Proto Labs Inc (PRLB) 2014 Q3 法說會逐字稿

Greetings, and welcome to the Proto Labs, Inc. third quarter 2014 call.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Bill Dietrick, Vice President of Marketing.

Thank you. You may begin.

Thank you, operator, and good morning, everyone. This morning before the market opened, Proto Labs issued a Press Release announcing its third quarter financial results for the period ended September 30, 2014. The release is available on the Company's website at protolabs.com.

Before we get started, during the course of this conference call the Company will provide financial projections and make other statements about its business that are forward-looking and subject to many risks and uncertainties that could cause actual results to differ materially from expectations. A detailed discussion of the risks and uncertainties that affect the business is contained in the Company's annual report, filed on Form 10K and other SEC filings, particularly under the heading Risk Factors.

Copies of these filings are available online from the SEC or on the Proto Labs website. The Company's projections and other forward-looking statements are based on factors that are subject to change and, therefore, these statements speak only as of the date they are given. The Company does not undertake to update any projection or forward-looking statement.

In addition, to supplement the GAAP numbers, we have provided non-GAAP adjusted net income and basic and diluted net income per share information that excludes the after-tax costs of stock compensation and amortization of intangibles. We believe that this non-GAAP number provides meaningful supplemental information and is helpful is assessing our historical and future performance. A table reconciling the GAAP information to the non-GAAP information is included in our financial release.

Now I would like to turn the call over to Vicki Holt, President and Chief Executive Officer of Proto Labs. Vicki.

Thank you, Bill. Good morning, everyone. Thank you for joining us today on our third-quarter 2014 conference call. With me today is Jack Judd, our Chief Financial Officer.

I'd like to begin with an overview of our third-quarter 2014 financial results. Then I'll provide an update on FineLine additive manufacturing and our new services, followed by more in-depth discussion of our Protomold parts business. Finally, I'll tell the story of another Cool Idea winner. I'll then turn the call over to Jack, who will provide a more detailed look into our financial results, and offer our views on the outlook for the fourth quarter of 2014. We will then be glad to take your questions.

I am pleased to report that Proto Labs has once again achieved record revenue. Third-quarter revenue was $54.6 million, a 30% increase over the third quarter of 2013. Our third-quarter revenue includes $3.4 million of additive manufacturing services, or 3D printing, from our FineLine acquisition. Without these revenues, third-quarter revenue would have been $51.2 million, an increase of 22% over the prior year.

In addition to revenue, the number of product developers who use our service during the quarter is a key growth metric. We have not yet completed the integration of the FineLine legacy Proto Labs product developers and the customer databases. Therefore, the product developer and customer numbers we present today exclude FineLine.

Our legacy Proto Labs revenue in the recent third-quarter came from nearly 8,700 unique product developers, a 19% increase over the third quarter of 2013, and a meaningful sequential increase from 8,200 product developers in the second quarter. Revenue growth in the US was 34% compared to the third quarter of 2013. Excluding revenue from FineLine, US revenue growth was 26%.

In local currency, revenue in Europe during the quarter was flat with prior year, while revenue growth was 24% in Japan. Global consolidated Proto Labs net income for the third quarter of 2014 was $10.4 million, or $0.40 per diluted share. This compares to $8.9 million or $0.34 per diluted share in the same quarter of 2013. Excluding the after-tax cost of stock compensation and amortization of intangibles, the non-GAAP EPS was $0.44 per diluted share during the third quarter of 2014.

Our record revenue and strong profitability in the quarter were achieved in the face of a notable slowdown of the business environment in Europe. The headwinds in the European economy hit us directly this past quarter, and were the major reason our quarterly results were at the low end of our forecast. Because of this, our future forecasts will be conservative until we see improvement in the European economy.

We continue to make great progress with our FineLine acquisition. Revenue this past quarter of $3.4 million exceeded our forecast, and represents a 38% increase over the prior year. Sequential past quarter -- sequentially this past quarter grew 15% over the total FineLine second quarter, including revenue both pre-and post-acquisition in the quarter. This strong revenue growth is evidence of the quality of our marketing and sales engine.

We have significantly increased our additive manufacturing capacity in Raleigh, North Carolina, over the past several months. Through purchases of additional equipment, our capacity has grown by 50% since the acquisition. And with more equipment scheduled for delivery this quarter, our capacity will increase another 30%.

