Proto Labs Inc (PRLB) 2016 Q1 法說會逐字稿

Greetings, and welcome to the Proto Labs Q1 2016 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host today, Mr. Bill Dietrick. Please go ahead, sir.

Thank you, Operator, and good morning, everyone. This morning, before the market opened, Proto Labs issued a press release announcing its first quarter financial results for the quarter ended March 31, 2016. 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 10-K 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 revenue growth on a constant currency basis for both total revenue and revenue earned through legacy operations, adjusted consolidated statements of operations, and adjusted net income and basic and diluted net income per share information on a non-GAAP basis.

The non-GAAP adjusted consolidated statements of operations and non-GAAP adjusted net income each exclude the costs of stock compensation, amortization of intangibles, and unrealized foreign currency activity. We believe that these non-GAAP metrics provide meaningful supplemental information, are indicative of our core operating results, and are helpful in 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'd like to turn the call over to Vicki Holt, President and Chief Executive Officer of Proto Labs. Vicki.

Thanks, Bill. Good morning, everyone. Thank you for joining us on our first quarter conference call. Also with me today is John Way, our Chief Financial Officer.

I'll begin today with an overview of our first quarter financial performance and operational highlights. John will provide a more in-depth look at our financials during the quarter and offer our outlook for second quarter revenue and earnings. Then we'll be happy to take your questions.

Revenue in the first quarter of 2016 totaled $72.6 million, an increase of 24% over the prior year's first quarter and within the range of guidance we provided during our Q4 call in February. Adjusting for the negative $400,000 impact of foreign currency on the quarter, revenue grew 25% on a constant currency basis. Alphaform, the German company that we acquired in the fourth quarter of 2015, contributed $4.9 million in revenue. Excluding Alphaform, legacy revenue in the first quarter was $67.7 million, 16% above revenue in the same period of 2015.

Looking at our performance by geography, revenue in the U.S. increased 15%. Revenue in Europe, excluding Alphaform grew 28% on a constant currency basis. Revenue in Japan was up 2% in constant currency.

Turning to revenue by service, first quarter injection molding revenue totaled $43.2 million, an increase of 15% over the prior year. CNC machining revenue also grew 15% year over year. 3D printing remained very strong, doubling in revenue over the prior year and growing 46% excluding Alphaform.

Demand for 3D printing services continues to grow in both North America and Europe. We're moving into a new 3D printing facility in Raleigh in phases and are now manufacturing SLS parts there. We expect the move to be completed during the second quarter and are very pleased with the smooth transition accomplished by our team while at the same time shipping a record number of 3D printed parts and delighting our customers with our outstanding service.

The integration of Alphaform is tracking to plan. We've been focused on incorporating our 3D printing operations software into our facility in Munich, and we went live this week with this software. With our software now in place, we're confident that our digital manufacturing operations will meet our customer brand promise. Therefore, we are beginning a more proactive marketing effort of our 3D printed services in Europe this week to engage new customers and drive sales. This acquisition offers a lot of opportunity, and we're looking forward to capitalizing on it.

While the first quarter revenue was within our guidance, our growth was below our longer term target in three areas of our business: revenue from injection molding, especially the parts component; revenue from CNC machining; and growth in Japan.

I'd like to review each of these factors and how we're addressing them. During the quarter, we experienced a slower than historic growth rate in injection molding parts. Customers used our on-demand manufacturing service for end-use production parts for their products right when they need them. We believe the slowdown in parts orders is related to the general reduction in industrial production in our key geographies.

As a reminder, there are two components of our injection molding business. First is the initial order of a mold that we refer to as the mold business. Approximately half the time we receive at least one order for follow-on parts on those molds. We refer to these subsequent orders as injection molding parts. The parts business is an on-demand service, and as a result, we have very little visibility into the timing or quantity of the follow-on orders with our backlog generally running under 7 days.

