Yonah Lloyd - Stratasys Ltd. Elchanan Jaglom - Stratasys Ltd. Lilach Payorski - Stratasys Ltd. David Reis - Stratasys Ltd..

David Ryzhik - Susquehanna Financial Group LLLP Brian P. Drab - William Blair & Co. LLC Troy D. Jensen - Piper Jaffray & Co. Shannon S.

Cross - Cross Research LLC Wamsi Mohan - Bank of America Merrill Lynch Gregory William Palm - Craig-Hallum Capital Group LLC Jim Ricchiuti - Needham & Company, LLC Ananda Baruah - Loop Capital Markets LLC James Medvedeff - Cowen & Co. LLC Hendi Susanto - Gabelli & Company, Inc..

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Stratasys Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this call is being recorded.

I would now like to turn the call over to Yonah Lloyd. You may begin..

Thank you, Michelle. Good morning, everyone. Thank you for joining us to discuss our second quarter financial results. On the call with us today are Elan Jaglom, Interim CEO; David Reis, Vice Chairman and Head of our Board's Oversight Committee; Lilach Payorski, CFO; and Cody Burke, Director of Investor Relations.

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

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

For more information, please refer to the risk factors discussed in Stratasys' Annual Report on Form 20-F for the 2017 year filed with the SEC on February 28, 2018, and in our report on Form 6-K, along with the associated press release concerning our earnings for the second quarter of 2018, which we are furnishing to the SEC today.

Stratasys assumes no obligation to update any forward-looking statements or information which speak as of their respective dates. 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 presentations and in today's press release. Now, I would like to turn the call over to our Interim CEO, Elan Jaglom.

Elan?.

Thank you, Yonah. Good morning, everyone, and thank you for joining today's call. We're pleased with our second quarter results, which were in line with expectations.

We observed a recovery in the high-end systems orders and return to more typical ordering behavior for our key verticals of aerospace, automotive and government in North America after slowdown in the first quarter. Additionally, we are pleased with the improved growth in consumables and service revenues compared to prior quarters.

I will return later in the call to provide an update on our search for new Chief Executive Officer, as well as other key developments. And David will provide more details regarding the highlights of the quarter. But first, I will turn the call over to our CFO, Lilach, who will review the details of our financial results.

Lilach?.

Thank you, Elan, and good morning, everyone. Total revenue in the second quarter was $170.2 million compared to $170 million for the same period last year. GAAP operating loss for the second quarter was $1.9 million, compared to operating loss of $5 million for the same period last year.

Non-GAAP operating income for the second quarter was $10.6 million compared to operating income of $11.1 million for the same period last year. Product revenue in the second quarter was $118.4 million, a decrease of 2.2% compared to the same period last year.

Within products revenue, system revenue for the quarter decreased by 8.2% compared to the same period last year. Consumable revenue increased by 4.8% compared to the same period last year, reflecting strong utilization of our installed base of systems.

Services revenue in the second quarter was $51.8 million, an increase of 5.8% compared to the same period last year, driven by high growth of customer support revenues and improved performance at Stratasys Direct Manufacturing.

Within services revenue, customer support revenue, which includes revenue generated mainly by maintenance contracts on our systems, increased by 9.6% compared to the same period last year, driven primarily by growth in our installed base of systems and improvement in our service contract attach rate.

GAAP gross margin was 49.1% for the quarter, flat compared to the same period last year. Non-GAAP gross margin decreased to 52.5% for the second quarter compared to 53% for the same period last year, driven by product mix. Non-GAAP product gross margin decreased to 59.6% compared to 59.9% for the same period last year, also driven by product mix.

Non-GAAP service gross margin was 36.2% flat compared to the same period last year. GAAP operating expenses decreased by 3.2% to $85.6 million for the same quarter as compared to the same period last year. Non-GAAP operating expenses decreased by 0.5% to $78.7 million for the second quarter as compared to the same period last year.