We are also making progress integrating our websites, and now have FineLine content on the Proto Labs website. We also expect to launch quick turns, in FineLine, stereo lithography, or SLA, in this fourth quarter.

We are accumulating many great stories of how our customers can leverage our services and drive expansion for Proto Labs. One recent story was regarding a new Protomold customer. He was early in the product development process with an uncertain design which needed to be tested. He knew he would eventually need Protomold injection molded parts in the specific thermoplastic for optimum performance for final testing. But, with an uncertain design, he was hesitant to move forward with the mold, which might need to be changed.

As an alternative, he sent the CAD file to Proto Labs FineLine Additive Services to get a quote using one of our less expensive ABS-like materials. He was able to do functional assessments from this material and understand what changes needed to take place in his design before moving to molding.

The FineLine parts performed properly for testing, and the product designer was able to revise the final design and move forward with all three molds with Protomold. FineLine gave him confidence in his final design, and the parts turned out as expected. Our speed, efficiency and breadth of service enabled the customer to produce a 3D printed part, make the appropriate design changes, finalize the design, and get prototypes made and still meet the project timeline. Stories like this happen every day.

Moving to our new materials, we remain very pleased with progress with liquid silicon rubber and metal injection molding. I expect our revenues from these new services will be approximately $3 million this year. As I've said in the past, both these opportunities are significant, and should play a larger role in our revenue goals for next year. We continue to introduce new capabilities to our customer base, and we feel confident in our execution, and will be purchasing additional equipment in our fourth quarter and early next year to support higher revenues for these services.

We continue to be in a soft-launch phase with lathe-turned parts in Firstcut. Our engineering teams review quotes to find examples of parts that should be turned versus machined, and seek feedback on quality from our customers. We remain positive on this newest addition to Firstcut, and look forward to a full launch in both North America and Europe in early 2015.

Another exciting update in Firstcut is that we are now offering same-day service, an additional important differentiation from traditional service providers.

A significant part of our business that is oftentimes overlooked is production parts business done as part of Protomold. We are much more than just prototyping. There is about a 50% chance that after making a mold, and sending samples to customers, we will run additional parts on that mold at least once.

Our parts business has predictability, but not visibility, like many of the rest of our services. We have told stories in the past of last-minute orders with tight timelines for tens of thousands of parts on each of several molds delivered in days. While these are great stories, the vast majority of our parts business comes in orders of a few hundred to a few thousand.

The reason for the relatively small orders are many, including the need for marketing samples, production testing, or just that the full production only require small quantities. Our business is perfectly set up to handle demand for low volumes of parts efficiently and cost-effectively.

In any one quarter, the customers who choose to have us run more parts can be almost a totally different population compared to the next quarter. That's okay with us. Our factories are set up to handle this kind of demand and generate high profits.

Starting in 2013 our parts business growth rate exceeded the growth in molds. Rather than being the historic 50% of Protomold revenue, parts are now 53% of that total. This percentage increase is also evident in the metric we provide on average revenue per unique product developer, which has grown on average 6% per quarter from Q1, 2013 through Q2, 2014. A portion of the increase in this metric is from additional orders for parts coming from our current product developer base.

I am sure there are many macro trends in manufacturing that have contributed to this increase, such as shortening product lifecycles and mass customization. This is positive news for Proto Labs, because low-volume production fits our business model perfectly. Proto Labs' automated front end and efficient low-volume production positions us very well to service this business profitably.

We've also seen that our parts order flow can be an early indicator of business trends. During 2013, revenue from our parts business was up 40% compared to 2012. Through the first six months of 2014, revenue was up 30%. During the just-completed quarter, our parts revenue grew 19%. This lower growth rate in our parts business was especially pronounced in Europe as parts revenue was down 6% compared to last year's third quarter.

During the recession of 2008-2009 we saw a slowdown in demand for our parts, but less so in other areas of our business. We believe our European business will be on the rebound when we see Protomold parts revenue increasing again.

Turning now to our Cool Idea Award program. This program continues to help innovative ideas come to life. Our most recent winner was Chicago-based startup Stride Technology.

