Shane Glenn - Vice President-Investor Relations Ilan Levin - Chief Executive Officer & Director Erez Simha - Chief Operating & Financial Officer.

Wamsi Mohan - Bank of America Merrill Lynch Troy D. Jensen - Piper Jaffray & Co. (Broker) Jim Ricchiuti - Needham & Co. LLC Kenneth Wong - Citigroup Global Markets, Inc. (Broker) Sherri A. Scribner - Deutsche Bank Securities, Inc. Paul Coster - JPMorgan Securities LLC Ananda P. Baruah - Brean Capital LLC Patrick Newton - Stifel, Nicolaus & Co., Inc.

Shannon S. Cross - Cross Research LLC Robert Stone - Cowen & Co. LLC Brian P. Drab - William Blair & Co. LLC Weston Twigg - Pacific Crest Securities Ben Hearnsberger - Stephens, Inc. Joe H. Wittine - Longbow Research LLC Hendi Susanto - Gabelli & Company.

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Stratasys Q2 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the prepared remarks, we will host a question-and-answer session and our instructions will follow at that time.

I will now hand the presentation over to Shane Glenn, Vice President of Investor Relations. Sir, please proceed..

Thanks, Brian. Good morning, everyone and thank you for joining us to discuss our second quarter financial results. On the call with us today are Ilan Levin, CEO; and Erez Simha, CFO and COO of Stratasys.

I'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 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 2016 are forward-looking statements reflecting management's current expectations and beliefs.

These forward-looking statements are based on current information that is, by its nature, subject to rapid and even abrupt change. Due to the risks and uncertainties associated with Stratasys business, actual results could differ materially from those projected or implied by these forward-looking statements.

These risks and uncertainties include, but are not limited to, any failure to efficiently and successfully integrate the operations of Stratasys, Inc. and Objet Ltd.

after their merger as well as MakerBot, Solid Concepts, Harvest and GrabCAD after their acquisition or to successfully establish and execute effective post-acquisition integration plans; changes in the overall global economic environment; the impact of competition 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 shifting in our revenue mix significantly towards our additive manufacturing services businesses; 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, as well as in the 2015 Annual Report generally.

Readers are urged to carefully review and consider the various disclosures made throughout the Form 6-K, that attaches Stratasys unaudited, condensed consolidated financial statement as of, and for the quarter and six months ended June 30, 2016 and its review of its results of operations and financial conditions for those periods, which have been furnished to the SEC on or about the day here of, Stratasys' 2015 Annual Report and in Stratasys' other reports filed with or furnished to the SEC, which are designed to advise interested parties of the risk factors that may affect our business, financial condition, results of operations and prospects.

Any guidance provided and any 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 to GAAP reconciliations are provided in the table contained in our slide presentation and today's press release.

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

Ilan?.

Thank you, Shane. Good morning, everyone and thank you for joining today's call. Having assumed the role of CEO on July 1, I would like to take a moment to thank our outgoing CEO, David Reis for his contributions and leadership.

David tenure of CEO was defined by period of significant growth for our company, which included the transformation of Stratasys into the industry's leading 3D printing and additive manufacturing company. David will continue as the Member of the Board and as an Executive Director.

I am excited and optimistic to continue that mission of growth and leadership. I believe our industry is maturing and evolving beyond general purpose 3D printing for design applications.

It is being transformed by the growing access to more affordable office and desktop printers and by the greater need for enhanced value for specific additive manufacturing applications within certain vertical industries. I believe FDM and PolyJet are mature, well qualified technologies, with a significant runway ahead for future growth.

We have targeted specific high value industries such as aerospace, automotive and medical, which will rely on these technologies to enhance their businesses.

We have a large installed base of customers in our targeted markets and beyond that will form the basis for future collaboration and innovation to deliver value around additive manufacturing applications. These assets provide me with the confidence that we will continue to capitalize on the potential of additive manufacturing, moving forward.

Looking at the second quarter, we were pleased to make additional progress in improving our financial performance during the quarter, driven by our successful efforts to control costs and improve operational efficiency.

These initiatives help drive improvements in our margins and a substantial increase in operating profitability compared to the first quarter.

In addition, our margins benefited from strong sales of our higher-end systems, including our new J750, full-color, multi-material 3D printer that removes technology barriers by enabling customers to achieve one-stop realism without post-processing. We announced the launch of our new GrabCAD service, GrabCAD Print, during the second quarter.