The company generated $13 million cash from operations during the second quarter as compared to $10.6 million of cash generated in the second quarter last year. We ended the second quarter with $346.7 million in cash and cash equivalents compared to $346.5 million at the end of the first quarter of 2018.

Inventory decreased to $117 million compared to $120.1 million in first quarter of 2018. Account receivable increased to $123.5 million compared to $119.8 million as of the end of the first quarter of 2018 with days sales outstandings or DSO on 12-month trailing revenue at 68.

To recap, revenue results were in line with the expectation as we began to observe recovery in high-end system sales in North America. We are pleased with the ongoing revenue growth in consumables and services, which demonstrate the strength of the recurring revenue generated by our leading installed base.

We are committed to our ongoing investments in long-term initiatives to support our technological leadership and expand our addressable markets. We continue our trend of positive cash generation from operating activities and believe we maintain a healthy balance sheet, and are well prepared to take advantage of opportunities moving forward.

We are reaffirming the full year guidance that we issued earlier this year. I would like now to turn the call back over to Elan..

Thank you, Lilach. Having recently assumed the role of Interim CEO, I would like to take a moment to thank our outgoing CEO, Ilan Levin, for his contributions over the 18 years that he spent with us, first at Objet and then at Stratasys.

The company's board of directors has appointed an oversight committee to help support the management of the company during the interim period until a successor is appointed.

The committee is comprised of the company's Vice President (sic) [Chairman] of the Board, Executive Director and Former CEO, David Reis; along with additional Director, Scott Crump, a previous Chairman and Founder; and Dov Ofer, previously a CEO in the printing industry with significant operational experience.

The company's board of directors also established an executive search committee composed of myself and Victor Leventhal, the Chairman of our Compensation Committee, to help identify a new executive officer. We're in the midst of this process and look forward to announcing a new CEO when we have completed the search.

I would like now to ask David to provide more detailed information regarding the results of the quarter.

David?.

Thank you, Elan. As Lilach noted, we were pleased with the performance of our high-end production focused products in the second quarter, driven by North America customers in government, aerospace and automotive.

As we noted on the last call, we saw no change in the overall level of engagement in these verticals, and continue to see an increased commitment to the adoption of additive manufacturing technology within these key customers.

In the second quarter, we made several announcements that showcase our continued leadership in additive manufacturing, including significant new product introduction at RAPID that we discussed in our last call.

We are pleased to share that the initial interest in our new solutions has been strong including multiple global installations of our Fortus 900 Pro and Fortus 900 Aircraft Interiors Certificate (sic) [Certification] Solution, which delivers the performance and traceability required for producing flight-worthy parts using ULTEM 9085 and achieve the highest FDM repeatability, complete material-and-process traceability and a robust statistical data set.

Additionally, we saw additional placements of the J700 Dental 3D Printer at dental labs to produce clear aligners, addressing an application that has matured out of the qualification phase and now is characterized by incremental unit sales to customers' installed base and steady recurring revenue from consumables.

We are pleased with the market reaction to our recently announced products, and believe that looking forward, our technology road map and investment strategy will accelerate the development of programs to extend our addressable market, including our new metal additive manufacturing platform, advanced composite materials, software and application development, as well as further advancement in our FDM and PolyJet technologies.

We believe that this effort will continue to lead to the development of products that will allow our customers to design and manufacture with confidence and will ensure continued leadership for Stratasys as we drive adoption and growth through deeper customer engagement and partnership.

I would now like to turn the call over to our VP of Investor Relation, Yonah Lloyd, who will provide you greater detail on our 2018 financial guidance.

Yonah?.

total revenue in the range of $670 million to $700 million with non-GAAP net income in the range of $16 million to $27 million or $0.30 to $0.50 per diluted share. GAAP net loss of $41 million to $25 million or $0.75 to $0.46 per diluted share. Non-GAAP operating margin of 4.5% to 6%.

Capital expenditures are projected at $30 million to $40 million, reduced from previous guidance of $40 million to $50 million.