We believe economic conditions have also tempered growth of our CNC machining service. When we look closely at the data, we continue to see our customers, both long-term customers and relatively new customers, reordering but not at historic expected levels. This caution has been confirmed in anecdotal discussions that our salespeople have had with customers. And I want to be clear. Orders for CNC machined parts are growing, just not at the rates we've experienced in recent quarters. We're confident that as economic conditions improve we will see growth return to historic levels.

In Japan, we've seen the impact of an economic slowdown where there's excess capacity at traditional injection molding and CNC machine shops. I was in Japan two weeks ago and met with our sales force who remain very confident in the outlook for growth this year. Revenue in Japan grew 41% in 2015 and 28% over the trailing 12 months. Due to the size of our operation in Japan, we anticipate revenue growth will fluctuate from quarter to quarter. We have increased the sales and marketing team there in both number and talent. They've been trained and are moving forward aggressively to drive sales. We're on track to move to a new facility in Japan in the third quarter to accommodate the expected growth in our operations.

We're out of space at our current site, and the new facility provides three times our current manufacturing floor space that will allow us to support our future growth and add additional services such as LSR and 3D printing to Japan in the future.

Product developer growth remains strong. During the quarter, the number of unique product developers and engineers served grew 20% to a record 13,249. Looking ahead, we are confident the initiatives we began in the second half of last year to capitalize on new market opportunities are the correct strategy, and we will continue these efforts.

They include segmented and targeted marketing efforts, changes to our sales compensation, redirection of resources, and continuing our strategy to go wide and deep with our customers to become a vital strategic partner.

An example of a strategic relationship with a customer would be Johnson & Johnson's Ethicon surgical products division that manufactures medical devices. The leadership within their product development team took the time to truly understand the power of Proto Labs' technology and business model. They are regularly utilizing Proto Labs' design for manufacturer abilities' feedback "to improve product designs". And they've incorporated our quick-turn delivery of prototypes into their strategic product development project plans to reduce time to market by as much as six months.

Leadership at J&J have told us that this collaborative effort has delivered significant value by allowing more iterations to improve product design and speed to market. There are many examples of Proto Labs beginning to engage customers more strategically, but I must remind you that while we are confident we're on the right track, developing these relationships takes time and is a major transformation for the Company.

We currently monitor our suite of services to ensure that they meet the demands of the market and are internal objectives. Based on this review, we've made the decision to exit three services including metal injection molding, or MIM, magnesium thixo molding, and also the resin resale business which came with the Alphaform acquisition. MIM and thixo molding require a long sales cycle and a high degree of technical market education but generate a relatively low volume of orders. While the Proto Labs launch was a technical success and the customer satisfaction for these services was high, the number of new parts designed annually in these niche manufacturing processes is lower than our expectation resulting in order volatility and related profitability that did not meet our targets.

These two services represented approximately 1% of our revenue over the last 12 months with significant variability from quarter to quarter. We also determined that the resale of resin is a non-core business for Proto Labs and would continue to be dilutive to margins. It represented about $1 million in revenue in the first quarter within the Alphaform business. Customers have been notified that we will no longer be taking orders for these services after May. Exiting these businesses will free up time and resources to focus on our services with higher growth and profit potential.

To finish up on our financial performance, we posted non-GAAP net income of $11.7 million in the first quarter or $0.44 per share within the range of our guidance. As anticipated, the earnings were affected by lower gross margins from Alphaform as we complete the integration and ramp up the digital manufacturing efforts there. John will provide more details on our financial performance in his remarks.

While the revenue growth this quarter was lower than our historical and our long-term model targets, we are confident that our strategic sales and marketing initiatives will restore our revenue growth rates over the long term. Proto Labs has seen fluctuation in demand from quarter to quarter in the past, and we successfully addressed these revenue growth slowdowns. We're confident we will achieve revenue growth rates at our target model over the long term.

Moving to other highlights, we were very pleased to receive several industry and community awards in the quarter. In March, we received Frost & Sullivan's Manufacturing Leadership Award for the second year in a row. In June, I'll be giving a presentation at the Manufacturing Leadership Summit on how digital manufacturing accelerates innovation. As part of the presentation, I will be highlighting our support of two strategic customers: Johnson & Johnson as previously mentioned in this call, and Lockheed Martin, a relationship we discussed last quarter. Both organizations used our services to reduce cost, improve design, shorten product development lifecycle, and bring creative new products to market.

