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Edited Transcript of SSYS earnings conference call or presentation 9-Mar-17 1:30pm GMT

Thomson Reuters StreetEvents

Q4 2016 Stratasys Ltd Earnings Call

EDEN PRAIRIE Mar 9, 2017 (Thomson StreetEvents) -- Edited Transcript of Stratasys Ltd earnings conference call or presentation Thursday, March 9, 2017 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Shane Glenn

Stratasys Ltd. - VP, IR

* Ilan Levin

Stratasys Ltd. - CEO

* Lilach Payorski

Stratasys Ltd. - CFO

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Conference Call Participants

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* Wamsi Mohan

Bank ofAmerica Merrill Lynch - Analyst

* Troy Jensen

Piper Jaffray & Co. - Analyst

* Paul Coster

JP Morgan - Analyst

* Shannon Cross

Cross Research - Analyst

* Ken Wong

Citigroup - Analyst

* Sherri Scribner

Deutsche Bank - Analyst

* Rob Stone

Cowen and Company - Analyst

* Patrick Newton

Stifel Nicolaus - Analyst

* Timur Ivannikov

Jefferies LLC - Analyst

* Weston Twigg

Pacific Crest Securities - Analyst

* Brian Drab

William Blair - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen. Welcome to the Stratasys Q4 2016 earnings conference call.

(Operator Instructions)

I would now like to introduce your host for today's conference call Mr. Shane Glenn, Vice President of Investor Relations. You may begin.

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Shane Glenn, Stratasys Ltd. - VP, IR [2]

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Thanks, Kevin. Good morning, everyone, and 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 of Stratasys.

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

We will begin by reminding everyone that certain statements made on this call regarding Stratasys' strategy and the statements regarding its projected future financial performance, including the financial guidance concerning its expected results for 2017, are forward-looking statements reflecting management's current expectations and beliefs. These forward-looking statements are based on current information that is by its nature subject to rapid and even abrupt change.

Due to the risks and uncertainties associated with Stratasys' business, actual results could differ materially from those projected or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to: any failure to efficiently and successfully integrate the operations of Stratasys and various entities that it has acquired including MakerBot, Solid Concept, Harvest and GrabCAD or to successfully establish and execute effective post-acquisition integration plans; changes in the overall global 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 in 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 in our profitability due to shifts in our product mix into lower margin products or shifts in our revenue mix significantly toward our additive manufacturing services business; costs and potential liability relating to litigation and regulatory proceedings; and those factors referred to in Item 3.D Key Information -- Risk Factors; Item 4, information on the Company; and Item 5, operating and financial review and prospects in our 2015 annual report together with the 2016 annual report that we will file soon as well as the 2016 annual report generally.

Readers are urged to carefully review and consider the various disclosures made throughout the Form 20-F and Stratasys' other reports filed with or furnished to the SEC, which are designed to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects. Any guidance provided and other forward-looking statements made on this call are made as of the date hereof and Stratasys undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise except as required by law.

As in previous quarters today's call will include 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 and GAAP reconciliations are provided in the table contained in our slide presentation and 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 [3]

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Thank you, Shane. Good morning everyone and thank you for joining today's call. Our fourth-quarter results reflect our ongoing efforts to focus and improve our customer engagement and product development.

Our levels of revenue combined with our ongoing efforts to better align our cost structure contributed to a significant improvement in operating profit and cash generation during the period. We are also making significant progress in transforming our business into a more customer-centric organization that emphasizes leveraging our extensive technology and application knowledge into value-added solutions for users within key vertical markets. This renewed focus is being supported by an increasing number of high-profile collaborations we have recently announced with industry-leading manufacturing companies such as Siemens, Airbus, McLaren Racing and Team Penske.

Additionally, we recently launched significant new products and implemented organization changes at MakerBot that will better position us to focus on the entry-level professional rapid prototyping segment of our industry.

I will return later in the call to provide you more details on these important initiatives as well as other key developments. But first it's a pleasure for me to introduce our new 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. As some of you may know I have been with the Company for over four years and it is indeed a pleasure to join the call this morning as the new CFO of Stratasys. We are pleased with our fourth-quarter results which include growth in recurring revenue that demonstrates strong utilization of our installed base of systems.

This stable growth in recurring revenue combined with our ongoing efforts to better align our cost structure has resulted in improved operating profit and cash generation. As a result, both our non-GAAP gross margin and non-GAAP operating margin improved significantly over the same period last year.

Total revenue in the fourth quarter was $175.3 million compared to $173.4 million for the same period last year. GAAP operating loss for the fourth quarter was $29.2 million compared to a loss of $187.8 million for the fourth quarter last year. Non-GAAP operating income was $11.6 million compared to a loss of $8.9 million for the same period last year.

Product revenue in the fourth quarter increased by 2% to $127 million as compared to the same period last year. Within product revenue, system revenue for the quarter declined by 4% over the same period last year driven primarily by the level of overall market demand we have discussed previously.