Our guidance reflects increased investments in R&D, tools, materials and additional resources aimed at expanding our addressable markets by accelerating our development efforts for the new metal additive manufacturing platform, further advancements based on our FDM and PolyJet technologies, and specific go-to-market initiatives in order to deepen our customer engagement.

We believe that this ramp-up of operating expenses as guided will provide the basis for long-term growth.

Non-GAAP earnings guidance excludes $32 million to $34 million of projected amortization of intangible assets, $17 million to $19 million of share-based compensation expense, and $7 million to $9 million in reorganization and other related costs, and includes $4 million to $5 million in tax expenses related to non-GAAP adjustments.

The estimated non-GAAP tax rate for 2018 is impacted by the ongoing noncash valuation allowance on deferred tax assets that we expect to record throughout the year on U.S. losses. Given the expected ongoing negative impact of not recording a tax benefit on our U.S.

tax losses on our net income, as well as significant quarter-to-quarter variability in our non-GAAP tax rate, the company believes non-GAAP operating income would be the best measure of our performance in 2018.

Appropriate reconciliations between GAAP and non-GAAP financial measures are provided in a table at the end of our press release and slide presentation, with itemized detail concerning the non-GAAP financial measures. Operator, you may now please open the call for questions..

Our first question comes from David Ryzhik of Susquehanna Financial. Your line is open..

Thanks so much for taking the question. Regarding the North American aerospace order on government, on the last quarter call, it sounded like the team was still working hard to understand why there was a slowing pace in those areas.

Have you fully identified those reasons and can you share if they're fully behind us? And then moving forward, if you can just share some color on the state of demand in these verticals in 3Q to date and how we should think about it over the balance of the year and I had a follow-up. Thanks..

Yeah. Hi, David. Good morning. It's David Reis. I think that, first of all, we don't know all the way to explain the slowdown in Q1, could be something maybe a little bit random. Nevertheless, as you mentioned, we did see a major recovery in Q2. Something might – on the government section, it might be connected to slow spending on the government side.

In any case, we did see in Q2 increased demand from those verticals. I cannot disclose what's happening in Q3, but we are progressing on plan. So we're optimistic that what we see in Q1 was hopefully a onetime event.

We see strong demand from existing customers, which are buying more systems for application and manufacturing that are in the process of passing or already passed the qualification process. So we're optimistic about this part of the market..

Great. Thanks, David.

And can you provide an update on OpEx expectations for the second half and specifically at the pace of R&D spending over the balance of the year?.

Good morning, David. Thank you. It's Lilach. So, the second part of the year, obviously, is a – we experienced seasonality from a revenue perspective, compared to the first part of the year.

It demonstrates with the stronger revenue based in the second part of the year and we're obviously going to see some fluctuation in the operating expenses as a result to address that.

From R&D perspective, we continue to invest in the same level of our plan in R&D to increase our addressable market and introduce new offering and product to the market. We said this as initiative at the beginning of the year, say for 2018, and we will continue to do that at the second part of the year as well..

Thanks so much..

Our next question comes from Brian Drab of William Blair. Your line is open..

Hi, thanks for taking my questions. So the first question is around the guidance. You've now put up for the first half of the year $0.20 in adjusted EPS, and the second half to hit the low end of the guidance would only be $0.10 for the third and fourth quarter combined.

And I'm just wondering what scenario you might be envisioning that could produce that type of results or is there just conservatism? Why not raise the low end of the guidance?.

Yeah. Our expectation, as we said, is twofold. Within the guidance, there is – I understand your math in terms of the $0.27 (00:18:26) plus the $0.10 but definitely we will fall within – we will fall within the guidance. Bear in mind that Q3 is seasonal and traditionally seasonality is softer quarter on the revenue aspect.

So we expect from operational perspective to see slightly lower margin on the operating activity in Q3. So all along we believe that we will stay within the range that we set for the year..