The GrabCAD Print services is an overall 3D printing solution that provides the ability to share, organize, print and analyze 3D models. GrabCAD Print is currently available in free public beta in North America. I will return later in the call to provide you more details on important initiatives and other key developments.

But first, I will turn the call over to our CFO and COO, Erez Simha, who will review the details of our financial results.

Erez?.

Thank you, Ilan, and good morning, everyone. We have made significant progress in improving our operational performance and are pleased with the pace of planned reductions in operating expenses. As a result, both our gross margins and operating margins saw improvement in the period, and we enjoyed positive cash flow.

Total revenue in the second quarter decreased by 6% to $172.1 million when compared to $182.3 million for the same period last year. We continue to see weak market demand and longer sales cycles, resulting in slow hardware sales across all regions and business units.

MakerBot product and service revenue was essentially flat, declining 2% in the second quarter over last year, but increased sequentially by 8% driven by the positive impact of ongoing reorganization of the business and the trends toward the use of desktop systems for modeling applications. GAAP operating loss for the second quarter was $17.1 million.

Non-GAAP operating income improved both year-over-year and sequentially to $10.2 million compared to $3.7 million for the same period last year and $4 million in the first quarter of 2016. GAAP net loss for the second quarter was $18.5 million, or $0.36 per diluted share.

Non-GAAP net income for the second quarter was $6.2 million, or $0.12 per diluted share, compared to non-GAAP net income of $8 million, or $0.15 per diluted share, reported for the same period last year.

Non-GAAP net income included a tax expense of $5.1 million, or a tax rate of 45.4%, which resulted from the non-cash valuation allowance on deferred tax assets related to our U.S. subsidiaries.

It should be noted that this deferred tax assets have expiry dates many years into the future and we do anticipate being able to recognize their value to offset prospective tax liabilities. Product revenue in the second quarter decreased by 8% to $123.8 million, as compared to the same period last year.

Within product revenue, system revenue for the quarter declined by 19% over the same period last year, driven primarily by the overall market weakness we discussed previously. We were pleased to see system utilization remain strong.

Consumable revenue for the quarter increased 11% compared to the same period last year, an improvement in year-over-year consumable revenue growth for the second straight quarter compared to the flat growth we observed in the second half of 2015.

While also impacted by the overall market slowdown, consumable revenue growth is more a function of our installed base and represents a recurring revenue stream which is less affected by the decline in system sales within any given quarter.

Services revenue in the second quarter increased by 1% to $48.3 million as compared to the same period last year.

Within service revenue, customer support revenue during the quarter, which includes the revenue generated mainly by maintenance contract on our systems increased by 11% compared to the same period last year, driven primarily by growth in our installed base of systems.

We are pleased with the growth in recurring revenue generated by installed base of systems. GAAP gross margins improved to 46.2% for the second quarter compared to 45.5% for the same period last year. Non-GAAP gross margins improved slightly to 55.9% for the second quarter compared to 54.7% for the same period last year.

Product gross margins improved driven by the sales mix that favored higher margin systems as well as aggressive cost control efforts in operations that reduced the level of production inefficiencies that we experienced in prior quarters. Service gross margin also improved compared to the same period last year, helped by our cost control efforts.

We were pleased to, again, recognize a significant reduction in our operating expenses and improvement in operating results during the second quarter. GAAP operating expenses declined by 17% to $96.7 million for the second quarter as compared to the same period last year.

Non-GAAP operating expenses declined by 10% to $86 million for the second quarter as compared to the second period last year. In addition, non-GAAP operating expenses in the quarter declined by 3% sequentially when compared to the first quarter of 2016.

These favorable trends over the last two quarters reflect the positive impact our operational initiatives and our overall focus on improving operational efficiencies and reducing our direct and indirect spending.

SG&A expenses declined significantly over the same period last year, reflecting the cost reductions, lower IT expenses related to our company-wide ERP rollout as well as the impact of lower resellers' commissions.

We should note that these planned cost reductions do not impact our long-term strategic initiatives and in some instances, we have actually increased investments in areas as we view as strategically important for long-term growth.

The following slide provides you with a breakdown of our geographic sales for the quarter, which reflects the broad-based weakness we have outlined previously. Our regional results were consistent with the trends we have observed in recent quarters. GAAP EBITDA for the second quarter amounted to $6.9 million.