Their creative ideas is a wearable device called [Ampi] which lets users discreetly capture and convert their daily physical activity into charging power for their Smartphones. The compact device can be strapped to a person's arm, leg, or hip where it charges anytime movement is detected. A user can then plug their Smartphone into Ampi to restore the phone's battery life.

Proto Labs provided the creative teams with the tooling and subsequent low-volume injection molded production run for the plastic Ampi clips and housings. The Cool Idea Award is just one example of creative and interesting ways our marketing team generates interest in our service offering.

Finally, before I turn the call over to Jack to review our financial results in more detail, I do want to provide a short update on our search efforts to find our next CFO. We are actively interviewing great candidates, and expect to have Jack's replacement on board before the end of the year. I will now turn the call over to Jack for further comments on our financial performance. Jack?

Thank you, Vicki. Revenue during the third quarter of 2014 was $54.6 million, an increase of $12.6 million or 30% over the same quarter in 2013. Additive Services revenue or 3D printing relating to our acquisition of FineLine in April was $3.4 million. Without this revenue related to the acquisition, our revenue would have increased $9.2 million or 22% when compared to the previous year.

Protomold and Firstcut revenues were $35.7 million and $15.5 million respectively. Revenue splits between our Protomold, Firstcut and FineLine Services were 65%, 29% and 6%. International revenue during the third quarter of 2014 totaled $13.8 million, or 25% of total revenue compared to $11.4 million, or 27% during the third quarter of 2013. The positive effects of currency were approximately $600,000 this past quarter.

Within our legacy Protomold and Firstcut Services during this past quarter we did business with 8,680 product developers. This represents an increase of 19% over the same quarter in 2013. Average revenue per product developer increased 3% from the previous year.

On a year-to-date basis, our revenue through the first three quarters of 2014 is 29% higher than the prior year, and excluding revenue from FineLine our revenue was 24% higher. Our gross margin decreased to 60.6% for the third quarter of 2014 from 61.8% the year before.

We estimate the impact on gross margin due to the lower gross margins on our additive business to be approximately 1.1 percentage points. We currently have active projects ongoing to increase the gross margin of our additive business such as offering quick turns, as Vicki mentioned earlier, and over several quarters we expect the gross margin will approach those of both Protomold and Firstcut, and we will continue to stay within our target model.

Operating income was $15.4 million in the third quarter of 2014, compared to $13.4 million in the same quarter 2013. As a percentage of sales, 2014's operating income was 28.3%, and 2013's was 31.9%. Year to date our operating margin is 29.9%. Our inside selling force and customer support employees totalled 189 at the end of September, an increase of 42 employers from December of 2013.

Diluted earnings per share in the third quarter of 2014 were $0.40; after adding back the after-tax cost of stock compensation and amortization of intangibles, our non-GAAP diluted earnings per share in the quarter were $0.44. A reconciliation of net income on EPS and non-GAAP income on EPS was included in our Earnings Release this morning.

Our capital spending on capital year to date through September totals $35.9 million, and includes $13 million related to our Plymouth facility, and $7 million related to our purchase of our manufacturing facility in Telford, England, that was completed in May. At the end of September 2014, our cash investments totaled $118.9 million.

I would now like to provide some guidance into our projected results for the fourth quarter of 2014. Including FineLine results, we currently expect revenue in the fourth quarter of 2014 to be in the range of $53 million to $56 million. Of this amount our additive services, or 3D printing revenues, are forecasted to be approximately $3.5 million. Stock compensation costs in the third quarter will be approximately $1.4 million; amortization of intangibles related to the FineLine will be approximately $185,000. Taking into consideration all of the above, our expected quarterly non-GAAP EPS will be between $0.40 and $0.44.

Our guidance philosophy will be conservative in light of the effect of our European performance this past quarter. We reaffirm our long-term target model of 25% growth and GAAP operating income of 29%. Our capital spending during 2014 will total approximately $44 million, of which nearly half will be for the building purchases noted previously, with the remainder being heavily weighted for new equipment to support growth for our present and new services.

This concludes our prepared remarks. Operator, we will now open up call for questions.

Thank you. At this time, we will be conducting a question-and-answer session.

(Operator Instructions)

Our first question is coming from the line of Troy Jensen with Piper Jaffray. Please proceed with your question.

Thanks for taking my question. Good morning, Jack, Vicki.