However, we observed favorable trends around system utilization as well as strong demand for our premium materials which contributed to consumables revenue increasing by 11% as compared to the same period last year. The growth in our premium materials supports our focus on specific value-added solutions with target industry markets. Service revenue in the fourth quarter was relatively flat at $49 million as 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 8% compared to the same period last year, driven primarily by growth in our installed base of systems. Our service revenue was negatively impacted by a decline in revenue for conventional manufacturing services within our Stratasys Direct Manufacturing business as we put greater strategic focus on additive manufacturing offerings.

GAAP gross margin improved to 47.3% for the fourth quarter compared to a GAAP gross margin of 30.6% for the same period last year. Non-GAAP gross margin improved to 53.6% for the fourth quarter compared to 48.1% for the same period last year.

Product gross margin improved significantly, driven by a shift in our sales mix towards high-end product, cost control efforts in operations and improved production efficiency. Service gross margin also improved compared to the same period last year, helped by our cost control efforts.

GAAP operating expenses decreased by 53% to $112 million for the fourth quarter as compared to the same period last year. Non-GAAP operating expenses decreased by 11% to $82 million for the fourth quarter as compared to the same period last year.

These favorable trends in operating expenses over the last year reflect the positive impact of our overall focus on improving efficiencies across the Company. These cost efficiencies are in line with our long-term growth strategy which also includes increased investments in areas we view as critical for long-term growth and productivity.

I'm pleased to report that cash flow generated from operations increased significantly over the year. The Company generated $26 million of cash from operations during the fourth quarter as compared to $7.7 million for the fourth quarter last year and generated $62 million in cash for the full-year 2016 as compared to cash usage of $21.9 million during 2015.

We ended the year with $280.3 million in cash and cash equivalents. Inventory at the end of the fourth quarter decreased to $117.5 million as compared to $123.7 million at the end of 2015 as we maintain tight control on inventory levels. Accounts receivable decreased to $120.4 million compared to $123.2 million at the end of 2015 with DSO on 12-month trailing revenue steady at 65.

In summary, in the fourth quarter we improved our operational performance, leading to improvements in both non-GAAP gross margin and operating income over last year. We observed strong growth of our recurring product and service contract revenue which represents high system utilization and demand for our premium materials.

Going forward we will remain focused on investing in value-added solutions within key target markets with aligning costs and resources towards achieving our long-term goals. Finally, we are pleased with our cash position which will enable us to capitalize on emerging opportunities going forward.

I would like now to turn the call over to our VP of Investor Relations Shane Glenn who will provide you greater details on our 2017 financial guidance. Shane?

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Shane Glenn, Stratasys Ltd. - VP, IR [5]

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Thank you, Lilach. Our guidance for 2017 is as follows.

Total revenue in the rage of $645 million to $680 million with non-GAAP net income in the range of $10 million to $20 million or $0.19 to $0.37 per diluted share. GAAP net loss of $53 million to $39 million or $1 to $0.73 per basic share.

Non-GAAP operating margins of 3% to 5%. And capital expenditures are projected to be $40 million to $50 million.

Non-GAAP earnings guidance excludes $34 million of projected amortization of intangible assets, $18 million to $20 million of share-based compensation expense, $2 million to $3 million in merger and acquisition-related expense and $8 million to $10 million in reorganization and other related costs and includes $3 million to $4 million in tax expenses related to non-GAAP adjustments. We maintain a relatively high estimated non-GAAP tax rate for 2017 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 in the future, and we do continue to 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 US losses, US net income losses the Company believes non-GAAP operating profit would be the best measure of performance in 2017. Appropriate reconciliations between GAAP and non-GAAP financial measures are provided in a table at the end of our press release and slide presentation that has itemized details of the non-GAAP financial measures.

Now I'd like to turn the call back over to our CEO, Ilan Levin. Ilan?

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Ilan Levin, Stratasys Ltd. - CEO [6]

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Thank you, Shane. In 2017 we are focused on better allocating our resources to achieve our long-term goals. Our industry is continually maturing and moving beyond general purpose design and engineering rapid prototyping into use cases that target specific high value-added applications within key industry segments ranging from advanced prototyping through to production tooling and production part manufacturing applications.

Today we are reallocating resources from a general-purpose one-size-fits-all development strategy and further emphasizing key customer engagements with development projects closely associated with their needs. By leveraging our extensive technology and application knowledge with our drive to build deep high quality and lasting customer relationships we are able to provide increased value to the market.

As we make this transition, we will continue to make the necessary changes to our organizational structure that will help us to achieve these long-term goals. As the market matures Stratasys is focused on investing in products that provide value-added applications and solutions for our customers. We aim to accomplish this by leveraging the core elements of our technology portfolio and extensive knowledge base within our organization.

We believe our core FDM and PolyJet technologies provide some of the markets most stable and proven platforms that have significant additional potential to unlock and develop. For example, we recently announced our new Nylon 12CF material for our FDM platforms. Nylon 12CF is a new carbon-fiber-filled thermoplastic that is strong enough to replace metal in many applications.