Non-GAAP EBITDA for the second quarter amounted for $19.5 million compared to $12.6 million in Q1 2016 and $12.1 million for the same period last year. The company generated $6.9 million in cash from operations during the second quarter and currently holds approximately $253.9 million in cash and cash equivalents.

Inventory at the end of the second quarter increased slightly to $125.7 million as compared to $124.5 million at the end of the first quarter. We continue to focus aggressively on managing inventory levels. Accounts receivable increased slightly to $113.3 million, compared to $109.1 million at the end of the first quarter.

DSO on 12 months trailing revenue increased slightly to 61 compared to 58 in previous quarter. In summary, we are pleased with our improved operational performance and positive cash flow, driven by the progress we have made in controlling expenses and improving operations.

We are pleased with the positive trend in both operating and gross margins, supported by our operational initiative, as well as favorable sales mix. Going forward, we will remain focused on managing expenses and driving additional operational improvement.

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

Shane?.

Total revenue in the range of $700 million to $730 million, with non-GAAP net income in the range of $9 million to $23 million, or $0.17 to $0.43 per diluted share; GAAP net loss of $84 million to $67 million, or $1.60 to $1.28 per basic share.

Non-GAAP earnings guidance excludes $59 million of projected amortization of intangible assets, $25 million to $27 million of share-based compensation expense, $7 million in merger and acquisition related expenses, $4 million to $5 million in reorganization and other related costs and includes $5 million in tax expenses related to non-GAAP adjustments.

Additionally, we are providing the following estimates regarding our company's potential performance and strategic plans for 2016.

Based on revenue trends in the first half of the year, we now believe that we will end 2016 at the low end of our revenue guidance and with gross margins in the range of 54% to 55%, operating margins of 3% to 5%, tax expense of $15 million to $17 million, which includes the negative impact of the planned accounting treatment for tax valuation allowance, and capital expenditures projected at $60 million to $70 million, with approximately $45 million designated for completing the company's new facility in Israel.

As previously discussed, our relatively high estimated non-GAAP tax rate for 2016 is a function of the ongoing non-cash valuation allowance and deferred tax assets we expect to record throughout the year.

As Erez mentioned, those deferred tax assets have expiration dates many years into future, and we do anticipate being able to ultimately recognize their value to offset prospective tax liabilities.

The company believes that it can achieve a significant improvement in its operating structure in 2016, which can translate into improved operating profit compared to the prior year. Given the expected ongoing negative impact of not recording a tax benefit on U.S.

tax losses on our net income loss, the company believes the non-GAAP operating profit growth would be the best measure of performance in 2016.

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 details of the non-GAAP financial measures. Now, I'd like to turn the call back over to our CEO, Ilan.

Ilan?.

GrabCAD Community, a vibrant community of millions of engineers and designers and students sharing CAD content, how-to tutorials and participating in publicly sponsored design challenges;.

GrabCAD Workbench, a Software-as-a-Service product for design teams to securely manage and collaborate on product design projects; and GrabCAD Print, offering simplified CAD-to-print workflow to make professional 3D printing easier and more accessible.

With GrabCAD and MakerBot's Thingiverse, we believe we maintain the largest communities of end users in our industry, providing a unique ability to interact and communicate directly with customers who can recognize value from our solutions.

In summary, we are pleased with our improved financial performance that has resulted from our continuous improvements of operations and the impact of our ongoing actions to reduce operating expenses.

We are also pleased with the initial success of the new J750, as well as early interest in GrabCAD Print and our overall software strategy to make 3D printing significantly more intuitive and highly accessible for our customers.

As our industry matures, our focus will be on our customers' needs and how Stratasys can provide a clear value proposition by leveraging our core assets and cultivating new capabilities.

This approach includes investing aggressively to develop an advanced ecosystem of applications and solutions that bring enhanced value for customers within key vertical markets.

And finally, although we are not observing any change in the near-term market environment, we remain committed to these strategic initiatives, and we are excited about our company's future. Operator, please open the call for questions..

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

Yes. Thank you. Ilan, congrats on the new role.

So given that you've just recently assumed the role of CEO, can you provide us some color on how you view the market opportunity and the direction you'd like to see this company head moving forward and any changes that you intend to bring to the strategy in the near or long term? And I have a follow-up for Erez..

