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Edited Transcript of SSYS earnings conference call or presentation 28-Feb-18 1:30pm GMT

Q4 2017 Stratasys Ltd Earnings Call

EDEN PRAIRIE Mar 31, 2018 (Thomson StreetEvents) -- Edited Transcript of Stratasys Ltd earnings conference call or presentation Wednesday, February 28, 2018 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ilan Levin

Stratasys Ltd. - CEO & Director

* Lilach Payorski

Stratasys Ltd. - CFO

* Yonah Lloyd

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Conference Call Participants

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* Ananda Prosad Baruah

Loop Capital Markets LLC, Research Division - MD

* Ben Zion Rose

Battle Road Research Ltd. - Founder, President & Analyst

* Brian Paul Drab

William Blair & Company L.L.C., Research Division - Partner & Analyst

* Christopher Ralph Van Horn

B. Riley FBR, Inc., Research Division - Analyst

* David Ryzhik

Susquehanna Financial Group, LLLP, Research Division - Associate

* Gregory William Palm

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Hendi Susanto

G. Research, LLC - Research Analyst

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* James David Medvedeff

Cowen and Company, LLC, Research Division - Associate

* Troy Donavon Jensen

Piper Jaffray Companies, Research Division - MD and Senior Research Analyst

* Wamsi Mohan

BofA Merrill Lynch, Research Division - Director

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Fourth Quarter and Full Year 2017 Stratasys Earnings Conference Call. (Operator Instructions)

I would now like to introduce your host for today's conference, Yonah Lloyd, Vice President of Investor Relations. Now you may begin.

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Yonah Lloyd, [2]

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Thank you very much. Good morning, everyone. Thank you for joining us to discuss our fourth quarter financial results. On the call with us today are Ilan Levin, CEO; and Lilach Payorski, CFO at 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 today's call including access to the slide presentation will also be available, and can be accessed through the Investor section of our website.

Please note that some of the information you'll hear during the discussion today will consist of forward-looking statements, including without limitation those regarding revenue, gross margin, operating expenses, taxes and future business outlook. Actual results or trends could differ materially from our forecast.

For more information, please refer to the risk factors discussed in Stratasys' Annual Report on Form 20-F being filed with the SEC today, along with the associated press release concerning our earnings for the fourth quarter and full year 2017.

Stratasys assumes no obligation to update any forward-looking statements or information, which speak as of their respective date. 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 our performance. Certain non-GAAP to GAAP reconciliations are provided in the table contained in our slide presentation, and in today's press release.

Now, I would like to turn the call over to our CEO, Ilan Levin. Ilan?

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Ilan Levin, Stratasys Ltd. - CEO & Director [3]

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Thank you, Yonah. Good morning, everyone, and thank you for joining today's call. We are pleased with our Q4 and full-year results, which demonstrate traction in strengthening customer relationships and deepening penetration in our target vertical markets. Throughout 2017, we experienced positive market reaction to new product introductions, including the F123 Series, our recently commercialized H2000 Large Part FDM 3D Production System and J700 Dental Solution, and our certified specialty resin materials for advanced aerospace applications.

We are also observing positive results from our strategy of investing in specific go-to-market initiatives in our target verticals of aerospace, automotive and healthcare, resulting in deepening customer relationships and further penetration into key accounts. Operationally, we continue to drive operational focus in cash generation, driven by our focus on execution and alignment of resources to support our strategic roadmap. I will return later in the call to provide you with some exciting details on these important initiatives, as well as other key developments.

But first, I will turn the call over to our CFO, Lilach Payorski, who will review the details of our financial results. Lilach?

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Lilach Payorski, Stratasys Ltd. - CFO [4]

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Thank you, Ilan, and good morning, everyone. Total revenue in the fourth quarter was $179.3 million compared to $175.3 million for the same period last year. GAAP operating loss for the fourth quarter was $6 million compared to a loss of $29.2 million for the same period last year. Non-GAAP operating income for the fourth quarter was $13.5 million compared to $11.6 million for the same period last year.

Product revenue in the fourth quarter increased by 2.5% to $129.8 million as compared to the same period last year. Within product revenue, system revenue for the quarter increased by 1% compared to the same period last year, driven by continued demand of F123 Series targeting professional rapid prototyping application, as well as initial sales of our new J700 Dental Solution, and our H2000 Large Part FDM 3D Production System.

Consumables revenue increased by 4% compared to the same period last year. Service revenue in the fourth quarter was $49.6 million, an increase of 2% compared to the same period last year. Within service revenue, customer support revenue, which includes revenue generated mainly by maintenance contracts on our systems, increased by 7% compared to the same period last year, driven primarily by growth in our installed base of systems and improvement in our service contract attach rate.

GAAP gross margin increased to 48.7% for the fourth quarter compared to a GAAP gross margin of 47.3% for the same period last year. Non-GAAP gross margin decreased to 52.5% for the fourth quarter compared to 53.6% for the same period last year, driven by product mix. Non-GAAP product gross margin decreased slightly to 58.8% compared to 59.5% for the same period last year, also driven by product mix.

Non-GAAP service gross margin decreased to 35.9% compared to 38.3% for the same period last year. Our services gross margin is driven by the mix between our customer service business and our [parts] business, whose gross margin can be impacted by the different technologies that make up the product mix in a given period.