We believe the new material will be valuable to users within the automotive, aerospace, recreational goods and industrial manufacturing sectors for applications such as design engineers that need to rapidly produce strong, lightweight and rigid components for functional prototyping, thus reducing time to market for new product; manufacturing engineers that produce assembly aids such as jigs and fixtures where material stiffness and strength add value and where replacement of metal is desired; and manufacturing engineers, making low-volume production parts with unique structural requirements where high-strength is required. As we prioritize our investments, we are emphasizing product and application development based on clear customer or segment feedback and insights specifically within our target markets of aerospace, automotive, healthcare and education.

We believe that the enhanced value resulting from these investments provides significant opportunities within these verticals for rapid prototyping, professional design, tooling and advanced manufacturing applications. For example, at the newly designated Stratasys-supported Center of Excellence at the Jacobs Institute, physicians have been utilizing our PolyJet 3D printing solutions to develop treatment plans for life-threatening vascular issues such as aneurysms, stroke and blood clots. In addition to making exact models to match specific patients, our technology is being used to create anatomical models for medical training as well as to develop trial runs for new treatment protocols, adding significant value by providing physicians a completely new process to address these applications.

We believe these initiatives and renewed focus will improve our quality of revenue going forward and better position the Company for long-term, sustainable growth.

A critical part of our strategy is our ability to collaborate with our customers, particularly for production tooling and advanced manufacturing applications. We have made several recent announcements regarding exciting initiatives with industry-leading manufacturing companies. We have expanded our relationship with Siemens to pursue the integration between Siemens Digital Factory and Stratasys' Additive Manufacturing solutions to create a cohesive best-of-breed technology foundation that enables large-scale manufacturers to enjoy the benefits of additive manufacturing within traditional production environments.

Within the automotive segment we announced that Stratasys has been named the official supplier of 3D printing solutions to the McLaren-Honda Formula 1 team to provide our suite of 3D printing and additive manufacturing solutions for visual and functional prototyping, production and composite tooling and customized production of parts. We also entered into a technical collaboration with Team Penske to provide 3D printing solutions for NASCAR and IndyCar engineering and manufacturing applications. As I hope you can see, we are committed to working with our customers to develop solutions that can provide value across a wide range of applications and industries.

While the rapid prototyping segment of our industry is the most developed, we believe that by providing enhanced value for this market we can develop further growth. We believe providing ease-of-use while also providing engineering quality models together with enhanced workflow software are key value components for the professional engineer or designer.

To further our leadership position in the rapid prototyping segment we recently introduced the Stratasys F123 Series for professional rapid prototyping. The new series of FDM systems are optimized for the complete prototyping workflow from initial concept validation to design validation to functional performance testing. The new solutions address the needs of the professional workgroup-prototyping market with a unique combination of office usability, precision, repeatability and affordability, all without compromising on the requirements for engineering quality models.

The F123 series benefits from 43 existing patents leveraging the best of our current and proven production portfolio and 15 patents pending featuring engineering that is exclusive to the F123 series. For the first time we are enabling customers to print low-cost concept models in a high-end professional 3D printer by offering PLA materials alongside our thermoplastic materials. PLA enables a cost effective and fast draft mode, saving customers up to 10 times the cost per part and doubling the print speed compared to other materials.

Material changeover is significantly faster than our previous models, allowing users to take advantage of the four material options and 10 color choices with reduced downtime. The F123 series features a streamlined workflow with GrabCAD Print making 3D printing more realistic, connected and accessible. GrabCAD Print eliminates the pain points and time wasted on file conversions by reading native CAD files and connecting directly to the F123 series, enabling increased productivity with print management and remote print monitoring.

Overall, we believe the new F123 series is the most reliable, economical and intelligent rapid prototyping solution on the professional market today.

In addition to continuing ongoing development of the professional rapid prototyping segment we believe that there is a strategic value in capturing entry-level users within the desktop segment where we can provide differentiated value. We believe MakerBot maintains the leading desktop brand with the most developed software ecosystem within the industry.

We recently implemented organizational changes at MakerBot that we believe will narrow our focus on development efforts for the entry-level professional. We remain confident in the long-term opportunity in the desktop segment and will continue to invest in products that serve the entry-level professional and education markets.

In summary, we are making significant progress in transforming our business into a more customer-centric organization, providing value-added solutions for users within our key vertical markets. We are focused on leveraging our extensive knowledge and capabilities to build deep, high-quality and lasting relationships where we are able to provide value to our customers.

We are pleased with the initial reception of the F123 series and believe that the rapid prototyping space remains an attractive opportunity from entry-level to professional users. We will continue to expand our collaborative relationships with key global manufacturing companies that can help advance our overall strategy.

Moving forward, we are focused on better allocating our resources to achieve our long-term goals and we remain excited about the Company's future and the long-term growth potential within our industry.

Operator, please open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Wamsi Mohan, Bank of America Merrill Lynch.

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Wamsi Mohan, Bank ofAmerica Merrill Lynch - Analyst [2]

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Yes, thank you, good morning. When you look at the high end of 2017 guidance, all the metrics are up slightly but the leverage really does not seem to be coming through in terms of increase in operating income dollars.

Do you think there is significantly more room to take down the cost structure? Where do you see those opportunities specifically within COGS and OpEx and is part of the reason that we are not seeing this leverage is a continued high base of investment? And I have a follow-up, thank you.