Thank you. So as I highlighted in the written statement before, I believe that the 3D printing additive manufacturing market is transforming and evolving over the years.

I think there's two very clear trends, one of which is to more affordable office and desktop printers, and the other trend is towards more enhanced value around specific additive manufacturing applications. And to that extent, I think we have two very strong core technologies within Stratasys.

Both FDM and PolyJet are very mature technologies, very, very well-qualified, have been certified by many customers and are beginning to be placed into in-process applications with many of our customers, which leads me to believe that we have a very significant runway with both those technologies.

And so, while we may add further technologies as we go along, we provide other technologies through our Stratasys Direct Manufacturing business. I believe that FDM and PolyJet are both very strong legs that we can rely upon for our future growth.

We've also targeted very specific industries where we believe that high added value applications with respect to additive manufacturing are very strong, including aerospace, automotive and medical.

And so, with all that, I think that, as we move forward, we will continue to realign resources internally, as we have in the past, but maybe even with a stronger focus towards those elements which I just mentioned, using both of core technologies as well as augmenting elements in the future through either parts business, as I said, or other technologies that we may bring to market..

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

Hi. Good morning, Wamsi. Yeah, first, I must say that we are really happy with the progress we are making with the operating expenses and the cost reduction initiative that we are taking.

I think that looking into H2 and it's embedded in our guidance, you should expect slightly higher operating expenses, which particularly represents seasonality in operating expenses between the quarters and not increasing operating expenses.

We intend to continue and maintain and push operating expenses as much as possible down, while investing and continue to invest in the long-term initiatives that we discussed in previous quarters..

Thanks a lot..

Thanks, Wamsi..

Thanks..

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

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

Thanks, Troy..

And so, maybe first for Erez here. If I look at your guidance, looks like the revenue guidance is unchanged, the operating margins guidance is unchanged, but you raised the taxes from – I think previously you said $10 million to $11 million to $15 million to $17 million, but you didn't lower your EPS guidance.

So can you just explain kind of the dynamics that kind of allow you to keep EPS unchanged here?.

Yeah, hi. Good morning, Troy. That's what, what we tried to communicate in the guidance is we are guiding you towards the lower end of our revenue guidance. So within the range, we think that we'll end the year at the lower end of our revenue guidance.

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

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

All right. Understood. Maybe one for Ilan here, and congrats on the new role. We talked to a lot of your channel partners and there's a lot of interest with your reseller base and the HP product. Several of them are contemplating, partnering with HP.

So I would just love to get an update on do you have exclusivity with most of your channel partners, how can you kind of prevent them from bringing on the HP product line..

Troy, hi. I'll take it, yes. For the channels themselves, we do have exclusivity globally. So we work with channels that are, in their agreement, they have their option to work with Stratasys only around 3D printing. And we do not see yet a significant impact of HP activity in the market.

I wouldn't say it's no noise at all, but we do not see a significant activity of HP in the market. We do have channels that are working with us for 20 years, and we went with us for a long way, I think that our product offering around FDM and PolyJet is attractive or very attractive to the channel compared to other alternatives in the market today.

And practically, until today, we didn't see any channel that is leaving us.

Ilan?.

So I would just add, Troy. Hi. Thanks and good morning.

So just to add to Erez, I think that what we're offering are mature, validated, very well articulated technologies with a clear value proposition that are well-known to the market in general and to our resellers so that despite any competition that maybe entering into the market, I think we're very well-positioned..

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

Thanks, Troy..

Thanks..

Thank you. Our next question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed..

Hi. Thank you. Good morning. A question on the SDM business.

What was the decline in that business in the quarter?.

Jim, good morning. It's Erez. We did not provide any specific information around it and what I can say is that, it's according to our plan. We are satisfied with the results. SDM is a business in the 3D printing market. So they see the same phenomena that we see in the other businesses, in the other business which is slightly weak demand.

In any case, it's not unusual or a surprise for us, and they are running according to our plan..

Okay. And looking ahead....

I would add....

Go ahead..

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

Okay. Thanks. One other question. Just as it relates to the full year guidance, even at the low end of the revenue range for the full year, you're still looking for some nice sequential improvement in the back half of the year.

Is that going to be weighted, do you think, more towards Q4, just given the normal seasonality, and I'm wondering what's giving you even that confidence, just given the market environment?.

