from Patrick Newton of Stifel. Your line is open.

Patrick Newton:Stifel Nicolaus:

Yes good morning David and Erez maybe just ask Troy's gross margin question from earlier differently is one is in the near term if we look at 2016 can you help us what would cost gross margin actually decline from Q1 levels back into the range of 54% to 55% for the full year, but it just seems like you next tailwinds benefits from operational improvements and that organic gross margin so as from upside and then the longer-term you posted close to 60% full year gross margin in the past is that is there anything structurally within Stratasys that we from working towards that level over the next several years.

David Reis:

Good morning and again in Q1 we saw over product mix this was high favorably towards high-end product and higher margin product and if I am looking at 2016 and look into gross margin results I am sure that -- will continue to do improvement on efficiency on the production tool. However, in order to maintain those current consisting gross margin we would have to fact the same mix of products and consume will that I can not say together this will be the mix this is one. The second one is the move some of the production outside cost money and before we see the benefit -- its not yet reflected in Q1 gross margin which will have the impact in Q2 probably in Q3 until -- as per the future traditionally historically is 60% gross margin we line on the very high weight on the high-end product and on which ---- on a significantly gross margin to product mix that we see today is different then in the past but I would say that looking into the future with existing product mix and also we conclude the move from for production outside we should expect a better gross margin above 65% I am not sure ---- 60% as about 25%.

Patrick Newton:

Great as my follow up I guess for David. You talked about the -- VBUs or I am --- vertical business units outperforming non-vertical areas in the quarter can you help us understand the percentage of the revenue that's running through your vertical business units currently.

David Reis:

We did not disclose the breakdown going forward we always see we expect to close the segment of activity that should go a faster than the overall business and I think as technology will improve our go-to-market will become more specialize the acceleration in those areas should be more visible but there is simply not giving the breakdown between those.

Patrick Newton:

Thank you for taking my questions. Good luck.

Operator:

Thank you. The next question is from Paul Coster of JP Morgan. Your line is open.

Paul Coster:JP Morgan:

Yes thanks for taking my question. David I just want to drill down into this current focus on desktop prototyping I am just wondering if this an observation about Stratasys business or about the industry is this the shift what is the shift promise the shift from the object dimensions back to make if that is the case might not be then is this good or bad I mean since we are going into lower ASPs more competitive environment that's consumables. your thousands on all of the above to it?

David Reis:

Okay, so first of all I tend to believe in the few ---- there is the growth in the desktop business is impressive and covering all the word globally and a number one and we don't I think mentioned on the previous call that when we analyzed the overall penetration also is impressive is still very very low if you look at global basis.

Going forward the market will continue shifting there will be a lot of desktop printers which will be used by engineers and designers and students as a desktop device. Nevertheless we believe that if we play drive and we explore the energies between desktop users and high-end product users there is still a lots of room to grow also for the high-end product that traditionally -- by Stratasys like the object printers, iconics printers and they mentioned -- like printers so I think if you look at knowledge geography ---- like printers So industry -- the desktop printers in the industry and as I mentioned and UPrint like printers so. Professional printers which are doing for most sophisticated more demanding work. I think that this differenciation in all market have been to bemore significantly because I think the difference between the basic job and the highest job more dramatic compared proof for example to the printing world.

So I think that this manage correctly and I said it on the script that thinks that we are by far the Company would the high sequential to benefit from this trend as long as we do it right because we are leading on both sides. So this is basically my answer.

Paul Coster:

Then so I stood on know if I am understand what it means in terms of product mix, but it sounds like this is sift back some MakerBot and then is that true what is that do see your channel strategy and how you in sense of us the channels take inventory in so on it sounds like is going to be require shift?

David Reis:

I am not sure I agree with you we just taking this is as a shift to is that both markets should grew. Obviously and you see delay in the numbers the desktop market were going to view and its growing dramatically faster than a the high end 3D printers which I think is natural like -- I believe both should grow. To a question regarding the channel to today MakerBot has it's own channel or channels. A strategies behind product is own channels but nevertheless we are exploring today synergies between those activities because as I said that think that we believe that desktop printers are very good candidates or a buying high end machine as they explore the technology and to understand that they have more need to all desktop can provide today or in the future.

Paul Coster:

Okay. Thank you.

David Reis:

Thanks Paul.