We also received the 2016 Community Impact Award from the City of Minneapolis in the Youth Initiative category for the efforts of the Proto Labs foundation in support of STEM education in underserved areas of our community. Being active in our communities by providing STEM support and sponsoring volunteer activities is an important component of our culture, and we were honored by this recognition.

And finally, Don Krantz, our Executive VP and Chief Technology Officer, was recently named the Titan of Technology by the Minneapolis-St. Paul Business Journal. This was a very prestigious and fitting award for a key contributor to Proto Labs' success and a wonderful way to honor Don, who is retiring at the end of the quarter following a 10-year career at the Company. His successor is Rich Baker who joins us next week. He has 18 years of experience of technology leadership, in several leading advanced manufacturing firms including NanoVox, PaR Systems, MTS Systems, and Dow Chemical.

As previously disclosed, Jackie Schneider, Vice President of Global Sales, is leaving Proto Labs to pursue her passion of working in a startup company. We want to thank Jackie for her efforts in building the sales organization to help take this Company from a small business when she started to almost $300 million today.

We will be evaluating on how we would like to fill her role, including the scope of responsibilities and the scales and experience that would be most desirable to achieve our long-term growth. We have a strong sales team in each of our regions that will continue to execute on our strategy. These regional sales teams will report to their respective regional leadership will Bill Dietrick as head of marketing assisting in the sales leadership efforts.

We also announced that Archie Black, President and CEO of SPS Commerce, a global software company, has joined our Board of Directors. Archie's experience in operating a rapidly growing technology-based company will be a welcome addition to our Board.

With that, I'll turn the call over to John for further comments on our first quarter and financial performance. John?

Thank you, Vicki. Revenue in the first quarter was $72.6 million, an increase of $14 million or 24% over the same quarter in 2015. Legacy revenue in the first quarter came from 13,249 unique product developers. This represented a 20% increase over the first quarter of 2015. Our unique product developer count does not include Alphaform as this information is not available in a comparable format at this time.

Average revenue per product developer decreased 3% on a constant currency basis compared to the first quarter last year. The decline in revenue per product developer is reflective of the mix of our business with strong growth in 3D printing and lower growth in our injection molding parts business.

Gross profit for the quarter was $39.7 million, an increase of $4.4 million over the comparable quarter of the prior year. Gross margin was 54.6%. Alphaform had a negative 380 basis point impact on our gross margins in the quarter. Excluding Alphaform, gross margin on the legacy business was 58.4% as compared to 58.6% in the fourth quarter and 60.2% in the first quarter of 2015. The fluctuation compared to the first quarter of 2015 was primarily related to additional investments in capacity to ensure we meet our brand promise to customers as we have discussed in previous quarters. The first quarter represents a [trough] in our gross margins. We will see improvement in our gross margins at Alphaform and in our legacy business in the second quarter and throughout the year.

Our operating expenses were in line with our guidance at $24.5 million, a $200,000 reduction from the fourth quarter of 2015. Sales and marketing expense totaled $10.9 million or 15.1% of revenue for the quarter.

We invested $5.3 million or 7.3% of revenue in research and development in the quarter.

Operating income was $15.1 million in the first quarter of 2016 compared to $15.8 million in the prior year. On an adjusted, non-GAAP basis, operating income was $17.1 million or 23.5% of revenue compared to $17.4 million 29.7% of revenue in the prior year. The reduction in operating margin relates to the dilution from the Alphaform acquisition and the investment in manufacturing capacity that we have discussed in prior calls.

Our effective tax rate was 32.4% in the first quarter.

Net income totaled $10.7 million resulting in diluted earnings per share of $0.40. Adding back the after-tax costs of stock compensation, amortization of intangibles, and adjusting for the effect of the unrealized gains on foreign currency, our non-GAAP diluted earnings per share in the quarter were $0.44. Alphaform represented a $0.04 negative impact on earnings per share.