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Ilan Levin, Stratasys Ltd. - CEO [3]

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So we are looking at always shifting our resources in line with our strategy. So if we are looking at a greater customer engagement all across the Company we are looking to free up resources and to move them into those engagements. And the last thing I think that we want to do is frustrate those efforts and not invest adequately so that we don't gain the benefit in the medium to long term.

So I think that is our key focus. We have been focused in the past more on cost reduction, and I think now it's a primary focus on the reallocation of those resources to where we need to put them. Obviously, we always continue to monitor the expenses going forward and make necessary changes up or down as the business moves along.

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Wamsi Mohan, Bank ofAmerica Merrill Lynch - Analyst [4]

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Thanks Ilan. And as my follow-up, you did outperform in the quarter on revenue and your system revenue declines have somewhat stabilized. But your revenue guide is largely flat to down in 2017 versus your competitor who thinks it's going to be up low to mid single digits.

Are you concerned around share loss as this reallocation as you said of resources to deemphasize maybe certain areas of the addressable market? Or are you just thinking that the market growth rate is basically going to remain quite challenged going into 2017? Thank you.

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Ilan Levin, Stratasys Ltd. - CEO [5]

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So we are encouraged about the quarter's results. We are also encouraged by what we are doing with specific customer engagement. That said, it's a little bit difficult for us to model in the immediate term actual revenue realization from those customer engagements.

Just to give all of you a sense that these customer engagements are a little bit different in nature than we have been doing in the past, we have sometimes or more often now multiple system orders in front of us or larger proposals outstanding than we have typically had in the past. So the timing of those types of deals and the probability of them landing in any specific period is harder for us to gauge.

So I think it's less of what we are seeing in the market in general or trying to make judgments on the market, but actually looking at it from what we are doing with specific customers, what we have in front of us and I wouldn't say difficulty but our uncertainty as to when that would drop and how it will look for the remainder of the year. There are some areas of our business that have been seeing a decline, and I don't think they are in any of the areas that we are trying to emphasize. So where we are trying to put our dollars in emphasis I think we are seeing good potential for growth.

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Wamsi Mohan, Bank ofAmerica Merrill Lynch - Analyst [6]

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Thank you.

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Operator [7]

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Troy Jensen, Piper Jaffray.

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Troy Jensen, Piper Jaffray & Co. - Analyst [8]

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Hey gentlemen, ladies, thanks for taking my question here. Maybe first, just for Ilan, diving into R&D I guess my sense is Stratasys is trying to get deeper into FDM and PolyJet technology now. And historically you know that I have been a believer that you guys are going to introduce metals or high-speed sintering or you have the five Skunkworks projects that you talked about.

So I would just be curious to know if the focus has changed and like two or three years from now how many new technologies will you guys have introduced. Or is all the development more on just really getting deep in FDM and PolyJet?

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Ilan Levin, Stratasys Ltd. - CEO [9]

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So naturally as a basis we feel very comfortable with both PolyJet and FDM. And when we engage our customers increasingly, specifically on tooling or on manufacturing opportunities, we see a very strong pull based on the FDM and PolyJet technologies. So there's no reason for us to feel that we don't have a very bright future and a lot of good things to do within those technologies.

We do work on others, as well. We do have projects outside of those two spheres that we are maintaining. We believe that they can also be brought in and sometimes even complement what we are doing in FDM and PolyJet.

But I think the two demonstrators, as an example, that we exhibited back in September at IMTS on the Robotic Composite and Infinite-Build are good examples of where we can continue to take our current well proven, stable technologies a long way going forward. So we are feeling very, very comfortable about those two technologies right now.

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Troy Jensen, Piper Jaffray & Co. - Analyst [10]

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All right, understood. And Ilan, just a follow-up on the material development, so this carbon fiber nylon sounds pretty interesting. Just wondering if you could help us think about the ramp of that?

And historically ULTEM was a great new product or material that you introduced that kickstarted some new applications for FDM. So can you just give us an example of the ramp we've seen with other important materials like this?

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Ilan Levin, Stratasys Ltd. - CEO [11]

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So in line with our strategy in general when we are looking more now at focused applications it's more important for us to get traction within a specific application, within a more, a narrower customer base. We are looking at it less in terms of quantity out of the gate, we are looking more at how much are these materials appreciated, what are the applications that they are best suited for and I think we are very in a very exacting way looking at the traction within specific customers, typically our beta customers but also our first, early adopters of how they are looking at it.

So if we look at the nylon we have some customers who are very excited about it and are tracking very nicely. So it's more we are looking at it on a very, very specific basis rather than on a scale basis. And we believe that's the right way because then we go back to market to visit other customers we have a lot more not only validation but we have a much better understanding of the application fit, and we think that's where the value is right now in the market going forward.

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Troy Jensen, Piper Jaffray & Co. - Analyst [12]

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Understood. All right guys, good luck this year.

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Operator [13]

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Paul Coster, JPMorgan.

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Paul Coster, JP Morgan - Analyst [14]

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Yes, thanks for taking my question, Ilan. So it's been a while now that you've been engaged with some of these customers on these more vertical solutions. I think maybe your predecessor or maybe you committed to it being sort of an 18 months to two-year timeline before we saw the projects really kick in.