Operator:

Thank you. Yes the next caller is Shannon Cross of Cross Research. Your line is open.

Shannon Cross:Cross Research:

Thank you very much. Good morning. My question is basically on the start with for David is on the competitive environment. There have been a number of changes and obviously some coming new -- at 3D system launch of carbon printers and the coming of HP at some point here, curious is to what hearing from customers how you're thinking about sort of positioning yourself to say some of the new competition and some of the new -- 3D system.

David Reis:

Its clearly not to talk about the competition and I think we are well positioned to deal with increased competition I think we are doing the investments in the right areas who have bet product from desktop to high-end and rapid prototyping to induce manufacturing product and the market will become more competitive and -- the market is very, very large I think there is space to everyone like us we are living today in almost every segment and we right investment to leading.

Shannon Cross:

okay great and then I guess Erez can you talk a bit about channel inventory I'm just curious since you within the various distribution channels that you have and consumables versus printers just how are you feeling about the channel inventory and perhaps you could give us some color on how some of your new systems are helping you manage it especially from MakerBot perspective.

Erez Simha:

Good morning we managed the channel injuries relatively close and tight I would think that there is any issue would challenge the inventory in Stratasys business we do not allowed not permit to keep our inventory by the minimum levels that we think is the right one the business and if this is by any chance being -- revenue with both and in general both -- few quarter is reduction in channel inventory which is in line with business -- we see in the market. When we see lower activity and lower demand and lower inventory in the channel which get in line and make sense --to us.

Shannon Cross:

Thank you

Operator:

. The next question is from Sherri Scribner of Deutsche Bank. Your line is open.

Sherri Scribner:Deutsche Bank:

Hi thank you. I just wanted to ask a big picture question. It sounds like you comment as the macro challenges remain and demand is still uncertain not allow the visibility but you reiterated your guidance can you -- does it really sounds like things are about the same as they were three months ago and we haven't seen substantial improvement in demand is that fair.

Erez Simha:

Yes Sherri good morning its Erez. It is fair and we stated into the guidance of 2016 we do not plan for a better 2016 compared to 2015 in term of timeline and there is no change in our planning. But we do communicated as you should expect a better performance in same for profitability and 2015 even though the business environment will not change.

Sherri Scribner:

Okay great and then thinking about the addition of adding ----- to manufacture so MakerBot when should we start to see some cost improvement as a result of the -- partnership and we are going to mostly see that and cost good to solder than any opportunities and operating expenses thanks.

David Reis:

It's --- to see the JBL impact on our financial report I guess at the phase of beginning of 2017 so the first quarter of 2017 we have opportunities to enjoy a better profitability margins and MakerBot product. It's mainly not only but mainly around cost of good sold and some G&A leverage yields around facility and other items but not significant one. The entire the majority of the improvement is going to be on the cost of good sold.

Sherri Scribner:

Thank you.

David Reis:

Thanks Sharen.

Operator:

Thank you. The next question is from Jenson North of Jaffray. Your line is open.

Jenson North:Jaffray:

Hi, congratulations on the good quarter when I look at the full year guidance especially where GM is now looking at the mid point of revenues with the implied that OpeEx would be flat up from here throughout the of the rest year is that -- accounted?

Erez Simha:

Yes Jason I would look at relatively flattish OpeEx numbers for the remainder of the year.

Jenson North:Jaffray:

Okay, and then diving into for Q1 for Asia-Pac was pretty strong for you. Can you give additional details.?

David Reis:

I wouldn't say here in pretty strong all the regions were according to our plan. We didn't see any significant change neither positive nor negative and the business activity in none of the regions again I wasn't say it was relatively strong it was inline with our plan and thus we do not see any different market behavior in APG compared to for example North America ------

Jenson North:

Okay. Thank you.

David Reis:

Thanks Jenson.

Operator:

Thank you. The next question is from Ananda Baruah of Brean Capital. Your line is open.

Ananda Baruah:Brean Capital:

Hey thanks guys for taking the question. I guess just two quick ones ---- regards to the prototyping dynamic so to shift in the out stream that you're. So David and Erez, you guys you actually saying that you're beginning to see in a bigger way MakerBot capture sales or deep purchase and used for prototyping activity that the higher in machine were previously use to. So I think that you're actually loosing some higher end sales while taking up the incremental MakerBot sales and then I have a follow up.