During the first quarter of 2016, we generated cash from operations of $16.9 million. Cash investments increased $11.5 million from the end of fourth quarter to $157 million at March 31, 2016.

Now I'd like to turn to our expectations for the second quarter. We currently expect Q2 revenue to be in the range of $75 million to $80 million representing revenue growth of 17% to 25% over the prior year. This revenue guidance includes a headwind in the second quarter of approximately $500,000 related to the exit of our resin resale, metal injection molding, and thixo molding offerings. We also estimate exchange rates will have an approximately $300,000 or 50-basis point negative impact compared to the second quarter last year.

Stock compensation costs for the quarter will be approximately $1.7 million. Amortization and intangibles will be approximately $186,000. In addition, we are evaluating our equipment related to the services we are exiting for impairment that may result in a charge in Q2.

We currently estimate our tax rate to be approximately 32.5% in Q2. Taking into consideration all of the above, including approximately $0.02 per share dilution from Alphaform, we expect our quarterly non-GAAP EPS to be between $0.46 and $0.50 per share in the second quarter.

That concludes our formal remarks. Vicki and I will now take your questions. Operator, can you please open up the line?

Thank you. We will now be conducting a question and answer session. (Operator Instructions)

Troy Jensen, Piper Jaffray.

Hey. Thanks for taking my time. Good morning, Vicki and John.

Good morning, Troy.

Good morning, Troy.

Hey. So, quick, Vicki, if we can focus a little bit on injection molding and it's 60% of your revenues and kind of the biggest chunk, right? So, just curious -- it feels like that was an area that you might have mentioned in previous calls as an area to focus as far as really trying to reaccelerate growth there and maybe the 3D printing distraction kind of prevented that. So, just curious to know how much are you guys planning on trying to get the injection molding side? I mean, the story there was always the huge, huge market, fractional share gains could really drive good growth for you.

Yes. And we still believe that. The [tam's] large there. Huge market, and we bring a lot of value in injection molding. We did refocus a little effort on injection molding here in the first quarter with great results on the mold side of things. So we moved that needle in the right direction. Injection molding tooling is a little more challenging of a sale than a 3D printed part merely because you're looking at a bigger investment on the part of the customer, so we saw some improvement there.

But when we report injection molding, we report both the mold and part, and we actually saw parts a little bit softer and it's interesting to take a look at -- when you look at it. We still saw growth in both mold and part, but when you take a look at the detail underneath it, there are some segments where we actually saw a little bit of contraction, strictly ones that are more impacted by the economic cycle, so things like industrial equipment where spaces like 3D printers for example. We actually saw quarter to quarter declines in revenue. Industrial equipment that might go into semiconductor or oil and gas applications also saw quarter to quarter declines, but despite declines in those segments, we grew overall.

As you saw, injection molding grew by 15%, so we're growing. The market's there, but in some parts area where we used for production, we did see a little bit of an impact we think from the economy.

I mean, do you think we can get that back into your business model range of 20% to 25% growth?

Absolutely. Absolutely. No doubt about that. We bring tremendous value in injection molding, both in the prototyping phase in terms of helping customers commercialize the product to low volume production and then actually also when customers have products that have relatively low numbers of production parts due to customization or just the niche they're servicing, we're sometimes the only option for them to get low-volume parts. So, I think we've got lots of opportunity here for growth with continued brand recognition in injection molding, and we're very confident we can get that back to the 20% to 25% range.

All right. Good to hear. Maybe a couple quick for John, though. So, John, on Alphaform acquisition, I think you said it was a 380 BPS impact to margin, and I get that. I'm just curious how much of that is one-time expenses that will fall off now? How much of that drops off if we exclude this resins business or this other revenue category that's come along with Alphaform? What I'm trying to get to is can you help us out with gross margins for Q2 with some of these things reversing?