GAAP operating expenses decreased by 16.8% the $93.2 million for the fourth quarter as compared to the same period last year. Non-GAAP operating expenses decreased by 2.3% to $80.6 million for the fourth quarter as compared to the same period last year. We remain pleased with the results of our efforts to execute on our long-term strategy, and deepening customer engagements in a key vertical, while at the same time achieving greater operating efficiencies.

The company generated $21 million cash from operations during the fourth quarter as compared to $26 million of cash generated in the fourth quarter last year. We ended the fourth quarter with $328.8 million in cash and cash equivalents compared to $302.8 million at the end of the third quarter of 2017.

Inventory at the end of the fourth quarter decreased to $115.7 million as compared to $124.1 million at the end of the third quarter. Accounts receivable increased to $132.7 million compared to $120.5 million at the end of the third quarter, with DSO on a 12-month trailing revenue at 72. To recap, we are pleased with our fourth quarter and full year performance and continue to make progress on our strategy of targeting high-value application in our target vertical while maintaining financial discipline and improving profitability. We have observed positive market reception for our new products in 2017, including the F123, J700 Dental solution and H2000, validating our industry specific and customer-centric approach to product development as the overall 3D printing market matures. We continued our trend of positive cash generation from operating activities and believe we maintain a healthy balance sheet and are well prepared to take advantage of opportunities moving forward. I would like now to return the call back over to Ilan.

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Ilan Levin, Stratasys Ltd. - CEO & Director [5]

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Thank you, Lilach. As an established global leader in the application of additive technology solutions, we remain focused on advancing our customers and their industry's 3D printing expertise and solutions. Our expertise in additive manufacturing is evident in the deep knowledge base and talented team that we have cultivated at Stratasys, coupled with the largest installed base of industrial printers in the industry, enabling us to develop industry and application-specific solutions as well as service offerings that include our recently launched Expert Services. Technology development at Stratasys is rooted in the process of purposeful innovation, driven by our efforts to bring the promise of additive manufacturing to new addressable markets as well as the development of solutions that address specific, high-value applications meeting our customers' needs.

The positive market reception to such products as our F123 Series, targeting professional workgroup prototyping applications and our recently announced J700 Dental solution are a testament to the impact of developing a product around a specific market need can have. Our leadership in the additive manufacturing industry is reinforced by nearly 30 years of experience, a commitment to R&D spending resulting in over 1,200 additive technology patents and patent pending and a deepening focus on customer relationships, that has resulted in strategic partnerships with some of the largest and most ambitious companies in high requirement industries.

Our commitment to investing in R&D has resulted in 2 of the additive manufacturing industry's most versatile stable and highly proliferated technology platforms, fused deposition modeling or FDM and PolyJet.

FDM technology, invented by Stratasys nearly 30 years ago is the most prominent additive manufacturing technology on the market with use cases that range from the simplest personal desktop 3D printing experience to high-end systems and materials used for production applications that include aerospace and automotive. Our FDM technology is still evolving in new and exciting ways as seen in our H2000 large format production system, which was initially introduced as the Infinite-Build 3D Demonstrator and has recently taken a step in our path to broader commercialization and our Robotic Composite 3D Demonstrator, which is still in development. Our PolyJet technology is unique in its ability to provide true multi-material, [multi-control] at the voxel level. This accessible, easy-to-use technology provides the industry gold standard in its resolution and visual and tactile realism and continues to add significant value to customers, addressing applications that include medical modeling, dental, consumer goods and packaging and advanced prototyping. Both of these technologies have proven to be highly differentiated in the additive manufacturing market, supported by robust patent portfolios and continued innovation driving new applications and advancements.

As a leading provider of applied additive manufacturing solutions, we are now increasing our investments to accelerate several internally incubated projects that we believe have significant potential to expand our addressable markets. We view the potential for FDM based conformal printing platforms and composite materials used in additive manufacturing platforms as a long-term significant opportunity. And believe that additive manufacturing systems that offer greater printer control and [later] for a platform for composite and hybrid process manufacturing will play a critical role in the aerospace and automotive industries.

In late 2016, we unveiled the Robotic Composite 3D Demonstrator, an early iteration of next-generation high-end FDM based printing for manufacturing. We are developing this platform in collaboration with Siemens as part of our strategy to develop these initiatives with close feedback from leaders in the manufacturing industry. At IMTS in 2016, we demonstrated the potential of using 8-axis of motion control to enable greater geometric freedom and the elimination of support structures for faster builds and reduced post-processing.

We look forward to providing you an update with additional details as we progress on this innovative proprietary platform.

Another key part of our development efforts is leveraging software development as an enabler for high-value applications. We have already made significant strides in software development, including GrabCAD Print and our more recently announced GrabCAD Voxel Print application as well as uniquely specialized software designed to deliver highly repeatable mechanical properties included on our Fortus 900mc Aircraft Interiors Certification Solution. We look forward to further releases addressing specific high-value applications as we accelerate our software development efforts. Building on our track record of innovation and leadership, earlier today we revealed the development of a new additive manufacturing process designed to become a viable manufacturing technology to displace conventional methods for short-run metal manufacturing. Traditional short-run metal manufacturing applications that utilize techniques such as investment casting, sand casting, and powder injection molding are limited by high costs for tooling and labor. The innovative Stratasys platform was developed internally over the past several years incorporating our proprietary jetting technology. It was designed from inception to provide the values of additive manufacturing for short-run production while overcoming the limitations of currently available metal-based additive manufacturing systems. With this new technology, we believe we will offer customers a new ability to short-run manufacture metal parts made with commonly used powder metallurgy, starting with aluminum at an economically competitive cost per part and throughput with easy to implement post-processing and high parts quality.