It looks like Europe is really kind of the only issue here in the quarter. I guess I would be curious to know: Was it weak all quarter or did you see deterioration in Europe in the last few weeks of the September quarter?

Actually, the deterioration would've been earlier in the quarter; a little bit of pick-up toward the end. It was a weak quarter, primarily in parts, as I mentioned. Molds in Firstcut were not as impacted as parts. And, as you know, our parts businesses -- we've got predictability but not visibility when we look at that business.

I understand. So, obviously, by your guidance there's been no signs of improvement in the month of October?

I think the way we are approaching this is that you'll see better guidance when we've had a better quarter in Europe. I just think that it makes sense for us to be very conservative in what we expect out of Europe until it's actually happened.

Okay. How about, Vicki, back on the -- some of the new services, specifically the lathe capabilities, which is in soft launch right now. When do you expect a hard launch, and do you expect the ramp to be quicker than what we've seen at LSR?

Yes, we expect -- it will be in first quarter -- toward the first part of first quarter, but we've really got to be ready. As you know, when we go through first -- go through soft launch, we not only are testing to make sure our quality is what it needs to be, making sure we don't have any bugs in our software. Because when we turn the switch on, we've got to be able to process quotes as well as orders in a very automated fashion in Firstcut. So, we've got to be ready. But I would estimate probably early in the first quarter.

Ramp for this will probably be somewhat similar to LSR and in MIM. It takes a while for the customers to understand we've got the new service offering in hand, and how they need to use it.

So, we will be doing some pretty aggressive marketing to product developers and engineers who have indicated to us in the past that they would like to see turned parts. So, we'll be going directly to them to let them know we now have that service available. But, again, they've got to have a project ready for it as well. So, I would anticipate it'd be a similar kind of ramp as we launch a new service.

Keep in mind also, Troy, is that we currently do produce parts in a milling process that should be lathed. So, some of our business that will be lathed will be business that we had before, but it was milled. And so, I'm not so sure you can just look at how much revenue we did with the lathe, and be able to accurately reflect how much it impacts our revenue. But we're very, very positive on it because I think it will help us be more competitive on parts.

Oh, absolutely. And so far, the response -- we are doing more and more parts every single month. And response from customers has been extremely positive.

All right, understood. Good luck in Q4.

Thanks.

Thank you. The next question is coming from the line of Brian Drab with William Blair. Please proceed with your question.

Good morning.

Good morning, Brian.

Good morning, Brian.

I think I might be missing something. I just want to clarify -- on Europe. Your reported revenue is up 9% year over year, but you're saying flat organic, but there's an FX headwind. Can you help me reconcile that?

There was an FX benefit in Europe in the quarter. So, while in dollars it looks better, on a pound-sterling basis, it was flat. So, I'm choosing -- [I'm sure it's better] to be conservative. I don't want the market to be thinking that the 9% was anything besides currency.

Okay.

And by the way, we knew going into the quarter that there was going to be currency benefit. So, it isn't as if the currency was not planned on our part.

You're recording revenue in pounds?

No, we record revenue for our financial statements in dollars. But when I do a conversion -- (multiple speakers)

I'm saying your sales are in pounds in Europe?

Yes.

Right, okay.

But, you know, when we're doing comparisons on a geographic basis in this call, I always like to do it in constant currency, so that we don't mix in the effective currency, either positive or negative.

We sell in Germany and France and everything in euros, and convert back to pounds. But, as we said, the slowness in Europe is primarily in the parts business. We still had very strong, consistent growth in our number of product developers that we're reaching, and even number of new customers. The parts business tends to reflect the economy more because it tends to be production.

Yes, understood. I was just trying to understand the FX impact. Because if we were just translating back euros to dollars, then -- but I think I was missing that the pound is playing a significant role here, and that you actually had an FX benefit. So, thanks for clarifying that.

Then, you mentioned, I think, Vicki, just a moment ago that parts business in Europe picked up a little bit in September?

No, not really picked up. (multiple speakers) The biggest impact of the shortfall quarter to quarter was probably felt more in the July-August time frame. It didn't really -- I mean, it was -- the quarter, parts business was weak.

Okay. And then, Vicki, can you talk a little bit about the sales initiative changes that you are planning to make, or making, in terms of targeting customers at the top, and selling down, as you say?