Okay. So I'm interpreting that as you're saying that third quarter revenue and margin would likely be down from the second quarter.

Is that how to interpret that?.

Revenue and operating margins, yes, given that (00:19:13)....

Okay.

And then what was the FX – currency impact in the second quarter on the revenue?.

Currency effect in the second quarter you asked or the third?.

Second quarter, how much did currency contribute to revenue?.

Yes. So second quarter, if you compare year-over-year, there is some impact of foreign exchange about $2 million impact on the revenue for year-over-year..

Thank you very much..

Our next question comes from Troy Jensen of Piper. Your line is open..

Yeah. Congrats on the nice results and I guess welcome back, David..

Thank you..

Hey, so, David, maybe to start with you. I guess I'd love to get your thoughts on just the direction for Stratasys since your departure. I guess I always thought of you as more of a technology-focused guy and really pushed the company towards new technologies like (00:20:12) projects you're working on.

But, Elan, when you see seem more focused as a solution guy on FDM and PolyJet and recently you guys divested a lot of your opportunities to get into some new markets, SME technologies, so just I'd love to hear your thoughts or the board's thoughts on the direction for Stratasys?.

I think it was a story, (00:20:37) long time. First of all, we will continue following the directions that was set the past one or two years into this interim period until the CEO is on board.

In general, you can see in the numbers that we're very confident in the future of the company and we are taking the measures to invest heavily in R&D and development of new products and new technologies. I think that the overall strategy did not change in the past few years. The market is changing with better things.

The overall strategies did not change.

We are very determined to develop our business in the three directions that we were very active in the previous years with heavy investments in developing, manufacturing products and tools that will allow our customers to go into development or manufacturing of jigs, fixtures, tools, and at the end of the day also end-use parts, and we're doing very good progress and I think it's evident in the fact that about half of our big box machines are being sold to customers of the company which are over time increasing their purchases from us and getting deep and deep into those specific applications, so this is one side of the strategy.

Other one has to dealt with the fact that we still have strong belief in the rapid prototyping business, evident in now the release of F123 machines, which we are replacement for the dimension in this uPrint machines and we are having great success there.

And we still are keeping very strong emphasize in our development and of the MakerBot line of business, which we believe will – first of all, I can share that MakerBot is meeting our plans for the year and doing better. We believe it's a very important market and we're investing also there a lot in R&D.

And third, like we promised many years ago, we're doing it now. We are very active in very specific, which we think would become also a very lucrative part of the metal market and will hopefully have good announcements in the coming years in this area. So this is our overall strategy..

Okay, David. And just to focus may be on a product growth, it was down 8% year-over-year and now it is just kind of FDM and PolyJet in the mix. So what gets that going in the other direction? I mean what do you guys really need to see....

Yeah..

...product growth accelerate for FDM and PolyJet?.

Yeah. So, yeah, this is one of the things that we're obviously a little bit disappointed, the fact that our hardware sales are down. We're getting kind of – we see two things, which are happening in the market.

On one hand, I mentioned earlier, we see increased purchases of hardware especially big boxes for more traditional, very large customers around the world, which is a signal that customers that actually adopted the technology are going through the qualification process.

They believe in Stratasys, believe in what we are selling and are buying more and more from us. You can see very strong yields – aerospace, auto, some parts of the dental markets. So we know that our products are valid.

The reason we are seeing some decline, which I'm quite confident it will improve in the coming quarters is the fact that the market is flooded today with a lot of other products.

And if you look at it from our customers' eyes and standpoint and I don't blame them for it, rightfully, they are looking to experiment and test whatever is coming to the market, including new entrants. I believe that we have at least one of the strongest offering in the industry.

With all due respect to all the other guys, you're selling more than all of them.

And I think that, over time, the market will crystallize and will adopt I'm sure, so some new technologies, but we'll go back to buy more and more Stratasys equipment as time will come, as we're going to come with more new product, more advanced product in all the areas that we are expert in.