Well, getting closer now and I'm wondering can you give us some sense of the level of engagement? Do you have staff co-located, how much skin in the game do your partners have in these additive manufacturing innovations? Thank you.

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Ilan Levin, Stratasys Ltd. - CEO [15]

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Hi, Paul. So we can look at it from a number of different aspects. If we look at what we have been doing in aerospace, specifically with Boeing for example or Airbus it's been, obviously, a lot longer than 18 months.

Our relationship with Boeing dates back a good number of years. And I think that's brought out a lot of good products, not only for them as a customer for aerospace but also just in general in the market.

So there's a lot of value that we see in the deeper engagement, specifically with traction. Those customers we absolutely see a ramp up and increased adoption. As we have announced earlier parts on certain Airbus aircraft now have FDM parts that are printed with our technology that's been certified both from a material perspective, a process perspective and so we are already benefiting from that and from that growth.

In general, with respect to engagement on the customer side and your question is how much skin in the game, I'm very pleased with the increasingly senior engagement we are getting from our customers. It's not atypical now that we are speaking to C levels even with organizations that are much larger than we are.

I think that is a sign of the maturity of the industry and the readiness for adoption in general. What is exciting me is that many of that C level engagement is a result of those customers being familiar with our technology, so it's not something that's new. We are not necessarily coming in and evangelizing 3D printing or our technology.

It's more of they are very often understand our technology sometimes equally to us and then there's a meaningful dialogue of how to take it to the next level. As I have alluded to in the previous question, our demonstrators is a great testament to that. That was in response to looking at our, in that case, FDM technology and understanding where we could take it and that was very much directed by our customers equally then to us, ourselves.

So I think in that respect there's a lot of engagement, there's a lot of seriousness from our customers. I think it's now more of putting the development plans around it and executing in order to deliver on the promise.

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Paul Coster, JP Morgan - Analyst [16]

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Okay, got it. At the lower level, are the engineers kind of co-located, is there any sharing of intellectual property or even budget?

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Ilan Levin, Stratasys Ltd. - CEO [17]

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It can include any of that. In general with respect to the IP what we are providing is clearly demarked, so we feel very comfortable in what we are providing and the value that we are generating around it.

But the partnership is very, very intense in some of the cases, and there's a lot of back and forth. But we think it's all a net add for us in terms of delivering that value.

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Paul Coster, JP Morgan - Analyst [18]

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All right. Thanks very much. Appreciate it.

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Operator [19]

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Shannon Cross, Cross Research.

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Shannon Cross, Cross Research - Analyst [20]

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Thank you very much for taking my question. Ilan, can you maybe go back, you've been there about nine months now I think and just give us an idea of maybe your perspective on what you've seen at the Company, what surprised you, what you think, maybe more like a 50-foot level? And I'm curious as to as you have looked at things and gone through back-office systems, your salesforce, whatever, just maybe a holistic commentary on what you have seen within the business surprised you, disappointed you as you have gone through it?

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Ilan Levin, Stratasys Ltd. - CEO [21]

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So I have been involved with the Company for many, many years, predating even the Stratasys-Objet merger, so nothing really surprised me. I've been very, very close to the Company for many, many years.

As we are implementing the strategy and reacting to what we see as a maturity of the market we are, obviously, transitioning and it's not so much a question of the surprise, it's moving away from, as you mentioned, back-office processes that might have been designed and catered to increase scale. And we are putting in now systems and methodologies in order to deepen our relationships with either specific industries or specific customers.

And you see it I think in the recent announcements where we are gaining traction with specific customers, we are highlighting them internally and externally to the market. We think it's a great leadership statement about Stratasys.

And so on the inside of the organization, and as you said, the processes we are trying to change those in order to cater to those types of relationships, that style of business where the quality of revenue I think will be further out, will be at a higher quality and less on the scale of single product meeting all market needs and working the business that way.

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Shannon Cross, Cross Research - Analyst [22]

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And then more specifically, can you talk a bit about pricing? Curious as to what you are seeing both on the supplies and from a product perspective? I'm sure some of it is driven from a competitive standpoint, but then also just what your customers are saying about their willingness to pay list versus discounting?

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Ilan Levin, Stratasys Ltd. - CEO [23]

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So as we continue this customer engagement journey and as we continually provide increased value as we have alluded to I think in the scripted remarks that our premium materials, meaning premium value, are being very well received by the market and I think customers are pushing us even higher on that. And I think there's a general understanding very much so in the target markets like aerospace, high-end automotive, healthcare is that the value that is being injected into the product that is really a requirement from our customers that there is an associated cost and price with that. So I don't see the issue of a discount, I see Stratasys' role as providing the extra value and getting that in return because we are really investing in our products.

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Shannon Cross, Cross Research - Analyst [24]

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Great, thank you very much.

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Operator [25]

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Ken Wong, Citigroup.

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Ken Wong, Citigroup - Analyst [26]

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Hi, guys. So Ilan and Lilach, this is your first official guide that you guys crafted as a management team. How should we think about the business inputs, the thought process, maybe even the level of conservatism that you guys built into this particular forecast?