Thanks.

David Reis:

Yes let me clarify. The desktop printers including MakerBot are becoming overtime more and more suitable for what we described as maybe lower in rapid prototyping application mainly concept in modeling okay. And some customers that would like to experiment with this technology might start the journey with the desktop printers and doing concept modeling in reasonable good quality okay. Like I said I answered earlier we seek as challenge and opportunity because we know for fact that customers which are buying desktop printers are electing many times sometime after the beginning of using this technology to buy higher-end printers because they realize they need more functionality, they need colors, and they need feet, they need different materials and many, many advantages for the higher end printers.

So, it is a kind of new maybe a market requirement but because of in overall penetration of rapid prototyping in general we believe it's an opportunity and as I said I think we are the best suited to enjoy it.

Ananda Baruah:

That's up on just as a quick follow up can you remind us if makerBot is recognized did you recognize the revenue on sell-in or sell-through and then what specifically are the challenges in that dynamic David that you have referring to a couple of times. Thanks there is this last two and that's it for me thanks.

David Reis:

I will start with the second part of your question. The challenge is to able in the smart way work together on go to market between MakerBot and Stratasys to identify those customers that are good candidate to buy high end machines with other hand make sure that MakerBot is continuing to be the number one branded and make sure that the they capture opportunities in the rest of segment. If we do those well we will definitely continue leading this segment to our -- segment to the industry.

Ananda Baruah:

And then the sell in versus sell through on MakerBot recognition.

Erez Simha:

Hey its revenue recognition according to sell-in so ones we shift the product with se sales and with the very tight control of level of inventory held at the channel.

Ananda Baruah:

Thanks so much Erez. Thanks guys.

Operator:

Thank you. The next question is from Brian Drab of William Blair. Your line is open.

Brian Drab:William Blair:

Hi thanks for taking my question. First within services could you give us any color on what you are seeing in paid products business and whether is that grew year-over-year or sequentially?

Erez Simha:

Yes so we didn't breakout the number of our database business but I think that you have to understand the environment we are coming from when we compared to previous year which was extremely busy in terms of integration and post integrations for the entire of service business. I think that our long our focus on longer-term growth and the integration of this business with broader strategy of combining a our wide ranging capabilities into a solutions based business model as what we are looking at the aim its difficult to compare as we enter this trend to other business businesses given the size of the -- a business today what we still in Q1 better margins as a result of more profitable -- that's fighting in --.

Brian Drab:

Okay, okay thanks. I'll leave that one for now and could you just a talk a little bit about what your goal is in the our sourcing of maker manufacturing -- were maker gross margin is today and where you planning to get a to but on that's what I am looking. So may be you could talk just roughly how many basis points of gross margin expansion you think you can get from this initiatives.?

Erez Simha:

Again we did it we didn't break down the gross margin of MakerBot. I can tell you the really high level through two reason for the move the test one and a cost reduction in a significant cost reduction around cost of goods sold to and a higher flexibility to the business model of MakerBot and Stratasys providing that this is a business which probably will help to deliver high amount of boxes in the future. We want to make sure that the entire business model is focused on the right thing and now has to deliver a high quality product in the right time and those quantities are -- I think we found -- it is a partner to become --

Brian Drab:

Okay. Thank you.

Erez Simha:

Thanks Brian.

Operator:

Thank you. The next question is from Jim Ricchiuti - Needham & Company. Your line is open.

Jim Ricchiuti:Needham & Co:

Hi thanks. Just question on the growth that you're seeing in the medical and aerospace and in general the focuse on the vertical markets. Are we seeing the same trends in these markets that is you're seeing an acceleration in desktop units within this market as well for concept modeling applications or are you seeing traction more traction on the higher volume added upside?

David Reis:

The increased or the growth in both medical and in aerospace and other verticals that we are focusing on such as auto and others, is a more and more driven by our move which is part of our strategy to be able to manufacture and use parts into moving to manufacturing okay. So this statement is not related to our previous statements which is talking about the great expansion in desktop. Its more a very industry oriented a focused on very large variety of applications which are targeting -----.

Jim Ricchiuti:

Okay so as we see this continued acceleration as you expand this vertical market strategy presumably you are going to see a pretty shift again toward higher volume machines.