So I hope it's a short-term phenomena and we're going to see recovery in the coming years and quarters to this extent..

Our next question comes from Shannon Cross of Cross Research. Your line is open..

Thank you very much for taking my question. I wanted to ask about the competitive landscape and I don't know, David, given you're....

Yeah..

...back and looking at....

Yeah..

...what's gone on in the last couple of years.

How do you see things sort of sorting out? What should the upstarts you (00:25:49) sort of most focused on? And where do you think your best position such as – I don't know sort of an overall view on competitive landscape?.

I think that – I'm kind of six to seven weeks back into the company on more daily basis, so I'm kind of relearning fast. So I'll share with you what I know now. I don't think that -we're lucky, I think all of us, that we're in a growing market.

Different segments are growing in different paces, but in general, the market is growing and we see growth in many areas of our business. I think that in general as much as it will sound kind of maybe strange to some of you on the call, I don't think that the issue today is competition as far as the product and technology is concerned.

We have some, let's say, share of wallet competition which as people will increase their spending on 3D and additive manufacturing technology will disappear. Head-to-head technology competition, if you look on our offering today, your high-end Fortus machines, the high end, very high resolution PolyJet machines, we don't have really competition.

Nobody can produce parts which are even closely resembling what we're doing with the J750 or produce parts, which are similar to what we can do today on the Fortus 900 and Fortus 450. So this is not competition to this extent. Like I said, I think we're lucky that the market is expanding.

And I think all of the companies, many of the players are finding their own issues in this very, very future big market. Short term, we have some competition on wallet share and mindshare, which I think will resolve itself after the market will crystallize.

By the way, to the people on the phone, which has more history in this industry, I think we saw similar phenomena in 2012, 2013, 2014 on the desktop market. If you look at it closely today, you will see that it's crystallizing today and the number of competitors will go down.

The market will elect three, four, five competitors globally, which will supply whatever its needs, and I think similar phenomena will happen in the high-end machines and I have no doubt the company will use technology and breadth of offering and Stratasys will be one of those three, four leading competitors..

And talking with customers or maybe it's a bit early, but I'm just curious, what do you think are the biggest impediments now versus a couple of years ago? And we're not going to get to mass manufacturing, but at least not for a while, but the movement to more of a manufacturing utilization for 3D versus where it's kind of the last few years?.

It's a very good question. I'll give you just one example. If you look on aerospace, I think that in many parts of aerospace, both the civilian and the military side of it is huge desire to adopt AMA technology (28:58) for what the good reasons of cost of manufacturing, weight, efficiency, you name it.

The time for adoption and qualification of those technologies for – one example is aerospace, okay, for aerospace – by the way, it's also true for the medical space.

It's a very, very long period and just to give one example, if let's say I'm a big aircraft manufacturer and I decided to adopt the Fortus technology for interiors, okay, which some very large companies are actually doing. It will become a big game, a big play in the next generation of airplanes because the current airplanes have already molds ready.

It doesn't make sense to print a part of an interior plastic part in an airplane today when you have the mold under your hand. So the adoption time, the time it takes to designers to bring it into their considerations when they're building the next aircraft, the next fighter takes years.

Now if you read and I'm sure you are, we're doing good progress with all the major players but not because they don't think it's a great technology or Stratasys is not good enough. The natural cycle of those industries is 5, 10, 15 years sometimes.

And in many cases or not many – in some cases, we are waiting for the next cycle to make it a mainstream technology. So this is just one example, but if you look on the medical space, you see similar phenomenas of regulation and FDA approvals and so on.

So the cycle of going into manufacturing – and it's true, by the way, to all our competitors; it's not a unique Stratasys situation – is lengthy. But I think that the vision of becoming a very, very large industry is not diminished by the fact that it's taking more time.

By the way, side note, it's allowing us time to develop even better technology and when they're going to adopt, we are going to provide things which are even more efficient than what they have today..

Thank you..