During our development efforts, we have engaged with several leading customers in our target verticals and we expect our new platform to meaningfully expand our addressable markets for the long-term and allow us to provide a highly differentiated metal additive manufacturing solution to our customers.

At this time, we are not discussing our timeline or expectations around commercialization and we do not expect revenue associated with this new platform to be recognized in 2018. We invite you to join us April 23 through April 26 at the RAPID + TCT 3D Printing and Additive Manufacturing Conference in Fort Worth, Texas, where we will unveil further details around this exciting new additive manufacturing platform.

Now it is my pleasure to formally introduce our new Vice President, Investor Relations, Yonah Lloyd who will provide you greater details on our 2018 financial guidance. Yonah?

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Yonah Lloyd, [6]

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Thank you, Ilan. Our guidance for 2018 is as follows. Total revenue in the range of $670 million to $700 million. Non-GAAP net income in the range of $16 million to $27 million or $0.30 to $0.50 per diluted share. GAAP net loss of $41 million to $25 million or $0.75 to $0.46 per diluted share. Non-GAAP operating margin of 4.5% to 6%. Capital expenditures projected at $40 million to $50 million.

Our guidance reflects increased investments in R&D, tools, materials, and additional resources aimed at expanding our addressable markets by accelerating our development efforts for the new metal additive manufacturing platform, further advancements based on our FDM and PolyJet technologies and specific go-to-market initiatives in order to deepen our customer engagement. We believe that this ramp-up of operating expenses as guided will provide the basis for long-term growth. Non-GAAP earnings guidance excludes $32 million to $34 million of projected amortization of intangible assets, $17 million to $19 million of share-based compensation expense and $7 million to $9 million in reorganization and other related costs and includes $4 million to $5 million in tax expenses related to non-GAAP adjustments. We maintain a relatively high estimated non-GAAP tax rate for 2018 given the ongoing non-cash valuation allowance on deferred tax assets, we expect to record throughout the year. These deferred tax assets have expiration dates many years into the future and we do anticipate being able to ultimately recognize their value to offset prospective tax liabilities. Given the expected ongoing negative impact of not recording a tax benefit on U.S. tax losses on our net income (loss) as well as significant quarter-to-quarter variability in our non-GAAP tax rate, the company believes non-GAAP operating profit would be the best measure of our performance in 2018. Appropriate reconciliations between GAAP and non-GAAP financial measures are provided in a table at the end of our press release and slide presentation with itemized detail concerning the non-GAAP financial measures.

Operator, please, now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from the line of David Ryzhik of Susquehanna.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [2]

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Congrats on the metals announcement and the return to systems revenue growth. Ilan, can you elaborate on the competitive differentiation of this new metal solution relative to existing metal solutions? You mentioned that it overcomes some of the limitations and would love to get your thoughts on how it's differentiated against SLS or some of the other jetting technology such as single pass jetting? And I have a follow-up.

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Ilan Levin, Stratasys Ltd. - CEO & Director [3]

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So I think in general, the additive, sort of the promise and opportunity that's represented by additive manufacturing of all the good things that a lot of us have been talking about for a good number of years of geometric freedom, weight reduction, the way you can unify assemblies for some of the key industries that we've been looking at for years. So on the one hand, we have that promise and when we look at currently available metal applications, I think they're more focused on the high end of those markets and that's primarily due to, I think, certain limitations with respect to the technology around the types of materials that can be used the specialty nature of those materials, some of the complex pre and post processing associated with that and so it's driven those systems to the higher end of the market, where throughput and cost maybe are a little bit less important in the initial adoption stage. With our new technology that we've revealed today, as we've alluded in the remarks earlier, it was from the outset designed for powder metallurgy that is commonly used in industry. We're starting with aluminum and that was certainly a market focused choice not a technology limitation driven by the system and we're very much focused on conventional techniques being used currently for short-run metal manufacturing and believe that we can offer something that could seriously displace that type of manufacturing. And as such, I think it represents a very large new opportunity for Stratesys in a new addressable market. I think some of the things that we would be looking at in terms of application would be short-run production in automotive, highly customized parts for high-end automotive and aerospace industries, things that are printed or built today that are not suited for mass production. And I think that would be our sweet spot with this new technology.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [4]

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And how would this impact your strategic relationship with Desktop Metal and I have a quick follow-up, if you can just touch on the H2000, did you guys recognize any revenue from that in Q4 and what expectations for the H2000 do you have for 2018?

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Ilan Levin, Stratasys Ltd. - CEO & Director [5]

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This, I don't believe, affects our relationship as previously announced with Desktop Metal. The first product to market with Desktop is more of a prototyping product in nature and we are working with our reseller network to bring that to market. With respect to the H2000, yes, we have recognized the system, we had a nice large order that we received in Q4 and we're able to [ship,] install and have that accepted by the customer, and so we recognized that revenue in the quarter.