Yes. So, the biggest component there really is revenue, so if you look at the cost structure that we have currently, we've got excess capacity. So, we've got the building, and we've got our workforce there that's lined up to produce volumes in excess of what we're producing. What impacted us a little bit this quarter was the mix of the business. So, like you said, the resin business actually came in stronger which actually increased our costs because those are third party, outsourced costs. So that's having an impact on that gross margin. That's roughly 50 basis points or 60 basis points, and we'll see that improvement over the next two quarters as that goes away.

Another component there, we're reconfiguring the floor space and have spent time setting that up so we have more streamlined operations to support that greater workflow and had people in the workforce working on that. In the fourth quarter, they were taking a lot of vacation, so they were getting paid kind of off the balance sheet, and that had a benefit in the fourth quarter, but then those costs were flowing through the P&L in Q1.

So those are kind of the big drivers there. So we will see improvement in the gross margin one, as that resin resale business goes away, but also as we start to layer on the new [volume] for the 3D printing. We'll be able to keep our costs relatively flat, but pulling the revenue through will have a significant impact.

All right. Got it. I guess could you help us at all with like potentially like a number or a range? I know you said historically [or just] three months ago that the 2016 target for gross margins is 56 to 59. Do you think we can get back to the low end of that range here in the June quarter?

Yes. I think that -- the low end of that range is probably the right way to look at it. And then we'll keep climbing from there.

The biggest thing that's going to help drive that Alphaform margin back to where we need to be will be volume and will be sales revenue because we've got a fixed cost component when we acquired that business of both the workforce and the equipment that we need to cover. And we are on track for this integration. We did not plan on turning on our marketing and sales engine in a big way until we had the software in place. And we literally turned that on this week. We went live this week.

So with that, we're now literally this week going live with our marketing -- our sales and marketing -- more aggressive sales and marketing activities for 3D printing in Europe. And I'm confident when we turn that on we'll begin getting Proto Labs customers at our price point coming in to our European business in 3D printing and we'll be able to start getting those margins up.

All right. Well, good luck, Vicki and John.

Thank you.

Brian Drab, William Blair.

Hi. Good morning.

Good morning, Brian.

Good morning.

So, Vicki and John, are you guys surprised somewhat that given the macro wasn't great in 2015, especially second half of 2015 when you did 25% plus organic revenue growth, that you saw this kind of drop off or decline into -- from fourth quarter to first quarter? I think you were surprising a lot of people second half of last year with that growth --

Yes.

-- and we were starting to think that maybe we were missing something but now you are saying the parts business has slowed down, so can you just give more color there?

Yes, Brian. That's a good question, and I will say we were somewhat surprised. As we sat here in fourth quarter, we got (inaudible) a couple of questions in February on our call and we had not seen the economic decline that many of the companies that are in the industrial production space were seeing. And we hadn't. And I will say here in the first quarter we grew 16%. So we grew organically 24% in total, 16% organically but it was a little bit lower than what we had expected. It was within our range but at the low end of that range. And as we looked at the data we did find that there are some sectors which (inaudible) used for production parts where we saw an impact. And then also I think we're at the beginning of a year. Many companies took a look at -- (inaudible) we believe many companies took a look at some of their spending in this environment of a little bit of uncertainty and maybe kind of pacing some of their spending on some of the projects that they've got. So we're an on-demand manufacturer so we see that really quickly with the lead times that we've got. So it surprised us a little but, again, we're confident that as things recover our business model is still very, very powerful among our customer base and we'll get back into that 20% to 25% range.

Okay. Thanks. And Vicki did I hear you say specifically that your customers that are manufacturers of 3D printers saw a slowdown in orders? Or you saw a slowdown of orders from them?

Yes. Yes. That's one space. I mean, among others is industrial equipment but 3 -- companies that buy our products that go into their 3D printers in total that saw a decline year-over-year.

Okay. And then one last one regarding the discontinuation of MIM60 and the [resale resin]. So for the full year will we take out about $2 million or $3 million in revenue for 60 and MIM and maybe $3 million out of $1.25 million? Or I guess -- it doesn't sound like it's that much in the second quarter. How much do we take out for the full year for these discontinuations?