Right, right, the wide and deep? Perfect. Great question, Brian. It's going very well. We're much, much further along in that strategy, by the way, in North America, where we have national account managers in place who are going wide and deep with strategic customers. And it's going quite well.

When we look at the data in the United States, our sales growth with our top-100 customers are several basis points ahead of what our average is, recognizing then that our sales growth with these larger accounts is actually happening at a much faster rate than the Business at large. So, definitely working. You can see that in the product developer database as well. So, we will be bringing that approach into Europe in 2015, looking to launch some of our first national account managers there as we go into 2015.

So, how many people have you added or directed to just focus on this initiative? And then, secondly, have you landed any big whales yet, or getting close to, in terms of a big customer that is going to use Proto Labs as now their preferred injection molding provider or rapid manufacturing provider?

Yes, okay. In terms of the people we've got, as we look at our customer-facing team here in the United States, we have about 110; we probably have about 10% of that focused on --

Little bit more, I think.

Well, if you include -- yes, if you include the -- all right, so, about 15% focused on NAMs, so the national account managers.

When you talk about big whales -- that's a great question because we do have some very large customers who use us in strategic ways. But usually it starts in one division, and we become a preferred small-volume prototyping partner in a division, and then we will move to the next. That's why the wide and deep strategy is so effective, because we can begin infiltrating across divisions within these companies.

When you say big whales, we still don't have what I call a lot of customer concentration or anything like that, but we are -- the strategy is definitely working, with being able to become a lot more strategic with some of these customers.

Yes, and I don't think that our Business ever will be in a situation where you come in one day and you've, all of a sudden, picked up an account where you're going to get $4 million or $5 million worth of business overnight. This Business is still going to be built by selling product developer by product developer. By going deep and wide, we just hope to speed up the introduction phase, and use the processes to successfully sell one division of a large company, use it in another division in the same company.

We will also always be focused on that innovation through low-volume production. So, we will not be a large-volume contract manufacturer out there.

Okay. I understand. What I maybe don't understand, Jack, on your last comment is: Why could you not go into a large manufacturing firm, convince them of your compelling value proposition, and have it so that, in their system at some point -- you know, when an engineer wants to -- comes to the point where they need to decide if they need injection molding, or some other process -- why Proto Labs wouldn't be in some sort of a dropdown menu as the preferred provider? I thought that that type of partnership with bigger companies, just because -- you know, your offering is so unique, why can't you get to that phase? It seemed like you backed off a little bit -- you're indicating that you wouldn't be able to do that, Jack.

Well, I don't want to make it sound like that's not our goal. But you have to reflect the reality of how purchasing departments work in large companies. But especially, as dynamic and great our offering is for prototypers, there is lots of things we can't do for them. So, even in the best circumstances, product development departments are going to have to have some level of relationships outside of what we can do for them. So, you know, that's a little bit of the reality of the matter. But we do strive to do as much as we can for product developers. But we're still growing on this.

Okay, okay. I'll follow up more later. Thanks.

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

Hi, thank you, good morning.

Good morning.

The question I had is -- thanks, by the way, for the color on the parts business; that's helpful. I was wondering: Is Europe typically a bigger customer for you, in terms of the parts business? In other words, does that tend to be -- is that business skewed more to that versus North America?

No.

No.

Okay. So, just looking at what you saw in Europe during the quarter, were there any particular verticals that stood out as being -- as weakening, or was it kind of across the board?

It was pretty much across the board. So, really, you can point to, you know, a few -- as with our parts business. We mentioned that we're -- we get benefit from the fact that products have a fairly short product life cycle, in which case they might choose us for their parts supplier. With that, you also have programs that fall off. So, you'll have parts business for a period of time; the product has a pretty short product life cycle, and then will fall off. So, we've got that impact, plus the impact that some of it is production and will be more impacted by actual economic conditions in the quarter.

Got it. And, Vicki, how would you characterize the parts business in North America as you went through the quarter?

It was fairly strong. It was pretty typical. It was pretty typical.

Very much what we thought it would be going into the quarter.

Yes, it really -- I mean, the whole reason we came in at the lower end of our guidance was really that European parts business. And that's why we are being pretty conservative with what we forecast into fourth quarter till we see that recover.

One final question, if I may? I think you said that you're looking for LSR and MIM to generate revenues of around $3 million for the year, for 2014?

Yes.