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David Ryzhik, Susquehanna Financial Group, LLLP, Research Division - Associate [6]

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And for 2018, does 2018 guidance assume a pipeline for H2000, a certain amount of units or does not?

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Ilan Levin, Stratasys Ltd. - CEO & Director [7]

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So we're -- in general, it's a different type of product than certainly our lower-end products where we're very strong, analysis on the unit count and how we launched that product, so here the product launch is a little bit different in nature. The commercialization of a system of this size is more on a crawling basis, but absolutely we're deep with customer engagement with the idea that we would continue to place systems on a regular basis now going forward.

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Operator [8]

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Our next question comes from the line of Jim Ricchiuti of Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [9]

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A question I have is just, I wonder if you could maybe define a little bit, how you view the short-run metals market. It sounds fairly clear that you're not going after the higher volume segment of the market, how attractive is this short run segment of the market and I don't know if you could give us a range of maybe parts that you might be focusing on?

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Ilan Levin, Stratasys Ltd. - CEO & Director [10]

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So we believe that it is a very sizable market and a large addressable market from our perspective. I think we would be looking specifically at auto, we're getting very strong, very positive feedbacks from customers that we are revealing the technology to and have been, I think, for the past several quarters already. Looking at parts, they've had access to the technology in our premises and have been very positively excited about it and our guiding us in how to develop it in that way. And I think a good application there would be pre-production of vehicles that they're looking at, making metal parts that are currently put on vehicles in a short production series. We're looking at small-scale manufacturing, in general. Some of that is in mobility or vehicles where the typical quantities might not be fully mass produced like in commercial auto. We're looking at lightweight complex parts that we could do and we're looking, of course, at the customized parts as well and consolidation of parts. So I think as we move down and people understand how to design for AM, I think we could broaden the opportunities, but certainly out of the box, we will be looking at the applications that I mentioned.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [11]

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Okay and you're guiding to higher R&D spending, and I'm wondering, is this a -- clearly you've been investing in this area for a few years now. To what extent is that -- is the investment in metals additive manufacturing in 2018 contributing to the increased R&D or is it more broadly-based across different technologies?

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Ilan Levin, Stratasys Ltd. - CEO & Director [12]

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So it does include a number of technologies, but certainly the new metal technologies is a prominent element in that and as we move past the incubation phase and into -- as we move through the product development cycle, where we are today, a lot of those incremental [vessels] will be made around materials and tools, some resourcing as well. So certainly the new technology will receive a healthy portion of this increase.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [13]

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And 1 final question from me if I may, Ilan. You seem satisfied with the way the vertical market strategy is unfolding at the company and I'm wondering if you can give us -- if there is any additional color you can give about the progress in either healthcare, aerospace some of these verticals as you look at what took place in 2017 and what you're anticipating for 2018?

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Ilan Levin, Stratasys Ltd. - CEO & Director [14]

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So you said it well in terms of the different markets that we're looking at, we're certainly taking an increasingly more market segment approach than ever which -- not only on the go-to-market side on account management, which is certainly a part of that, but also a little bit on the development cycle. Some of the new products that we're bringing to the market, which we mentioned in our earlier remarks, specifically address the markets you've mentioned of healthcare and advanced manufacturing. Each of these markets, obviously, react differently; in both cases, however, from a go-to-market initiative perspective, we're adding a lot of application engineering and account management around these 2 sectors. And in terms of traction in general, an example is advanced manufacturing, I think we have the customers that we need, we're in high level of engagement, they understand the technology I think very well, but we need to realize that the qualification periods, and that's what we're working with them on together, the qualification needs for those industries are lengthy, often independently done within each of the OEM manufacturers that we're selling into or their supply chain. And so it's very much of a mutual relationship, and their feedback [gives] very good traction there, a very good engagement, and once we exit, and where we exit those qualification periods, we see an increase in business. I think over the coming years, we will see more of that and then, obviously, that would lead to a longer-term growth in a sector like advanced manufacturing. On healthcare, I think we've added -- we have lot stronger clarity today where our technologies fit in within the landscape and once we identify those areas, we're much better able to create a go-to-market initial solely around those areas. I think we're getting a lot -- we've made a lot of improvements there, and so I'm very pleased with that. And as a result, once we identify those areas and put the resources around it, I think we'll quickly see, let's say, in healthcare a very positive reaction on the business side as well.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [15]

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You feel you're getting more early momentum in the healthcare market?

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Ilan Levin, Stratasys Ltd. - CEO & Director [16]

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I believe, yes, I believe in the specific areas that we're focusing in some of our Jet, our Dental Solution, which we just recently launched, yes, I think we're getting a very good traction on that, primarily because of the language and the specificity that we can approach the market with and put the proper go-to-market initiatives around it leading us to better traction.

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Operator [17]

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Our next question comes from the line of Troy Jensen of Piper.

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Troy Donavon Jensen, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [18]

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Congrats on the fourth quarter results. So if I could just follow up on the metals, just a question on the underlying technology. I'm curious if this is going to be jetting a green part that need to be [cooked], like in XJet or is this actually producing an end part with no post processing?