So first I'll say that we are going to continue to produce parts for the next six months for our customers to help them with the transition. So we want to work very closely with our customers so that we have a way to help them transition to a different source if they were planning to use us for production parts. So, we'll still be selling -- we will be -- continue to sell molds if they would like to proceed with their mold orders here through the month of May, as well. So -- but we'll see some sales.

Yes, so it'll be kind of over the next two quarters that we'll feel it. The resin business will be done at the end of May, so we'll feel about a $350,000 impact in Q2 and then another $700,000 approximately in Q3 related to that, and then, as Vicki said, MIM and thixo will be winding down. That one we're going to be taking orders and talking to our customers to see what those volumes are, but the range of the numbers over the next 12 months is what you said: $2 million to $3 million. So, pressure as that business winds down.

John, that resin business in the fourth quarter last year was how much?

It was a little below the million.

Okay.

It's in that other category that we've broken out. It was about $800,000 I think.

Got it. Okay. Thanks a lot.

Ben Hearnsberger, Stephens, Incorporated.

Hey, thanks for taking my question. I wanted to look at a -- or revisit the full year guide, the model you guys put out on the last call. In light of slowing growth in 1Q and implied sub 25% growth in 2Q, is that full-year guidance for 25% to 30% revenue growth still good or do we need to rethink or re-evaluate that?

Yes, Ben, so -- we do have short lead times in our business as an on-demand manufacturer. Our backlog is seven days, so we provided guidance and will continue to provide guidance kind of on a quarterly basis, and I do think as you're looking at it and questioning that, that range is going to be a challenge. I mean, just the math -- doing the math would show that. So I do think we'll have to readjust or look at that from that perspective, but right now we've got visibility, we've got Q1 under our belts, we can provide guidance on Q2, and as we're watching basically this economic situation and the impact to our customers, that's -- we've got to wait for that to pick up.

Okay, and in light of maybe some slower growth, should we rethink these cost levels? Are you going to maintain kind of the high end of your spending range in light of kind of what we're seeing on the top line or are you going to start to adjust those downward?

Yes, so I think from a percentage of revenue levels, we'll manage those costs. So, sales and marketing, I think we're going to continue to invest at about that 15% level. We do want to make sure that we are investing to drive the revenue growth and continue to penetrate the opportunities there, but we do want to be prudent in how we're doing that and make sure we are aligning with the revenue.

Similarly, on the manufacturing side, we've put in some more processes to make sure that we've got our costs aligned with the revenue that we see coming in, and I'm confident that we'll see some benefit there as we go through the year. So I think as you look at the percentages that we've guided related to revenue, I think those are all still valid.

Okay, and one last question on cross-selling, and you may not be able to put this data out but maybe provide some color if you can, of the 13,000 or so [unique] developers you had on the platform this quarter, how many used multiple services across the platform?

Yes. So, when you look at it at an individual product developer level, there's probably only about 15% to 20% of the individual product developers that buy multiple products, but when you look at it at a customer company level, the vast majority of our top customer companies buy across all three services. And that kind of makes sense when you think about it because you've got different developers and different designers who tend to focus on different parts of a process. So, within customer companies, you look at our top 500 customer companies, vast majority buy multiple products.

Okay. Thank you.

Bobby Burleson, Canaccord Genuity.

Yes, good morning. Thanks for taking my questions. So, I was just wondering, Vicki, if we look at the MIM and the thixomolding exiting those businesses, wondering when the initial decision was made to get into those services and what, if anything, has changed in that evaluation process?

Yes, good question. Yes, so the Company started working on MIM and thixo technology development as early as 2013. It was a very challenging technical problem to solve, and the team did a fantastic job on re-inventing the manufacturing process for medal injection molding and thixomolding in a way that we could do it with -- cost effectively with low volumes. So, huge breakthrough, but I think what -- and the market itself in terms of the total size of the market, I think we did a pretty good job assessing that. And the market growth rates in that market we did a pretty good job assessing.