Were the revenues meaningful in Q3? Is this something you expect to ramp up more in Q4?

It's ramping up every quarter. Remember: We launched these services in the second quarter. And very similar to the comment that I had with the question around our lathe turned parts, it takes a while for developers to understand the service is out there, and to reach out to us on the website and give us that order. It also depends on if they've got a project out there that fits that material and fits that process.

So, it just takes a little time to educate them. And that's why it's a ramp. But each quarter sequentially gets a little bit better as we reach more and more developers, and we help them understand what the service can do for them, and they try us out on a part that could benefit from that particular material or process.

The ramp up in sales on these new services is really not that much different than we experienced back in 2007 and 2008 with Firstcut. So, as dynamic and nice of a service that Firstcut is right now, it started out where you would sell a few hundred thousand dollars worth of Firstcut parts in a quarter.

Okay. And, Jack, R&D was up quite a bit. Was there anything unusual about that? Should that be the level we should be thinking of going forward, moving it up?

Some of the greater spending in R&D is reflected because of the integration activities we have with FineLine on the software side. But I still think that, overall, our R&D should be between 7% and 8%, like our target model states.

Got it. Thanks very much.

Thank you. Our next question is coming from the line of Andrea James with Dougherty & Company. Please proceed with your question.

Thanks for taking my questions.

Good morning.

Good morning. Is there a way to think about how much more business you can capture that you were previously turning away with the new LSR and MIM services? And was that the $3-million figure that you were citing?

So, the LSR and MIM is what -- we expect $3 million of sales from those new services in 2014. Again, that will be ramping. We haven't come out with an exact total available market estimate for LSR and MIM. We have kind of lumped that into our total injection molding segment. We do think that the sales revenue for those materials will be more significant as we go into 2015.

I appreciate that. And then, is there -- because the way you guys focus your R&D, as I understand it, is you are able to see -- you get the files uploaded and you're able to see what you're turning down, and then come up with new services based on that. Is there sort of a ratio that you can give, or any color there on how that's been changing over time? Does that question make sense? (multiple speakers) Like, especially with the addition of FineLine as well? Go ahead.

It does make sense. So, we do look at the percent of uploads that we can turn around and quote, and the ones that actually, you know, turn into orders. So, we look at all that data every single day. Also, we inform our R&D efforts from voice-of-the-customer conversations that we have with what the customers would like to see as a new service. So, that's how we add our new processes, as well as our envelope expansion.

So, we collect data on, for example, parts that should be turned, yet we mill -- that's the lathe program. We estimate that about half of the machining total available market probably could benefit from turned parts versus what we do with milling. And we have been attacking that market with milled parts, which aren't as efficient, and the quality is different for those. So, we think that that will allow us to more effectively go after that total available market for machine parts with lathe. The liquid silicone rubber and metal injection molding product line is really included -- materials is included in that total available market we've identified for injection-molded products within our TAM.

Helpful. And then, I'm trying to understand Europe real quick. When you say that the parts are tied to production, do you mean end use as opposed to prototype?

Correct, correct. Some of it might be market sampling. Some of it might be gearing up with more products for extensive testing. But some is also production.

So, the sampling is done. When we sell a mold, we send samples of a product. So, we'll send 25, or whatever the customer wants in terms of the sample; that's what I would call prototyping. But then, about half of our customers that buy a mold from us and take those parts, will actually come back and get more parts off that mold. That's what we call the production business.

Okay. So, that would be tied, in part, to consumer spending then, of all kinds?

Yes, exactly. Exactly. And remember: We have a customer base that pretty much reflects industrial production. So, you have got automotive in there, consumer, industrial machinery. And so, as your industrial production goes down, you're going to see some of our customers being a little bit more conservative on, you know, inventories and what they build, and a little bit of adjustments that take place. And I think we see that more in that parts business, of course, than we do in the molds, because innovation continues to take place. And Firstcut and our Protomold mold business, as well as our additive manufacturing business, tends to be earlier in that product development lifecycle.

Got it. Thank you; that's very helpful. Thank you. I appreciate it.

Okay, thanks, Andrea.

Thank you. Our next question is coming from the line of Scott Schmitz with Morgan Stanley. Please proceed with your question.

Good morning. Just to follow up on that, Vicki, are you seeing any change in the quoting activity or conversion rates, even -- within both the US and then in Europe, aside from the part business?