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Ilan Levin, Stratasys Ltd. - CEO & Director [19]

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So we're not really disclosing the specifics of the process, it does incorporate like we mentioned in the early remarks, our jetting capabilities and proprietary technology, we have mentioned powder metallurgy. So it's, obviously, giving on that side with powders. On the post-processing side, I think, what we're offering in the system are more standard, familiar post-processing techniques and manufacturing, that hopefully will be well received by the market and well understood by the market, hopefully, reducing adoption cycles and perhaps the qualification processes that we see in other AM technologies.

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Troy Donavon Jensen, Piper Jaffray Companies, Research Division - MD and Senior Research Analyst [20]

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So correct me if I'm wrong, but if it's a powder metal by definition, doesn't it need to be cooked?

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Ilan Levin, Stratasys Ltd. - CEO & Director [21]

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No, we're not revealing the process and its details at this point.

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Operator [22]

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Our next question is coming from the line of Wamsi Mohan of Bank of America.

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Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [23]

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So when you look at 2018 guidance, you're guiding to about 2.5% growth at the midpoint for revenues. Can you give us some sense of how much of this growth is coming from new products, and secondarily, if you see you're exiting here with a pretty decent growth rate both for consumables and for maintenance? And I'm wondering if that trajectory is maintained. Does it imply in your guidance that you're expecting systems to decline in 2018? And I have a follow-up.

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Ilan Levin, Stratasys Ltd. - CEO & Director [24]

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We're not anticipating a decline in systems, Q4 represented a growth in our hardware business or system business, and we anticipate that that will continue to grow going into 2018. The first part of your question, sorry, I answered the second part. If you could just repeat the first part...

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Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [25]

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Yes, what the contribution that you're expecting to growth from new products is?

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Ilan Levin, Stratasys Ltd. - CEO & Director [26]

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So we've introduced a number of products in 2017. I think, in general, with our [space] and certainly in the current environment, where we're going in terms of manufacturing processes and tooling, adoption does take time. So I do anticipate that the products that came out in 2017 will continue to contribute positively in 2018, their growth story is certainly not over and ramp up times in many of the industries that we're looking at takes longer than that. So we're looking for growth from there. In addition, we do have products coming out in '18, but again once when we focus on the specific markets that we're looking at, it isn't the kind of consumer [advocate] adoption that you would see, it's a slower paced adoption. So I think most of the growth reliance would be coming from products that we've launched already, but get better and better traction from them throughout '18.

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Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [27]

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And Lilach, if I could ask what are you expecting for operating or free cash flow in 2018? And can you talk about the incremental CapEx or what specifically you are targeting with this incremental CapEx?

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Lilach Payorski, Stratasys Ltd. - CFO [28]

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From operating perspective, as we guided, we're expecting to have operating income between 4.5% to 6% for the year. Regarding CapEx, we guided between $40 million to $50 million. The incremental CapEx (inaudible) is coming to support our construction project here in Rehovot, our headquarter premises requires additional investment. So this is the incremental CapEx you can see year-over-year.

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Wamsi Mohan, BofA Merrill Lynch, Research Division - Director [29]

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And how about free cash flow?

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Lilach Payorski, Stratasys Ltd. - CFO [30]

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Yes, from a free cash flow perspective, specifically we do not provide these metrics, we do focus on cash and we were very pleased with the cash generated in Q4 and the entire year, we generated [$62] million for the entire 2017. We'll continue to focus on that going forward and looking [forward] to increase cash, but specifically to free cash, we are not presenting this -- we're not providing this metric.

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Operator [31]

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Our next question comes from the line of Brian Drab of William Blair.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [32]

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On Evolve, I'm not sure if I've missed it this morning but I was wondering if you could provide us an update on the progress that you're making within the Evolve subsidiary?

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Ilan Levin, Stratasys Ltd. - CEO & Director [33]

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So we're continuing to make progress there. It's a technology that we've been working on for several years. I think it also represents a significant opportunity to displace the plastic injection molding conventional techniques. And so we're still working on that development process and the systems related to that.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [34]

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And then also something -- I'm not sure if I missed, but I'm looking for more detail on -- maybe if you could rank the largest projects that are contributing to CapEx, I know you've listed some items here, but just those that specifically fall within CapEx spending, the largest [to the smallest]?

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Ilan Levin, Stratasys Ltd. - CEO & Director [35]

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Could you repeat the question again? We got a bit of an alarm here in the room that distracted us. So if you could repeat the question?

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [36]

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$40 million to $50 million in CapEx, just what are the biggest items contributing to that?

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Ilan Levin, Stratasys Ltd. - CEO & Director [37]

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$40 million for next year you are talking about? It's really hard to hear. Yes, the main element that impact this is our continuous investment in our construction project here in [May], headquarters in Israel.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [38]

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And specifically, what are you constructing is what I'm curious about, if you don't mind giving us some sense of what...

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Lilach Payorski, Stratasys Ltd. - CFO [39]

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We have a facility. We're building our headquarters here in Israel.

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Brian Paul Drab, William Blair & Company L.L.C., Research Division - Partner & Analyst [40]

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And is it manufacturing facility for a particular technology or consumables or all the above?

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Lilach Payorski, Stratasys Ltd. - CFO [41]

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It's our main premises for offices in R&D activities.