Yeah. Jim, this is Shane. Good morning. We would expect to see the same type of seasonality trends that we've seen in the past. As you know, Q3 is typically a weaker quarter for us based on some of the seasonal trends, particularly in Europe. Some of the capital equipment purchasing trends typically will drive a very strong fourth quarter.

So I think it's safe to say we would expect to see similar type of trends this year..

Okay. Thank you..

Thanks, Jim..

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

Hey, guys. I think kind of one area where it did look like things improved was in the MakerBot business.

Would you say that this is a scenario that's stabilized, should we see this kind of sequential growth going forward?.

I can hardly hear to you, and I'll try to repeat the question.

You asked about MakerBot, if you think this business has stabilized, right?.

Correct. And should we....

Yes..

...expect that going forward?.

The answer is absolutely yes. I think that we went through a very significant reorganization and restructuring in MakerBot business, and we started to see the results also on the financial side of MakerBot performance. We saw a nice sequential growth in revenue this quarter.

And we think that our MakerBot position and brand will help us to play in the market of desktop printers in the future..

Got you. And then, for Ilan, I'm not sure if you've had a chance to kind of really think through what the longer term profit levels could be for this business. But I guess, when you guys return to a normal state, is 20% EBIT margin achievable, or is it something below that, any thoughts from you would be great..

So I'll take it. I think that, again, the long-term model, we did not yet release a long-term model. And we'll do it once we feel comfortable both with the market trend and market behavior and the visibility that we have. I think that it's too early to talk now about longer-term business model. The market is changing.

The visibility is relatively low for period of two years to three years and we prefer to wait a little bit more before we release our long-term guidance..

Okay. That's fair. Thanks, Erez..

Thanks, Ken..

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

Hi. Thank you. I was hoping to get a little more detail on the decline in the system sales, down about 19% year-over-year.

Can you provide us with some detail on mix in that and how much of that year-over-year decline is attributable to the MakerBot business?.

Yeah, Sherri, good morning. It's Erez. I think that the year-over-year decline in units are low. We didn't provide too much color on it. It's coming from the low-end market, so the small units.

We actually saw a very clear shift this quarter towards high-end product, mainly around the J750, that resulted with a very nice gross margin and I'd say operating results, but once you count the units, you don't see it..

Okay. And then, thinking about the GrabCAD business, does that sit in your services segment, so would we see that in services margins and how should we think about margins for that business? Thanks..

GrabCAD today is a cost center, and it's part of the R&D expenses, Sherri..

Okay. Thanks..

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

Yeah, thanks for taking my questions. I've got two, actually.

The first one relates to materials and, obviously, seeing growth there off the installed base, but to what extent is it volume driven versus mix versus pricing? And then, the second question just goes back to the price strategy of having these vertical teams that would develop the applications specific to the needs of customers and industries.

Are you retaining that strategy? Is the timeline to delivering still sort of 18 months, generally, on one of those projects and how are you sort of managing the risks there? Thank you..

Hi, Paul, good morning. It's Erez. I'll take the first one, Ilan will take the second one. So material growth of 11% this quarter is mostly, if not all of it a result of increase in an incremental installed base and not a result of changes in prices.

So it's actual growth both in units and in dollar that had impacted and created an 11% growth quarter-over-quarter..

Thank you..

Hi, Paul. It's Ilan. So with respect to the vertical industries that we've identified, specifically, we can mention aerospace, automotive, and medical. So we're already providing solutions that are specific to those industries and applications already.

Many times these applications that we are already providing or that we will provide in the future are made up of different parts of what we own internally whether that's the hardware elements, materials, part of our service business.

So it's a lot of mix and matching within that and perhaps adding some additional layer of technology or business layer around that. And so, as we go forward, I think we will continue to do that. We believe it's a very big opportunity for us.

We will be doing it I think with greater collaboration and partnership with several select customers from each of those industries. I think you've seen some of those press releases over the past 12 months and I think you'll continue to seeing that going forward as well..

All right. Thank you..

Thanks, Paul..

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

Hey. Thanks, guys. Good morning. Ilan, congrats on the new appointment, and good morning, Erez, Shane and Cody. Hey, two from me if I could. I guess the first is just going back to the rev guide. It does seem – I mean it's just more context, basically, if you guys could.

Shane, if you do normal seasonality over the last couple few years, what my model shows is that you actually wouldn't achieve even the low-end of the guide, you mean like a flat in September, could be like a mid-teens, sequentially, December which would put you below the $700 million, because you've kind of done like mid single to high single-digits the last two years in December.