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Ilan Levin, Stratasys Ltd. - CEO [27]

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So, obviously, we are working on what we are seeing throughout 2016 and the quarter. We are pleased with the uptake in consumable consumption in general which does point to strong utilization of our system, so we are very encouraged by that. When we put it all together we look at it both from an industry perspective and pipeline customer perspective.

I think that's primarily the way we look at it. And we are, as we said before, I said before, deemphasizing certain elements of our business that we do not believe lead to strong customer engagement. And so when we put that altogether the guidance we came up with is what we presented.

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Ken Wong, Citigroup - Analyst [28]

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Got it. And then I guess a second part, maybe this is for Lilach, the operating cash flow the [$60] million which I believe is a high for you guys, that is quite impressive, any color on how cash flow might trend in fiscal 2017?

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Lilach Payorski, Stratasys Ltd. - CFO [29]

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As we said, we are pleased with our cash generation in the fourth quarter. We always evaluate an opportunity to drive cost efficiency and improve our cash flow generating. Going forward we definitely emphasize on that going into 2017, but specifically the level of the cash flow we anticipated will be probably something similar as what we saw in 2016.

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Ken Wong, Citigroup - Analyst [30]

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Got it. Thank you very much, guys.

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Operator [31]

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Sherri Scribner, Deutsche Bank.

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Sherri Scribner, Deutsche Bank - Analyst [32]

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Hi, thank you. Just thinking about the business overall, it seems like the system business continues to decline but you saw better performance on the materials, obviously, as you emphasized those more advanced materials.

Is it important from your perspective to be driving systems growth longer term and do you expect potentially systems to recover? Or is it more important to focus on better utilization of those products and driving the materials through those systems?

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Ilan Levin, Stratasys Ltd. - CEO [33]

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Well, pretty much goes hand in hand. So as we see increased utilization we expect to see increased hardware and chicken and the egg and the other way around, as well. So what we are trying to drive is as I said clearly focusing in on a application within a customer, ticking the box to make sure that we are satisfying those needs, making sure ensuring that there is traction, meaning that whatever hardware we have provided, whatever systems we have provided they are consuming the right levels of hopefully premium materials because that's typically what applications are driving. And then we can come in and as their business ramps we can benefit from that increase, as well.

So it's very much not what drives one or the other, it's the application that drives. And the greater clarity that we are presenting, the opportunity and the greater embracing that the customer does, we are all better off both in terms of systems and material consumption.

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Sherri Scribner, Deutsche Bank - Analyst [34]

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Okay, that's helpful. And then thinking about the business, historically there has been a lot of prototyping business with your business but some of your new applications and some of the specific customers that you are talking about sounds like finished parts than pieces in airplanes.

Can you talk a little bit about your perception of how much more opportunity there is in the prototyping segment of the market? It seems like there's still a lot of opportunity in finished parts and what is your strategy in terms of emphasizing those or is it more about different applications? Thanks.

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Ilan Levin, Stratasys Ltd. - CEO [35]

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So on the prototyping side I think our F123 system is adding a lot of usability into it. I think by adding PLA we are really broadening the market quite a bit there. And it's still very much of an engineering package and the high-end materials that are running through the F123 are still providing a very professional experience for those set of users.

So I think there's a good opportunity there. And I think that that trend of providing perhaps an all-in-one package and driving the affordability, driving the accessibility further and further is a very, very interesting opportunity.

If we look on the MakerBot side with its leading brand in software ecosystem they are providing similar attributes but from the bottom. And I think both, from both angles that entire segment still has a tremendous growth opportunity. Stratasys and as an industry we need to incrementally and then step function at times improve what we are bringing to the market, and I think that there's a lot of room to grow there.

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Operator [36]

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Rob Stone, Cowen and Company.

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Rob Stone, Cowen and Company - Analyst [37]

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Hi, thanks for taking my question. I wanted to ask a little bit more color on the fourth quarter and how that feeds into your guidance. Within the 4% decline in systems, can you comment at all on how that broke down between desktop and industrial?

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Ilan Levin, Stratasys Ltd. - CEO [38]

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So we don't break down the product revenues into different product families. Just as a general comment, despite the slight decline in system revenues that decline is less dramatic than we've seen in past quarters over the past year, year and a half. So we are hopeful and encouraged that system rates are climbing back up, system attach rates are climbing back up and the traction there is a little bit better.

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Rob Stone, Cowen and Company - Analyst [39]

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Okay. My follow-up question relates to how you are thinking about that implied within your guidance?

If consumables and customer support keep naturally growing along with the installed base, does your roughly flattish revenue guide at the midpoint imply a similar offsetting decline in system sales? And can you give any color, you talked about larger orders, can you give any color on the duration of the sales cycle now versus what you saw maybe a year ago? Thanks.

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Ilan Levin, Stratasys Ltd. - CEO [40]

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So with respect to the guidance in general, as I have alluded to in my previous remarks we are deemphasizing parts of our business. Just as an example, we have the conventional manufacturing services part within our FDM business that is experiencing a decline. That kind of area may continue to decline as a result of our strategic focus.