Our next question comes from Wamsi Mohan of Bank of America Merrill Lynch. Your line is open..

Yes, thank you. So in an answer to a prior question, you said, look, I mean if you look at the desktop market from a few years ago, there were a lot of smaller competitors. They all got washed out.

But don't you think that the competitive environment today is much more coming from companies with much larger resources that are targeting the larger profit pools and they have a lot of staying power than the competition you saw from poorly made Chinese like desktop, vendors in the desktop space? So just wondering, as you look at the competitive space, do you think that at the high end, there is more risk to growth and to the margin profile of the company longer term? And I have a follow-up..

Yeah. My comment was, first of all – I'll answer your question in a second – my comment regarding the desktop had to do with not so much the nature of the competitors, but the overall kind of haze that was in the market in 2012, 2013, 2014 when you have so many offerings and it's not clear who is doing what, and what is good for what.

So this was my comment. Regarding the high-end part of the market, I think I would be foolish if to say that – I don't want even to mention names – compare with GE and HP and other major players that entered the market in the last few years. Nevertheless, Stratasys is not a small company.

I'm not comparing ourselves with HP, but specifically in this area, we are definitely a big player. I think we have technology, resources, people to be in a fight in this market and give a good fight to the big guys, which today, by the way, are much smaller than us, but I'm not going to tell you it's going to be an easy fight.

But I think that we are big enough to be able to continue compete and continue to lead despite the engines of the big guys. And I think we are reasonably optimistic about it..

No. Thanks for the clarification.

And then just as a follow-up, one of the problems typically that you see in such an industry is that, as companies with much larger resources enter the market, companies like yours that are very good at what you do and have been there for years, look very attractive as a quick means to sort of gain technology expertise, expand footprint and larger companies can help you scale.

So how does the board think about the trade-offs between being independent versus being part of a larger organization as you look over the next several years?.

I think that the belief today is that we still have a long way to go as an independent company. And we are just in the early stage of fulfilling our vision and dreams in respect to the industry. Now as much as we are 25 or 30 years in the business, I think that from the industry's standpoint, we are early stage.

And I think that for point of view of value, we believe that we can generate very large value in the coming few years as a stand-alone company. I think this is the general notion today..

Okay. Thanks. And last one if I could, I mean is there any impact from the tariffs and trade disputes to Stratasys as of now? Thank you..

There is no material impact specifically related to this and we continue to monitor the situation and address the implication..

Thanks a lot..

Our next question comes from Greg Palm of Craig-Hallum Capital. Your line is open..

Yeah, thanks.

You commented on sort of maybe outsized strength in North America, but I guess can you comment on your other geographies as well?.

Yes. We're doing according to plan in Asia. Europe was a little bit slower. But I don't see anything dramatic in any direction, okay? So the overall picture of the company is, for the most part, the overall picture of the different territories. With Europe a little bit slower in the first half, we hope to recover in the second half..

Got it. Okay. And then service sales ticked up a couple of million here in Q2 compared to sort of what this last, I'd say, 8 to 10 quarter range as has been.

Can you give us a little bit more detail on sort of what are the drivers there?.

Yeah, customer support is a function of our installed base of system as well as our ability to offer extended services offering to our customers. So we definitely see a nice traction there as well as we saw a very good momentum on our Stratasys Direct Manufacturing, our part business.

We saw improved growth as a result of recent organization as well as interesting synergy between this organization and America organization and the organization basically sells the hardware. So all along a good momentum on the services side that we experienced..

And, Greg, as a reminder what we did earlier this year is we brought the SDM business underneath Rich Garrity who's running the American operations. And he really helped to create some of the cross-functional synergies that we last referenced. So we saw some of the impact of that already now in Q2 and looking forward to more of it..

And just to be clear, was there any sort of kind of onetime, maybe large order or anything in the SDM specifically or is that – you feel pretty good about sort of what the momentum is going forward?.