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Operator [42]

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Our next question is from the line of Greg Palm of Craig-Hallum Capital.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [43]

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I guess first, there's been a lot of chatter on the competitive landscape, HP's and [trends'] impact on the industry, so I was hoping you could just kind of address the broader competitive landscape and just tell us if it's an impact that you've seen directly or if you feel like it's maybe them specifically going after different use cases applications than you are.

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Ilan Levin, Stratasys Ltd. - CEO & Director [44]

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So certainly the competitive landscape is evolving as the market is maturing, a lot of new entrants from multiple different directions, certainly you've mentioned HP, I think, as leaders in this business for over 20 years, we are maturing as well with the market. And as I mentioned earlier, we're increasingly looking at our business according to market segments. When you look at the different market segments, different technologies specifically cater to different elements of the market. Though at Stratasys, we have a number of technologies, each of them catering or covering one or more of these markets. I think many of the entrants are coming in with a singular technology at this point and typically, obviously, will cater or lend themselves more to a specific market segment, not all of them do we play with in. So it isn't necessarily looked at [as] in a competitive landscape in a traditional sense. I think from an additive manufacturing perspective, this is very good for the industry. I think it adds validation to the concept of additive manufacturing and the general qualification and how it's applied to manufacturing and in that sense I view it as a positive. And it's all up to Stratasys, when it views its markets, how it can lead the sub-segments of the market in the best way it can.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [45]

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I get the sense that you're one of the only ones that is approaching the market by use case application. I mean, can you just talk about what the feedback is from customers? I mean, do you feel like you get sort of more deeply ingrained and that could maybe not accelerate sort of near-term adoption but longer term in terms of building relationships? I got a feel like that's a pretty good thing, right?

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Ilan Levin, Stratasys Ltd. - CEO & Director [46]

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So I think It even goes beyond the relationship, which is key to continuing the business with such as a customer. I think the reason I'm saying it goes beyond is that when we look at where we're are at, let's say, in advanced manufacturing with aerospace customers or in auto, we do sell to and have for years, to many of the OEM manufacturers, as well as many of their supply chain. So now the question is how do we get beyond prototyping, how do we get beyond some tooling applications, the initial manufacturing and work with them for qualification, for education within an organization to work on the design and therefore get more applications running through the systems. When you're in those discussions, I think I've mentioned this in previous calls as well, when you're in those discussions, it's not a question of competition, it's a question of moving the qualification process along, moving the design process internally within your organization and education with respect to a specific technology for a specific group of [parts]. And so that's where I view is the long fruitful hard work that we're doing today regularly and not so much selling the attributes of either FDM or PolyJet versus other technologies. Those industries, we need to be patient, they're used to this level of patience, that's what they do. I've recently visited customers in some of our sectors where qualification periods can take 2 to 4 years. And so we just need to be there and that's what this customer engagement from our perspective is all about.

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Gregory William Palm, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [47]

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And I guess as it relates to R&D and the increases there, I mean, is it safe to assume that some of the increase is related to commercialization of the Evolve platform? You mentioned other technologies outside metals but just want to confirm that.

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Ilan Levin, Stratasys Ltd. - CEO & Director [48]

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So we're not commenting right now on the commercialization or the timing of commercialization with the new technologies in general. But as we move them along in the development process, certainly the expenses related to the development process, particularly in materials and tooling as well as resources becomes more substantial and that's what that uptick is all about.

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Operator [49]

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Our next question is from the line of Ananda Baruah of Loop Capital.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [50]

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A couple from me if I could, Ilan, so do you feel given the progress that now you guys are sort of into what can be a revenue sort of accelerative dynamic? So you have your guidance for this year, but would it be possible to sort of see those levels increase for the next couple of years given new markets, given mix, given new platform?

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Ilan Levin, Stratasys Ltd. - CEO & Director [51]

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So I do feel very comfortable on the customer engagement side. I think we're putting the right things to place on that side. We're developing, I think, a very nice roadmap, technology roadmap and a product roadmap that more diversifies than we have for us in the past that you can address new addressable markets. As I previously said, some of the sub-segments where we're getting actually larger and larger orders, multiple machine orders, the qualification period still takes time. We're through those, Stratasys can be a full partner to them but we are dependent on specific processes within companies, but we're only seeing an increasingly strong level of engagement with those customers that lead us to believe that we're on the right path in terms that would lead us to the growth.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [52]

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So would that be -- so if I can kind of ask a question a different way given that, would that be what you guys would sort of see all things being equal as the impediment to greater and greater growth, kind of, in subsequent years would really be customer process and sort of deal completion process, to kind of encapsulate that? Is that really what it is? But do you guys feel like you have the right products in place and the right degree of customer engagement in place such that if the process can get handled in the right amount of time, you could actually see yourself entering into a dynamic where you have stronger and stronger growth in subsequent years?

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Ilan Levin, Stratasys Ltd. - CEO & Director [53]

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Yes, I would agree with those basic elements of customer engagement and of our comfort level that we have, good products, the right products today and as we've alluded in this call in terms of new technologies that would absolutely lead to our growth.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [54]

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And with regards to the incremental investing, my hunch is that you're probably going to maintain the incremental investing at least over the next couple of years. So can you sort of provide, I guess, like give us some signposts for what would allow you guys to increase the operating margins in subsequent years? Is this operating margin expansion past 2018? Is that entirely predicated on revenue growth, so you're just getting leverage and scale from that or would there be other things that could take place, that would allow the operating margin to expand past '18?