So where we are putting our efforts and where we are putting customer engagement it's not that we are anticipating a decline, it's just maybe a question of how do we time the revenues as they come. And with respect to sales cycle in general, it very much depends on the system. I think the early reception of our F123 series, obviously, alludes to a shorter sales cycle because of the size of the system and the cost of the system.

As we go to our more industrial systems, obviously, the sales cycles can be a little bit longer. But the good side on that is we are seeing more multiple system orders, proposals outstanding, and it's a very nice opportunity there because once embraced as a technology or as a process for a specific application, and as I said before it ramps up as the business ramps up at one of our customers. So that's a nice opportunity.

And then when you feed that all into the guidance it is a question of how do we project the immediate-term actual revenues out of those opportunities.

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Rob Stone, Cowen and Company - Analyst [41]

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So it's really more uncertainty around timing than anything else it sounds like.

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Ilan Levin, Stratasys Ltd. - CEO [42]

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Yes, we feel comfortable that when we engage customers we are in meaningful dialogue not as to a specific sale but a meaningful dialogue of the application match. And we are finding increasing number of places where we can make a value impact. So, again, it's not as if we were as an industry perhaps evangelizing the importance of 3D printing or how it can come into play in a business, but rather now it's a lot more around the specifics of how does it ramp up, they understand the technology more, and so those are far more rewarding conversations than perhaps we used to have several years ago.

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Rob Stone, Cowen and Company - Analyst [43]

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That's helpful. Thank you.

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Operator [44]

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Patrick Newton, Stifel.

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Patrick Newton, Stifel Nicolaus - Analyst [45]

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Yes, thank you, good morning. Thank you for taking my questions.

I guess first for Lilach on gross margin, focusing on products and services, on the product front you said that the increase was due to mix towards the high-end. I'm curious if that shift is fully embedded into results or if we should expect to see ongoing tailwind from product gross margin in the coming quarters?

And then on the service gross margin it's been on a downward trajectory over the last several years. Is there any reasonable gross margin range looking out over the long term that you think you could inform us of?

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Lilach Payorski, Stratasys Ltd. - CFO [46]

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Good morning. We have not provided guidance specifically for the gross margin, but we do expect gross margin to remain relatively stable going forward. You touch on both, either on product and also on services we encouraged by the fact that we have a shift towards high-end product and definitely will take a place in our gross margin going forward as well as our initiatives around cost cutting around the services. But I would expect to see similar trends going into 2017.

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Patrick Newton, Stifel Nicolaus - Analyst [47]

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Thank you. I guess as my follow-up for Ilan, you had previously spoken to some lower-end printers from a number of competitors negatively impacting some of your more midrange solutions. I'm curious if you can comment on any changes to that trend and is there an acceleration of this headwind that might be at least partially embedded into the 2017 guidance?

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Ilan Levin, Stratasys Ltd. - CEO [48]

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I don't see there's dramatically different trends in the market what we have seen over the past number of quarters. With respect to Stratasys and its product line, I think the F123 series, which is a new product line for us, positions us well at the entry-level for quality engineering grade prototyping application. So we think we are introducing a nice dynamic into the market with the new product.

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Patrick Newton, Stifel Nicolaus - Analyst [49]

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Great, thank you for taking my questions. Good luck.

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Operator [50]

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James Kisner, Jefferies.

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Timur Ivannikov, Jefferies LLC - Analyst [51]

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Good morning, this is Timur Ivannikov on for James Kisner. Could you provide more color on services?

Revenue was flat, and you said you have been more focused on additive manufacturing versus traditional. And could you talk more about what you did there and when you expect to return back to growth? Thank you.

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Ilan Levin, Stratasys Ltd. - CEO [52]

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So our services revenue includes both our system maintenance revenue and revenues that are associated with our Direct Manufacturing FDM business. Within FDM we are beginning to see, and that was the reason we decided back to require it, was we're beginning to see more and more elements of synergy between what Stratasys is providing and what FDM is providing.

To date, they have been run pretty much as separate businesses. And I think that we are beginning or we are striving to, anecdotally, provide services of full nature to specific customers. And as we at Stratasys increase our customer engagement we are able to bring in FDM.

Right now it's a sporadic, anecdotal basis. But I think there is some very good stories that are coming out of it for very high added value customers that are looking for either offloading capacity or as instead of buying even systems first using or as they ramp up their business using the services of FDM.

So for us it's more not a question of specifically the growth of any one unit. It's how we can serve our customers better. And we believe that as we get closer to our customer and deliver the right service to them or the right business model for them, Stratasys in general benefits.

And I think as we move forward we are going to be looking at it more on an industry- and customer-specific basis rather than a different unit and its financial metric performance.

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Timur Ivannikov, Jefferies LLC - Analyst [53]

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All right. And are you expecting to make additional investments into, let's say, a project-based management of this service contracts?

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Ilan Levin, Stratasys Ltd. - CEO [54]

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Could you repeat that?