And so, what occurs to me is number one, mix is helping you. So maybe that kind of pushes it up some in the second half of this year relative to the last couple of years.

But it still seems like you need to at least want to get some sequential growth in the September quarter as well, off in June, to put yourself in kind of a solid position to do that low-end of the guide. So I'd love to get more context around that, even considering – when you're considering normal seasonality. Then I have a follow-up. Thanks a lot..

Ananda, hi. Good morning. It's Shane. I think that we don't want to get down into providing specific guidance around Q3 and Q4, although I do understand your question.

I think if you look at the guidance that we've provided, we're still within the margin of error of the numbers that we've provided with also the addition of the comments we said around revenue being at the low end of the range, and to Erez's comments, about improvements in the operating expenses and the successes that we've had there, which are essentially offsetting what we're seeing on the tax side.

Beyond that, I don't want to go into any additional details. I think that if you run the numbers, you would still find that we're in the margin of error still within those ranges..

Okay. Okay. I mean as long as you guys are comfortable with it. Okay. And then, the follow-up for me is, Ilan, we'd just love some context around the language that you used in the prepared remarks around aggressive investment with regard to some of the key strategic areas.

I don't want to read too much into it, but clearly, there is stuff that you see that you want to have energy behind. So I'd love to hear about what some of those areas are.

And then, to any extent that you could talk about being able to fund those from some of these cost savings relative to having to put like new investment dollars behind that, that would be great. Thanks..

So a lot of it is reallocation of resources internally. But as we go back to the vertical markets that we've identified and not that we are exclusively focused on those, but if we just took those as an example and we have begun to identify together with key customers areas where the technology can be applied in an in-process application.

We then pulled in sometimes jointly funded, but certainly, putting our heads together around how to get to that application and bring those to market. So that's a lot of those kind of investments.

We've already started much of those investments, and I anticipate that we will continue to make those investments usually in response to specific applications that customers are putting in front of us, after having seen our technology and seen how we can help them..

Got it. That's very helpful. Thanks a lot, guys..

Thanks, Ananda..

Thank you..

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

Yeah. Good morning, Ilan. Congratulations on the new position and good morning, Erez. I wanted to jump into the gross margin guide. I asked a similar question last quarter, but we've had two consecutive quarters above the high-end of your full year guidance range.

So could you walk us through what needs to happen in order to get back into that 54% to 55% range for the full year and just help us understand with new products, what appeared to be mixed tailwinds and then ongoing benefits from operational improvements and product efficiencies, why gross margin would be stepping down in the back half?.

Yeah, hi, good morning. It's Erez. So two comments to your question. The first one I think that the first half was unusual in terms of product mix as well as impacted significantly by introduction of J750 that carried very high gross margin. I'm not sure that this product mix looking forward will stay the same. I'm sure that it will not.

The second reason is there are some outsourcing activity that we are doing in specific part of the company that the cost impact of it will have impact on gross margin in Q3 and Q4. We don't see it yet in H1, but we will see it in H2. So we kept the gross margin as guided knowing that H2 would probably be lower than H1..

Great. Thank you. And then, I guess, for Ilan or Erez, you spend quite a bit of time discussing GrabCAD.

If we look at GrabCAD communication (sic) [Community], Workbench and Print, can you help us understand how the products are going to be monetized and then walk through your go-to-market strategy, and given that you already commented this as a cost center, how should we think about timing to GrabCAD contributing to the P&L?.

So I think GrabCAD and the offering to customers goes way beyond a specific profit center or revenue line for Stratasys. It's part of the whole entire ecosystem that we're providing.

And we think that software in general, GrabCAD specifically, can enhance the user experience when combined with our hardware materials, service offering and anything else we can offer. So I see it more as a strategic play that's the glue between everything that we provide and enhancing the customer experience.

How and at what timing that we may monetize specific elements of our offering, I think, is less integral to what the GrabCAD is about..

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

Thank you..

Thank you, Patrick..

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

Thank you very much for taking my question. I'm curious as to some of the trends that you talked about last quarter versus what you saw this quarter.

Clearly, the J750 drove upside in terms of the mix, but are you still seeing and hearing from people about more of an indication of moving to the lower end than the mid range or is that something that was sort of a one quarter phenomena? And then, also can you give us an idea of some of the backlog demand that you see for the J750?.