What we didn't really understand until we got into this market is that there are -- that the volume of unique new parts being designed every year are lower than they are in some of the other processes that we serve, like injection molding of thermos plastics, injection molding of thermo [sets] like liquid silicon rubber or even machined parts. So because that actual volume of unique parts is lower, that's where we need to see the velocity for our model to really make sense. And we just did not see that this was going to be able to scale to the level that things need to scale for our digital manufacturing model to meet our profitability target. It also had a very -- it's a niche manufacturing technology, and it used a lot of sales and technical sales resources to close relatively few parts. And so this allows us to redirect those resources on injection molding for thermal plastics, injection molding for thermos sets, our CNC machine parts, and get a little more productivity from that sales and marketing spend.

So it's a combination of the lower volume of unique parts that come in that we really didn't expect and getting that sales -- productivity out of that sales and marketing.

And, Bobby, that also creates challenges from a profitability perspective because we've got the equipment that's -- and the staff that is underutilized from a capacity perspective, so we're actually carrying the cost to run more volume through but having the lower volumes is --

Understood. Okay. Thank you. And then just one more quick one. Strategic engagements, curious once an agreement's reached how long it takes for that to kind of flow through an organization in terms of using Proto Labs. Is that a long process once an agreement's reached? Is there additional selling that you guys need to do within the organization? Just a little bit more color on how we can think of that going forward.

Right. Yes, so recently we wanted to talk about an example like J&J's that helps you get an appreciation for this. So, we talked about the J&J Ethicon division. It's one division of Johnson & Johnson, and the advantage that we got within that division by having senior leadership really understand our model, that helps drive it through much more quickly because the senior managers will go to their developers and their engineers and really encourage the use of Proto Labs. And it does accelerate our growth within that group. We still have to penetrate other parts of Johnson & Johnson, so it's a long -- it's a process that takes time, and it's interesting. They use the word agreement. It's not always an "agreement". It's really getting that understanding by the customer how to unlock the power of Proto Labs because we can bring so much value to them, but usually it takes somebody who's got some strategic insight that can kind of understand how to incorporate us into their business.

Okay. Great.

So, it takes a little bit of time. It takes a very different kind of selling engagement, which we're early. It takes time for us to kind of shift our selling model. Our transactional selling model's been very successful for this Company. So, we're not abandoning the transactional selling model. What we're doing is adding a strategic selling model on top of it. So it takes some time.

Okay. Yes, there was one more thing I forgot to ask. Thanks. John, one of the things that was mentioned, I think, was Q1 year-over-year growth organically 16%. On a constant currency basis, did you guys fall within your 20% plus target range?

No. Constant currency had about a 70 basis point impact on the quarter. So, yes. I mean, we're below that target range on the legacy business.

Okay. Thanks.

Jim Ricchiuti, Needham & Company.

Thank you. Good morning. Vicki, you've alluded to the fact with the parts business you have a decent window on demand, kind of almost in real time, and I'm wondering how that business tracked as you went through the quarter and maybe what you're seeing thus far in the month of April and if there's any flavor you can give us geographically.

Yes. So, yes, how it tracked -- January was slow. January was a lot slower than what we had expected to be. So, once again, I think there's a little bit of -- it was a line back to January and the rhetoric in the industrial space, there was a lot of uncertainty in the marketplace. So I think we saw some companies being very cautious on spend. It continued to build pace throughout the quarter, so continue to move up, but there wasn't a big spike in margins. Very steady, steady improvement. And it is that state of where we are today that it is informing our second quarter guidance, and as John said, we are an on-demand manufacturer with a 7 to 10 day backlog of orders. As we see a change, we'll adjust that guidance. So as we see that improve, we will adjust it. But at this point, I think it's prudent for us to be conservative in that guidance given where we are.

Fair enough. Next question, final question from me, is just on new products. Given the exit from the MIMs market and thixo, how should we think about the bogey for new products? I mean, I guess you're in these areas for about three years or so and represented about 1% of revenues. Is there a way for us to think about new products for you guys and what you would like to see from them over a certain period of time?