No, nothing specifically in terms of one order. Definitely a good momentum and looking forward to materializing this as well in the future..

Great. Thanks..

Our next question comes from Jim Ricchiuti of Needham & Company. Your line is open..

Hi. Why don't we go back to the earlier question about system revenues? We've seen declines now in – what – four of the last six quarters. And my question is, it sounds like you think that's going to turn around. But beyond that, as we think about the consumables portion of the business, you're still showing modest growth in that area.

At what point should we be concerned that this decline that you've seen in systems revenue begins to present the headwind on the consumables business or are you seeing some areas of the business that's really beginning to drive the consumables business? Thank you..

So hi. It's David..

Hi, David. Good to talk to you..

Hi. How are you? I think that the increase in consumables is indication for increased adoption of the technology in different segments. There's a reason for increase on the consumables side.

We don't expect – like I said earlier, from the reason I mentioned earlier, we hope and expect that the combination of the market offering being more crystallized over the coming few quarters, and new offerings that will come out of Stratasys in different areas, we hope will stop and hopefully will turn around the declining seen in hardware sales, okay? So, you asked me if mathematically is this the point in time that the hardware sales go down will hit consumable growth, the answer is of course yes.

Mathematically, it could happen in one point of time. And hopefully, we're not going to get to it from the two reason I said. We are working very hard on the R&D side, those things as you know take time. We increased our R&D budget. We have good product in the pipeline.

And then part of that, I hope that market will rationalize and people like our regular customers, our old customers will go back to buy Stratasys' products in higher numbers and it will straight up the model as well..

Are there some applications or markets that stand out that have been driving some of the consumables business during this period of transaction?.

Yeah, we see nice increase on the high-end FDM side. We see very nice increase on some of the dental applications, which are related to manufacturing..

Okay. Thanks a lot..

Our next question comes from Ananda Baruah of Loop. Your line is open..

Hi, guys. Thanks for taking the question. David, welcome back. (00:41:24) just for a little bit here.

A couple if I could, David, you had made mention earlier and I think I touched on it again that you believe, to paraphrase, in the near term, you think customers will sort of wrap up taking a look at the myriad products and begin to make choices and sort of that will have a positive impact for the stronger players on sales.

Can you speak to some of the things or what is it that had you develop that gut feeling? Is there anything specific about that or is it kind of based on past experience having gone through it before? And then I have a follow-up as well. Thanks..

I apologize. I don't think I said near term, I said in the future. Yes, the rationale and the way I see it is that we do see that customers that adopted our technology in more than a few verticals are coming back to us and buying more and more machines. By the way, both on the high-end prototyping side and on the manufacturing side.

So my assumption and I know that they know what they're doing. So if they decided to adopt and sell the technology, went through the qualification process and, let's say, decided to buy two or three or four more Fortus 900, it means that those machines are actually doing work which is needed in the profitable and good ROI to those customers.

Now the percentage of customers around the world that adopted those technology from their potential number of customers that can adopt those technology is minor, okay? So we have many, many, many customers around the world that are in either the look and see or experimental stage of buying different technologies within the AMA (00:43:33) market.

So because we see – I think we said also in previous call that about half of our sales of large box of machines are going to our installed base, okay? So I don't see a good reason why, over time – and again I don't think I said near time – over time, there are potentially many other customers which should follow some of the big names that you're familiar with that decided to adopt our technology, okay, as leader in their industry.

There are many followers which are in the process and like I explained earlier why it takes time, okay? So maybe compared to our competitors and it's a big difference, we have proof that our customers are adopting those technologies and expanding.

I think our competitors, for the most part, where we were three, four years backwards when people bought our technology to experiment and see what they can do with it. And this is the reason for – again, I'm saying I'm cautiously optimistic and, again, I don't think it's near term.

I think this is a medium/long-term horizon the industry in general, not Q3, Q4, Q1 upside down results..

Got it. That's very helpful. Thanks for walking through that most specifically.