Hey. Hi, good morning. It's Erez. I'll start with the later part of the question. I can say that the introduction was a very successful introduction of the J750 in the market, well perceived by the customers with the booking that were greater than our plan and expectation.

However, I don't think that it does represent kind of a trend that will continue for long-term looking forward. It's typical for introduction of new product to see such a reaction of the market. And practically, if you look at the customer behavior today, we don't see a different trend if you ignore the J750, in behavior trend.

There's still longer sales cycle. There's still ongoing effort for the next sale. And again, I don't think that the market has changed at all compared to previous quarters. I hope I answered..

Okay. Thank you. And then, Ilan – yes, you did actually. Thank you..

Okay, thank you..

Ilan, can you talk a bit about what you see in the pipeline? You're doing this event in August and that in terms of, well, announcing something. And I'm just kind of curious as to your thoughts on sort of how technology will progress within this industry.

And what kind of, I don't know, surprises or holes you see within what Stratasys has planned over the next couple of years, within the scope of what you can talk about publicly at this point. Thanks..

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

So I think you'll see going forward a lot of technologies and perhaps even full solutions that are wrapped around technology, in general, that we have. I think FDM and PolyJet are very good starting points in that respect.

And customers are very enthused as how we can take those technologies and move them beyond the specific printers that we're doing today and perhaps thinking in a much different way and a broader way of adding different elements into that materials in a broader sense, to sort of opening our minds around what we can do with FDM and PolyJet to get full solutions that can either be used for manufacturing tools or for end use parts, specifically in the industries that we've identified.

So that's what excites me. And I think there's a lot of opportunity going forward, which leads me to believe that we have a very long runway with our base technologies as they stand today..

Thank you..

Thank you. Our next question comes from the line of Rob Stone with Cowen & Company. Please proceed..

Hi, guys. Thanks for taking my questions. The first one is on the tax rate. I know you're not in a position yet to really provide guidance for next year.

But assuming hypothetically that business trends continue with sort of flattish revenue and some improvement in your operating expenses, if you have ongoing GAAP losses, would you expect to see the same kind of trend in the non-GAAP taxes in 2017?.

Yes. Hi. Good morning. It's Erez. Yes, absolutely, yes, I don't think that you will see a change looking forward for the next few quarters. And the impact of tax expenses on the P&L, we explained it in the past.

It's coming from our situation in specific area and actually in the U.S., accumulated losses that we cannot recognize tax benefit accounting-wise. And we have to meet certain criteria in order to come back and recognize those tax benefits.

Looking forward, I think that in the next three quarters to four quarters, I don't think we'll be able to recognize those..

Okay. That's very helpful.

And then, with respect to the guidance, can you comment at all on what you're assuming for weighted average shares?.

About what? Sorry..

You have a range of non-GAAP EPS guidance for the year. And I'm wondering....

Yeah, yeah..

...what you're assuming for the share count?.

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

Great. Thank you..

Thanks, Rob..

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

Hi. Just one question on the J750. I'm wondering it sounds like this had a significant impact on margins in the second quarter.

What percentage of those machines are being sold through resellers versus direct? And if a large portion is being sold through resellers, was it sort of the case right after the introduction of the machine that we put several of these machines or many of these machines to resellers and still haven't seen the sell-through on some of those..

Hi, good morning. It's Erez. In general, our go-to-market is indirect, and the J750 is not different. If you're asking about the channel inventories, the answer is absolutely no. There's no sell-in – almost no sell-in without their approval.

We did sell some demo machines to a reseller that are needed to run the business, but this is ongoing trend and ongoing phenomena that we do every quarter. And again, as for the inventory, if this is your question and I understand you correctly, so the answer is absolutely not..

Okay. So no meaningful impact from just placing them at resellers, this is representative of the initial wave of demand..

Correct..

Okay.

And then, could you comment further just on your recent introduction of the Direct Manufacturing consulting service, and how significant of a revenue stream do you think that could be in the future?.

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

I do not expect and the business model behind it is not to become a company that generates significant amount of revenue out of it, absolutely not.

The rationale behind it is more non-quantified to try and enhance and improve penetration within existing customers and new customers, bringing the knowledge that we have and using the technology that we have into specific customers' processes..

Thank you very much..

Thanks, Brian..