David Reis:

Yes this is my expectations. The relative the gross is going to be driven by our increased penetration into the manufacturing and ----- applications.

Jim Ricchiuti:

Okay.

David Reis:

Sorry, just why growing also rapid prototyping its not contributing, I mean the same companies will result also desktop printers to concept and we will adopt high ----- in the J750 for their high-end prototyping it's not one on the account of the others it's an area which is growing faster it is not mean the other areas are not going to grew.

Jim Ricchiuti:

Understood. Reis just on the R&D side. Sounds like you've given some guidance for OpeEx, how should we think about the R&D components this year given where you starting from?

David Reis:

So I think it should be relatively flat compared to level in Q1 and again we made some changes in R&D and moving money and focus from some product to other direction focusing on very strategic project that we seen ---- very important for the strategic long-term and direction of the Company. I wouldn't expect a significant increase or decreasing R&D in the rest of the year.

Jim Ricchiuti:

Thank you.

Operator:

Thank you. The next question is from Kenneth Wong of Citi. Your line is open.

Kenneth Wong:Citi:

Hey guys, thanks for taking my question. I just -- the impact of desktop first have you seen that particular trend play out on your services business at all.?

David Reis:

I don't have a number to answer this question. But I think it's few assumptions to say that basic ----- modeling again will move to the desktop. So I think overtime it will have also impact on the service we will not only own our service views. Nevertheless the service views like the rest of the industry is growing more and more into manufacturing applications.

We should think we'll be able to competitive more for the small decrease in the work which is not today for a concept modeling.

Erez Simha:

I would add may be that in case that the service ---- we run today is more focus and more on more complex applications weighted toward and used products and as David say it's really difficult to calculate, and to measure and to, quality the impact of desktop on concept modeling and as a result service bureau in more weighted with complex applications?

Kenneth Wong:

Got it that's fair and then on the material relationship I guess beyond MakerBot you guys seeing opportunity to outsource production of any other your product lines

David Reis:

So outsourcing is part of strategy in Stratasys we started in MakerBot and we are we have seen a process of evaluating the ROI and the benefit from outsourcing other activity in Stratasys we had some outsourcing activity going on in Stratasys today but in order to develop its further to significant activity we want to make sure what's the ROI, what --- and you could make sense with and really to make sense and -----

Kenneth Wong:

Got it and then last question for me guys guy. You guys saw a nice little inflection on the consumables growth that popped up from flat in the back half as you mentioned should we look at the growth in consumables as a good way to measure whether or not you guys have started to work off some of that access capacity that you guys have spoke of in the past

David Reis:

It's very I think it's very difficult question I think the growth in consumable is a good education to the utilization of machines. A breakdown in allocating the gross utilization between the sorry the ability to breakdown the increasing consumption between the natural growth of the install base and the increased utilization in stuff. It -- we see both increasing in which is resulting towards increasing install base and increased utilization.

It might be against the numbers are small it might be indications that the customers that you can commissions more yes.

Kenneth Wong:

Okay great. Thanks a lot.

Operator:

Thank you we have time for one more question. The last question is from Robert Stone of Cowen and Company. Your line is opened.

Robert Stone:Cowen & Company:

Guys' thanks for feeding me and a follow up for Erez you mentioned that transition of MakerBot to -- is going to cost use some money in the time is that -- reflected in gross margins or is that part of the restructuring that's noted in the guidance.

Erez Simha:

Its part of its going to be part of cost of goods sold and the gross margin guidance that we provided. Some of it more amount is part of the restructuring cost guidance that we had provided for the 2016.

Robert Stone:

Okay. You have highlighted the impact on taxes from the evaluation allowance can you provide any color on what thinks your effective tax rates will be beyond 2016?

Erez Simha:

Currently I would assume that -- allowance will continue to take place beyond 2016 and again I want to mention that this is purely accounting provision. We have would be able to -- we have been able to use in the next I would say 20 years and we think that we will be able utilize them, but again there assumptions for beyond 2016 as we see it now the we should continue to record --allowance.

Robert Stone:

Okay. Thank you.

Operator:

Thank you and at this time I would like to turn the call back over to David Reis for closing remarks.

David Reis:

Thank you for joining today's call. Talking with you again in next quarter. Thank you and good bye.

Operator:

Thank you. Ladies and gentlemen this concludes today's conference. You may now disconnect. Good day.