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Timur Ivannikov, Jefferies LLC - Analyst [55]

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Yes, so one of your competitors they are looking into doing project-based management of service relationships when they engage with a customer. It seems like I haven't heard anything formal from you, so just asking (multiple speakers)

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Ilan Levin, Stratasys Ltd. - CEO [56]

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So we've had different parts of the organization doing like services in the past. Today we have put that all together into what we call our expert services unit and we do absolutely that, which is provide consulting services to our customers either about re-additive manufacturing in general or services directly related to our technology and how to appropriately find applications fits within the organization. So we absolutely do have something like that, and that's basically more to provide a better service to our customers than looking at it as an independent unit within Stratasys.

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Operator [57]

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Weston Twigg, Pacific Crest.

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Weston Twigg, Pacific Crest Securities - Analyst [58]

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Hi, yes, thanks for taking my question. First, just wondering, you mentioned that you are trying to better allocate resources to achieve your long-term goals, but I haven't heard to outline those goals recently, maybe not since 2015. So I was just wondering if you could use this call is an opportunity to provide us an update on your long-term goals?

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Ilan Levin, Stratasys Ltd. - CEO [59]

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So we are absolutely moving to something that's more customer-centric and that's more application-centric. I think we were in the past, the industry in general and Stratasys included were very system-oriented, typically characterizing their activities by the size of the system, its price meaning affordability and where it lies on the sort of general rapid prototyping landscape.

Now I think believe customers as we move to tooling applications and manufacturing applications, but not only, also within rapid prototyping in general customers are far more specific today, very often they will have, they will be well-versed in many different technologies and each one of them has a different application set that they cater to. So when we talk about reallocating resources it is moving it from the general-purpose, one-size-fits-all, massively dominated on the system side and now we are doing it around the combination of materials, software and the system to deliver a specific application. That's on the development side.

Sometimes we call it solution, sometimes we just call it an integrated product but it can come or an application so it can come in different flavors. But that's basically what that caption is.

Then on the go-to-market side as we are reallocating our resources we are looking at how to deepen our engagement with specific customers, how do we have better strategic account management and application engineering in the field speaking to customers and providing a value in terms of not only the fulfillment side and identifying potential customers, but more of the meaningful dialogue with a customer of what their specific needs are and if we have something that's readily available or we need to augment what we have in a meaningful way to make it productive for them.

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Weston Twigg, Pacific Crest Securities - Analyst [60]

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Okay, so you are willing to share sort of strategic focus but not necessarily quantitative metrics with us for your goals?

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Ilan Levin, Stratasys Ltd. - CEO [61]

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That's right.

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Weston Twigg, Pacific Crest Securities - Analyst [62]

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Okay. Second question, the Infinite-Build printer, you gave us a little bit of an update today with the Boeing information, we saw Ford is using it. Can you give us an update on just progress with that platform, the traction with customers and a potential launch date? And then just on top of that, can you also tied in your new materials to that platform like the nylon carbon fiber?

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Ilan Levin, Stratasys Ltd. - CEO [63]

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So the nature of the two systems that we demonstrated, the Infinite-Build and the Robotic Composite, are very different than any of our other systems that we have launched to date in terms of scale and usage. And I don't think that we will have a commercialization path or launch date that we used to typically have with our other systems, or, let's say, compared to the F123 which is a very formal launch.

The development of those systems and the usage of customer and usage by customers is done almost hand to hand. So we have been delivering parts that are built off of those systems or some of those systems. They are very deeply engaged. So there's a lot of benefit and value that customers are beginning to derive even if we haven't formally called it a commercialized product readily available for sale.

And I think that's what we can expect to see for the foreseeable future because these systems are very high added value. It can be even a case where different customers require different attributes and requires either expert services around it, application engineering, maybe perhaps further development on a different branch. But I think even today the customers are benefiting from the technology already.

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Weston Twigg, Pacific Crest Securities - Analyst [64]

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Okay, that makes sense. It ties into your strategy toward being more customer-centric around applications rather than commercializing the product for broader sale.

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Ilan Levin, Stratasys Ltd. - CEO [65]

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That's right.

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Operator [66]

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Brian Drab, William Blair.

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Brian Drab, William Blair - Analyst [67]

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Hi, thanks for squeezing in the question. Actually, maybe two quick ones.

So could you talk a little bit about the cadence of revenue and earnings that you are expecting as we move through 2017? You have the tough comp I think in the second quarter given the intro of the 750 last year. You are talking a little bit about revenue from larger partnerships and timing. Any help in modeling the progression as we move through the quarters would be great.

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Lilach Payorski, Stratasys Ltd. - CFO [68]

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So as you probably noticed given our previous years, typically Q4 we see a significant increase, also the end of the year. And this is what we are probably going to expect for this year, as well.

In terms of operating expenses throughout the quarter we believe this is going to be a similar level throughout all the fourth quarter with some fluctuation based on revenue seasonality.

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Brian Drab, William Blair - Analyst [69]

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Okay. Thank you very much.

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Operator [70]

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Ladies and gentlemen, this does conclude today's Q&A portion. I would now like to turn the call back over to Ilan Levin for closing remarks.

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Ilan Levin, Stratasys Ltd. - CEO [71]

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Thank you for joining today's call. And we look forward to speaking with you again next quarter. Thank you.

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Operator [72]

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Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.