Thank you. Our next question comes from the line of Weston Twigg with Pacific Crest Securities. Please proceed..

Hi. Thanks. Just wanted to touch on the J750, again, because it seems like the way you describe the platform, there's also a lot of the limitations associated with past printers and you had good demand on the initial launch.

And I would expect demand to stay really high through the rest of the year given the way the product has been described, but you indicated that you're tracking to the low-end of your annual revenue guidance.

So can you help us understand that disconnect and whether maybe the J750 could drive some additional upside in second half sales?.

I don't tell you to refer to specific numbers, but as I said, I think that the phenomena that we saw in Q2 around the J750 does not represent an ongoing trend that we can rely on for a long time. And it has nothing to do with the impact on the guidance of the revenue.

With the J750, if you look at the number, and you look at H1 and you look at what's going on in the market, you understand that we are heading towards the low-end part of the revenue guidance..

Okay. The other question I had was on product gross margin. It improved in the quarter. You said it was partly based on cost controls.

And so, I'm wondering within that, how much of that was related to recent MakerBot changes versus other segments and if there's more room to improve the gross margin, if end demand still remains soft for several more quarters..

So most of it was coming not from the MakerBot business, but from the other businesses. It's the result of A, J750, as we said, and some cost initiative that we took in production to eliminate the inefficiency in production.

And looking forward, again, I said, and we maintain the gross margin for the year, we do expect H2 to be a little bit lower than H1. And they [have] to come into the range that we provided them on..

All right. Thank you..

Thanks, Weston..

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

Hey. Thanks for taking my question. I have a question on GrabCAD and R&D spend.

Can you give us the percent of R&D spend associated with the GrabCAD platform and give us a sense for how that level is trending now that you've released some of the beta products?.

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

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

So, currently, and I think that Ilan discussed it, it's the GrabCAD is more than just generating revenue. I don't think it will be, if at all, significant revenue in 2017. And, yes, it will be part of the services, if it will be..

Thanks, Ben..

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

Hi. Good morning.

Can you maybe give an update on how big prototyping is today as a percentage of the company? And maybe, more importantly, how long from where you sit today, do you expect the mix down to lower price desktop and office products to persist or how long until you think we can reach "equilibrium" that will provide some stability to ASPs? Thanks..

I didn't hear the first part of your question.

Can you please repeat it?.

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

So I think that we don't quantify the numbers. A significant part of the company business is still prototyping. Although we are heading with incremental business towards the end use part of manufacturing with the new applications. We do see a trend of, we call it, more for less or providing more offering compared to previous quarters.

It does have impact unit-wise on our markets. Don't forget that we have access to this market with a very strong brand for MakerBot..

Understood.

And then, maybe the second half of the question, how long do you expect this mix down to desktop and office to persist? I mean is it essentially over here in the last two or three more years, how long until we reach "equilibrium" in your quarterly mix?.

I would be very careful providing any kind of time schedule here. The market is developing. So it's still a young market. And I really don't want to provide any timeline then..

Okay. Understood. Thanks..

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

Good morning and all the best for Ilan's leadership, first of all. May I inquire insight into your service segment? Customer support revenue grew 11%, while the overall service revenue grew 1%.

What did offset the double-digit growth in customer service? Do you see weaknesses in your printing services? And I think it will be helpful also if you share how RedEye, Solid Concepts and Harvest Technologies performed and what your expectation on additive manufacturing service business?.

It was a bunch of questions. I hope I remember everything. The service revenue includes both service contracts and, what we call, SDM, Stratasys Direct Manufacturing business.

We provided colors on the service contracts which are recurring revenue generated by the installed base and we're happy to see an increase of 11% year-over-year in service revenue. This naturally was offset by a slight reduction, a slight decrease in the SDM business and, as I said earlier, SDM is running according to our plan.

There were no surprises there. The message here was that the installed base of Stratasys, which is a very large installed base, is generating stream of recurring revenue both for consumables and service contracts. This is naturally part of our business model..

And then, one additional question.

How do you characterize the longer pre-sale cycle now versus in the past?.

I think that practically what we see is that we take us more time to close deals.

And it's coming from, I think, few reason, not one reason, the availability of offering in the market in front of our customers, different solutions that we see, and the trend that we see is, at the end of the day, longer sales cycle that has impact on our ability to continue and grow..

Got it. Thank you..

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

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

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