No. No, we continue to work on that so we can do work to make sure we get high-quality prospects who turn into uploaders who turn into customers. We have launched in both the US and Europe, in the process of launching in Japan a, what we call, a Proto Labs proposed revision, which turns back to the customer, suggestions in order to make their quote orderable with that first rev, so to speak. And we actually have seen improved close rates from the customers that use our Proto Labs proposed revision.

We're only right now having a little over 10% of our quotes are eligible for Proto Labs proposed revisions, but we get a several-percent-point improvement in close rate with that. So, we see that a little bit in some of our metrics starting to trickle in, in the third quarter. So, that's helping. I think you see that reflected in some of the good metrics that we're showing in terms of new product developers joining -- being added.

Here's a little bit of a nugget for you, too, on the parts business in quoting is the majority of our parts business does not have a quote attached to it. It just comes to us through a PO. We tell the customer what parts will cost when they get a mold. But they won't come in and put a quote in, and then 10 days later put an order in off of that quote. So, we have even less visibility on parts than we do on mold.

Got it. That's helpful. So, then to follow up on that, it sounds like, in your guidance, you are not assuming any change in the number of unique product developers, it's really in the revenue per developer. And a lot of that's a function of the parts business. Is that the right way to think about it?

We are going to be very conservative on how, especially in Europe, and how Europe recovers in the fourth quarter. We still expect good growth from product developers, like we've had in the past, but I think parts business -- or we're assuming parts business will be very weak in Europe in the fourth quarter.

To build on that, I think you hit it -- you really got that correct, Scott. And with that -- you know, long-term prospects, I still feel very, very confident in where we're going and with our target model and with our growth rates, because we're getting the penetration that we expected to be getting with new product developers and customers.

So, all is going well there. The services are going great. I think we have hit it right with what is going on with the parts business in Europe.

Okay, great, thank you.

Thank you. The next question is coming from the line of Jason North with Jefferies. Please proceed with your question.

Hi. Could you go through the puts and takes here, looking at gross margin, and looking at it from the viewpoint of excluding -- mainly focus on the US, ex FineLine, so excluding the Europe impact here for the quarter and for Q4 as well? Thank you.

We don't disclose gross margin by geographic market. And I have said in the past, not necessarily so in Japan because it doesn't have enough volume, but the gross margin between Europe and the United States is very similar. We don't have a pricing difference or a cost-to-production difference that would change our gross margin by geography.

I did say in the script that FineLine affected our gross margin -- our consolidated gross margin -- by about 1.1 percentage points. You'll notice that we're still within our target model. We would have -- without FineLine, we would have been at the upper end of our target model. So, our manufacturing, I still believe, performs wonderfully in an environment that we have.

Okay. I was just looking for qualitative statements for the US, not an absolute number, but how it's kind of trending here.

Our margin in the United States is strong, and tends to be consistent from quarter to quarter.

Okay. Great; thank you.

Thank you. Our next question is coming from the line of John Baliotti with Janney Capital Markets. Please proceed with your question.

Good morning. Hey, Jack, how are you?

Good.

Vicki, on a secular basis -- I mean, obviously, Europe, you're not the first to call out that there's some slowdown going on over there. How are you -- you know, without it creating a leading question, but how do you take advantage of that, long term, with customers there?

Again, I think our model is very, very strong with small-volume production and innovation. And, as you know, when you go through various kinds of economic downturns, there is some initial reaction, but then there is still the need to innovate and the need to differentiate yourself.

So, we continue to work -- I mean, customers are still very, very active with us. We've got lots of programs that are under way, and we really are doubling down on sales and marketing in the EU, with some additional investments there; we're adding some sales people in each region of Europe right now.

Are you able to reinforce the idea that using Proto Labs, not just for the initial design work, but given their pullback -- let's say, economic pullback or slowdown -- that using you as a more variable cost is a long-term benefit to them?

Right, exactly. So, customers don't have to buy a big batch of product; they can buy what they need. So, if they've got demand that's less predictable, we're a very good supplier for them.

Right. And also the equipment, obviously. My thinking is that, in times like this, they start to think about their own manufacturing capacity, whether it's the upfront, low-volume work, or the design work. And, you know, if they do shrink their business a bit, maybe they don't need those people to come back because of what they can do with you.