And then just going back to the guidance and sort of what's implied for the second half, so is one of the reasons – it could just be conservatism, but which one of the reasons is one of the reasons for the implied softer sort of second, lower half of the guidance EPS range? Is it that you're increasing investments in certain areas? And if so, could you speak to what those areas are? Thanks and then that's it from me..

Thank you. So it's a combination of a couple of things. First of all, Q3 from a revenue perspective, traditionally, it's a softer quarter. So Q1 and Q3 are softer quarters than second quarter and the fourth quarter, so what we experience in next quarter, it's probably going to – on the revenue side to see a softer revenue perspective.

And from an operating perspective, we will continue to invest in R&D and in those initiatives that we believe that will promote our company going forward, either from R&D perspective as well as go-to-market.

So if you couple this together, you will end up having a slightly lower operating margin in Q3 in terms of how you model your second part of the year..

Our next question comes from James Medvedeff of Cowen. Your line is open..

Hi, thanks for taking my questions. So as a perfect segue from that last answer, you mentioned gross margin should be lower in the third quarter versus the second quarter.

And I'm wondering how much of that is due to lower system sales quarter-over-quarter? Or, in other words, is it due to mix or is it due to some movement in the margins within the different categories?.

Can you repeat please on this question please?.

Yes, I'm sorry. You mentioned that gross margin should be down in the third quarter versus the second quarter.

And I'm asking how much of that is due to mix between systems and consumables and service versus how much might be due to changing margin profile of the different segments?.

Okay. I would like to clarify, it's not been mentioned that the gross margin is down. It's been mentioned that the operating margin is down. So we have not anticipated any significant changes on the gross margin trends.

Obviously, gross margin is due – there is various vector in gross margin, product mix as well as cost changes in the lifecycle of our product in terms of cost perspective. So there is definitely various vectors going into the gross margin.

But we do not expect to see anything specifically in the third quarter that implied our gross margin to go down in the third quarter.

Overall, our operating margin will be slightly lower than what we experienced in the second quarter, given that we're going to start with the softer revenue perspective, and we are continuing to invest in R&D initiatives and we maintain a similar run rate on the other operating level expenses..

All right, I apologize. I thought that earlier in the call you had said the gross margin would decline in the third quarter. So I apologize..

That's fine..

Now, just as a point I'd like to make, it would be very helpful if you began to re-disclose or disclose again the unit shipments as you used to do. That would be very helpful in the modeling process. And also I had a couple of housekeeping questions.

How much was CapEx in Q2 and how much was depreciation?.

In the second quarter, CapEx was $5 million. Depreciation, we will get back to you regarding this number..

Our next question comes from Hendi Susanto of Gabelli & Company. Your line is open..

Good morning, Elan, David and Lilach. My question is the full-year revenue guidance implies sales growth between 3% and 12% in the second half of 2018.

How should we think about potential scenarios that can help Stratasys generate growth in the upper end or at the midpoint of that range considering that Q3 is a soft quarter?.

Yeah, it's true that Q – third is a traditionally softer quarter, but the fourth quarter is also traditionally very strong quarter of revenue. So we do expect to see overall the second part of the year stronger than what we saw in the first part of the year. So those are the changes that we are – this is what we are expecting.

We are pleased with recovery signs that we saw in North America, only though the main vertical that we are focused on government, auto and aerospace, we do have a very strong pipeline discussions and engagement with our customers, which led us to believe that we will be able to deliver on this set goal for the second part of the year.

So coming from the second quarter, we are confident that we'll be able to meet the said guidance..

Even at midpoint and upper range of the guidance?.

Guidance..

Yeah, we're going to meet the range of the guidance. We are not specifically address now whether it's going to be the upper end or the midpoint..

Got it. That's helpful. Thank you so much..

At this time, I'd like to turn the call back over to Elan Jaglom for any closing remarks..

Okay. Thank you for joining us today. We look forward to speaking with you again next quarter. Thank you..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day..