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Ilan Levin, Stratasys Ltd. - CEO & Director [55]

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So I think in general over the past year to 2 years, we've focused on internal focus on what we need to get done and that's, obviously, resulted in bringing down our OpEx significantly and I think making our financials healthier. When we're looking forward, I think what we've done over the past several months internally was gain a certain level of comfort of where we want to invest, where do we want to play from a technology and product perspective, and the incremental investments are around that and so we want to see this through. We're not now looking at how to tweak it and perhaps make our OpEx suitable to a given top line on a given day. What we're trying to do is focus very strongly on longer-term projects, see them through [fruition], because we do believe that they will lead us to stronger growth, hence we're very focused on that right now.

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [56]

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Okay. So it's really more of a growth focus. I just want to make sure that I've interpreted that accurately. And just one last one from me quickly, can you just repeat what we should expect -- what the tax expectation should be, I seemed to have missed that?

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Ilan Levin, Stratasys Ltd. - CEO & Director [57]

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Sorry, which expectation?

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Ananda Prosad Baruah, Loop Capital Markets LLC, Research Division - MD [58]

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Tax projection.

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Lilach Payorski, Stratasys Ltd. - CFO [59]

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So tax expectation, in 2018, we still remain a [U. S. tax flow] situation and we have the full valuation allowance, (inaudible) tax rate is not really indicative of how much tax is equivalent to the specific operating income that we have. Therefore, we do believe that operating margin is probably the best measure for us to measure the business and, therefore, we do not provide any specific measures around taxes.

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Operator [60]

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Our next question is from the line of Ben Rose of Battle Road Research.

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Ben Zion Rose, Battle Road Research Ltd. - Founder, President & Analyst [61]

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Few questions. I know that you have made some changes in the Far East in terms of management and so on. I was just wondering how things are progressing in the Far East and what your expectations are for the coming year.

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Ilan Levin, Stratasys Ltd. - CEO & Director [62]

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We have, in general, as we go deeper in customer engagement globally, we've endeavored to do the same within the Asia Pacific region and are specifically focused currently on China and Japan is 2 markets that we believe warrant our increased focus, but not -- I mean, those are the primary ones but not exclusive, it's not that we're not doing anything else in the other regions. And looking at that, we are bringing more, we are adding customer-facing activities to both of those regions in order to make it customized in a word or more suitable for those 2 specific markets. Certainly the competitive landscape for each are very different and the opportunities also in terms of adoption cycles are different for both those markets and we thought the best way to do that would be to address them in a very specific way and not in a unified global or cross-regional manner.

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Ben Zion Rose, Battle Road Research Ltd. - Founder, President & Analyst [63]

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And I know that in the past, you've discussed sort of the lag between systems sales picking up and seeing kind of a follow-through on consumable sales. And I'm wondering, with the pickup in systems this quarter, how you're feeling about the sale of consumables kind of broadly speaking coming into the rest of 2018?

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Ilan Levin, Stratasys Ltd. - CEO & Director [64]

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That really depends on who we're selling to and for what application. So a sale that would -- we would expect a higher rate of consumables coming out of the gate would be a systems that is going into an existing customer, who is using it, is ramping-up usage and needs more of our systems and then we're very comfortable that usage will be very strong coming out of the gate. If it's customers who are trying to sort of get an organization to adopt it and sometimes we get those kind of top-down decisions, then adoption can be very dependent on departments or specific organizations certainly within an industry. A great example of that might be an F123 Series sale, where we've seen organizations come in and -- design organizations or engineering organizations come in and place many different systems across the organization either to drive innovation, to drive product development cycles (inaudible) of the consumable or consumption of each of those systems is something that is very difficult to scale out, say, for maybe a statistical model that we would have, [in fact] working for many years. It could be very different across either product mix or specifically use cases in a customer base.

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Ben Zion Rose, Battle Road Research Ltd. - Founder, President & Analyst [65]

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And, sorry, just one final question from me. Thinking about the cash level that you have now, was curious to get your current thoughts, number one, on the prospect for acquisitions going forward. Looks like there's been a bit of a lull here vis-a-vis the last year or so in contrast to previous years in terms of the scope and the magnitude of acquisitions that you've done. So I guess, really the first question is, should we expect additional acquisitions into -- in addition to the R&D ramp-up that you have and then also if I could get your thoughts on a possible share repurchase going forward?

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Ilan Levin, Stratasys Ltd. - CEO & Director [66]

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So in general, I think, we're very much interested in building an ecosystem through partnerships, through investments by extending our reach in a multitude of ways, and some of that might be on the technology domain, on the application domains, on the go-to-market domain. I think we're very focused on doing those types of relationships, that doesn't mean we don't look or wouldn't look at opportunistic acquisition opportunities that are out there, but our primary focus is on building relationships, again, not only on the customer side, but in a variety of different ways and we would seek to make investments that would be able to enhance that ecosystem. We do not have any plans for any buyback at this point.