Yes, that's a potential outcome, too.

You mentioned, Jack, in the release about R&D having included in there some of the integration activity for FineLine. I know you've talked about 6% to 8% as sort of that target range, and 8% if opportunities lend themselves. Any way to -- and it's been sort of that 7.5% up to this quarter. Was FineLine a meaningful portion of that pickup? Or is it just more opportunity in general for the Business?

The extra spending was mostly related to the integration efforts of FineLine.

Okay. So, as you pointed out with gross margin, the impact -- the 1.1% impact that you expect to moderate over time -- do you still see this as kind of -- because the marketing percentage of sales, G&A percentage of sales, were all pretty much in line with the first half of the year. So, it seemed like you were able to keep those pretty efficient. Do you expect R&D to kind of moderate, again, back to how you've been thinking about that long term?

Yes. And since you're asking lots of questions, and we didn't say it specifically in the script, I think it's pretty significant that we were able to bring an acquisition on board in April. And it was actually accretive to us by a little bit in this past third quarter. So, even with all of that integration activities, it was still positive to us.

Yes, I mean, because normally we would expect to see G&A or some of those -- especially G&A would tick up because of adding headcount and so on, but it's been very steady for the first nine months of the year. So, it seems like, if it's an integration cost, those are typically one-time issues that -- or one-time cost that would eventually go away. So, it looks like that might've been like a penny or two to the quarter, if we kind of looked at what it's been for the first half of the year. I was just curious.

Overall, the accretive --

Overall, I mean --

Overall accretive was about a penny.

Right. Okay. Thanks very much.

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

Hi, thanks for taking my questions. So, maybe one for you, Jack. We've seen a big jump in CapEx. Obviously, you've had some big projects that you've completed this year. Is the expectation that CapEx kind of normalizes at a lower level next year, or there's some more big projects in the pipeline?

Thank you for these questions on the capital side. This year has seen a lot of capital, and some of it was opportunistic with buildings that will tend not to repeat. We also are spending an inordinate amount of capital on new services. Because, as you can guess, we have to have a lot of equipment on board before we have the revenue, when you roll out a service.

So, yes, next year should see more of a normalization. Again, if you take just the equipment side of our Business, the CapEx should be between 8% and 12% of revenue. If I had to make a prediction right now, of course, which we'll update it, we'll be more on the lower side of that next year than the upper side.

Okay. Thank you for that. And, not to beat a dead horse, but just one more question on Europe. Is there anything that you can do, or is there anything in the pipeline that you expect to implement to really try and mitigate the slowdown over there? Or is it really just the down cycle there, and the macro headwind, that is going to be difficult to overcome to an extent?

I think there's two things we're doing. First, we talked about really doubling down on sales and marketing in Europe. And there's a couple of very specific tactics we're using around marketing in order to increase developer engineering customers, as well as new customers.

And then the other piece is what we're doing with the sales team in Europe, in terms of adding to the sales team that will be launching our national account management -- selling technique in Europe as well. So, both building and investing in that sales team, and doubling down in marketing. We'll also be launching our turned -- our lathe turned-part service in Europe simultaneously with what we're doing here in North America, and I think that will bring some value there as well.

Okay. And the new sales team, in terms of when they are in place in Europe -- you said that was early FY15; is that correct?

Correct. In terms of having everybody in place and trained and the new techniques in place. We're hiring, as we speak, so we will be adding here in the fourth quarter as well, and then kicking off the national account management program into next year.

Excellent. Thank you very much.

Thank you.

Thank you. Ladies and gentlemen, we have reached the end of our question-and-answer session. I would now like to turn the floor back over to Ms. Holt for any additional concluding comments.

Thank you again for joining us today. We remain extremely optimistic about the outlook for Proto Labs, and its continued growth and profitability, despite the current economic conditions in Europe. We are extremely well positioned to pursue a large and growing market, and we are forecasted on maintaining our long-term financial model, and I'm confident in our success.

I'd like to thank our employees for their hard work and dedication, and our investors for their continued support. I also want to extend a special thank you to Jack Judd for all the contributions he's made to Proto Labs over the years. Jack and I will be available today and the rest of the week if you have further questions. Thank you.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. We thank you for your participation, and you may disconnect your lines at this time.