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Operator [67]

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Our next question is on the line of Christopher Van Horn of B. Riley FBR.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [68]

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This is Dan Drawbaugh on the line for Chris. Just to start, you have recently announced some additional solutions targeting the dental market and I think you noted earlier that the J700 has been seeing some positive reception trends. So do you -- focusing on that market in particular, do you see a share gain opportunity there, or is the opportunity for you more just an overall expansion of the market?

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Ilan Levin, Stratasys Ltd. - CEO & Director [69]

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So we believe that we could effect in a share gain. It's a high-end system, the J700. So we believe it does not appeal across the entire universe, in healthcare and I think I mentioned it in some of my earlier remarks, I think over the past year, we've gained a lot of clarity as to where we want to go in terms of application fit, where we want to go in terms of our go-to-market effort, so we're pretty clear internally and within that universe, we believe we can gain market share and also [having] developed long-term relationships for the future, which is what we're trying to do across all our businesses and not necessarily place many units of many, many different customers.

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [70]

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And then turning to the guidance, I think in previous quarters, you had flagged a bit of a shift towards some of the lower cost systems and sort of that mix had been a headwind to revenue. How are you contemplating that in 2018? Does that sort of flatten out at some point this year or is that continuing?

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Ilan Levin, Stratasys Ltd. - CEO & Director [71]

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No, so in the F123, which specifically appeals to kind of a personal desktop workgroup sub-segment of the market, we believe has a lot of growth in front of it, is widely untapped or only tapped partially at this point. It's all a question of the right exposure and the right product line in order to serve that market, I think, it's still evolving as a sub-segment and still has a lot of growth [ahead for].

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Christopher Ralph Van Horn, B. Riley FBR, Inc., Research Division - Analyst [72]

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Okay. So it sounds like there's positive volume in the future for F123?

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Ilan Levin, Stratasys Ltd. - CEO & Director [73]

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We believe, it still has -- we only launched in February/March of 2017. So we still have [room to go].

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Operator [74]

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Our next question is from the line of James Medvedeff of Cowen.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [75]

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Well, most of my questions have been answered, but I just have a couple of, I mean, housekeeping basis here, what was CapEx and depreciation for the full year of 2017?

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Lilach Payorski, Stratasys Ltd. - CFO [76]

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It was above $22 million, between $22 million and $25 million [supplement] this year.

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Ilan Levin, Stratasys Ltd. - CEO & Director [77]

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We can drop you [a note] and we'll give you a specific number.

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Unidentified Company Representative, [78]

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Will give you a specific number

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [79]

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So CapEx and depreciation right?

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Lilach Payorski, Stratasys Ltd. - CFO [80]

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(inaudible) depreciation.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [81]

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I do have a question on gross margin going forward. Mix currently is dragging them down, I guess let's start with (inaudible) on the services side, where you have so much growth in the support relative to the regular production of parts. Is that sort of a new level of gross margin for the services business, or like how should we think about that?

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Ilan Levin, Stratasys Ltd. - CEO & Director [82]

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The gross margin on the services side is also dependent on a little bit of technology and product mix within the service revenue, we have our parts business, as well as our system maintenance revenue within the [parts] business, which is primarily coming out of Stratasys' direct manufacturing, has a variety of technologies, not only our FDM and PolyJet technology as a service. So the gross margin there -- when we say product mix on the service side, it depends both on the system maintenance and FDM side and then within FDM, the different technologies in a given period that are being provided. Naturally, we would I think like to see a higher gross margin coming out of service, and so we're working on improving that continually.

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James David Medvedeff, Cowen and Company, LLC, Research Division - Associate [83]

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I just noted that it's been running [26%] plus or minus (technical difficulty)?

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Ilan Levin, Stratasys Ltd. - CEO & Director [84]

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You're breaking up a little bit on the line. I think we've got -- I'm not sure I got your question or maybe -- it was a little bit about the gross margins to date on the service side. We can speak offline a little bit in terms of just making sure that we're aligned in terms of the way we're looking at it over the past number of quarters, if you wish.

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Operator [85]

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Our next question is from the line of Hendi Susanto of Gabelli & Company.

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Hendi Susanto, G. Research, LLC - Research Analyst [86]

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[If we see the] materials growth and support growth in Q4, should we use that a baseline or in other words, what should your expectation be for 2018 supports and materials growth?

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Ilan Levin, Stratasys Ltd. - CEO & Director [87]

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So we don't break out specific growth on the different, if I understood you correctly, on the consumable side, on the growth going forward, end of Q4 the line was a bit choppy. And if we can be -- we should be using the Q4 metrics as a baseline going forward. So we don't break out those growth rates, again the performance in general between systems and consumables very highly dependent on product mix, certainly the hardware side could be a little bit lumpier as we move into larger and larger orders. So I'd be a little bit cautious to take any specific period as a benchmark for future forecasting.

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Operator [88]

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I do show that we have no further questions at this time. I'd like to turn the call back over to Ilan Levin, CEO, for closing remarks.

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Ilan Levin, Stratasys Ltd. - CEO & Director [89]

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Thank you for joining today's call, and we look forward to seeing you at the RAPID + TCT 3D Printing & Additive Manufacturing Conference in April and to speaking with you again next quarter. Thank you.

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Operator [90]

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Thank you, ladies and gentlemen, and thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.