Yes. So, let me give you an example of a couple of products we've launched that are scaling at the rates that we expect and we need for our models. One is liquid silicon rubber. It's scaling very, very well with strong year-over-year growth, strong number of new parts volumes, new unique parts coming through, and the other one would be our [laturn] parts new process that's launched in CNC machining that's tracking where we want it to be. We learned a lot through this MIM and thixo launch around what we need to really understand with a new service that we launched and how it needs to fit into our model, so I don't think we'll make this mistake again. There are new processes that we have in Proto Works under -- in R&D that fit our model very well, and we'll be launching new services as we go forward that will broaden the [tam] and allow us to bring the Proto Labs unique digital business model to a broader number of services. So, we'll continue to do that. I think we learned a lot through this process.

If you were to look at LSR and the [laturn] parts, is there any way for you to help us maybe get a better handle on what -- how meaningful that's been? I mean, other than saying it's scaling. I'm just kind of curious is there any way for us get our arms around that?

I'm trying [think]. We don't really break out individual materials or processes. I could just say that those are definitely contributing to -- in a meaningful way to our growth, although the biggest growth as I've said a number of times is bringing in more product developers and having them buy our full suite of services.

That's helpful. Thanks.

Michael Weisberg, Crestwood Capital.

Hi, everyone. When I think of your major end markets, I think of aero, medical, auto, and I'm wondering first have you seen the parts slowdown in those end markets?

Not as much in medical, not as much in aerospace. Auto? No. So, really, industrial machinery is the biggest category where we've seen a drop off. It is difficult because it's a customer by customer situation, as well, so individual customer companies, there's so many of them so you've got to know what their story is. So I'm not saying there wouldn't be any in an auto category or in a medical category, but generally, as you look at it have looked at these top 100 customer companies, we saw an impact -- greatest would be in industrial machinery and equipment.

And I think I would add to that that as you look at our revenue across industries, it's more than just those three. So, a good portion of our revenue is from industries outside those that you just named.

Okay. And did you see it more in the United States than in Europe where the revenue growth was faster?

Yes.

Interestingly, because I'm thinking back. Didn't you have a real parts slowdown in Europe, like third and fourth quarter of 2014?

Yes.

Yes. That one was maybe a similar type situation, but really was a year over year comp challenge as well. As we look back to 2013, we had really larger orders coming through. So, the growth in Europe at that time had as much to do with the year over year comp as the economy.

I guess you threw out semiconductors and gas. Is that companies making industrial equipment for the gas end market? Is that how we're supposed to read that?

Yes. I mean, again, I can say I took a look at -- we took a look at these top few hundred customer companies and tried to understand. And there was a theme around when you really looked at boy, this company's down a little bit. Why? You look at, wow, boy, they service oil and gas. This one service semi-conductors. This is a 3D printing company. So, I mean, you can kind of see a theme with some of these industries that are impacted.

And we match that analysis up with companies that are going through financial challenges and reporting like revenue declines year over year or layoffs or other things like that. When you look at those customers -- companies that are our customers, we're seeing impacts of those businesses on the revenue.

Yes, because you don't do much direct to oil and gas. It's just industrial companies that have end customers there that might have been slowing as a result?

Correct.

Correct.

All right. Got it. A small --

But, despite -- I just want to keep adding (inaudible). Despite those things, we still grew this business by 16% (inaudible). So I think, yes, you've got to look at there were these little headwinds in a few areas, but there were enough tailwinds that the growth in our business model to still grow that 16%.

Right. And then Alphaform, there was a -- the resins are in the other business, and presumably that goes away?

Yes.

Yes.

Yes.

And then it looked like there was a maybe $1 million non-3D from Alphaform, and I don't know where you put that and does that stay or go away also?

That will stay. That is injection molding and it's in that category.

So that part will stay?

Yes.

And is the thought on alpha the same? You expect to make money there second half this year?

Yes. So, we're now six months into the integration process, and we've learned a lot about the trajectory that we're going to be able to move our margins. They will steadily improve and we do believe that we will be break-even by the end of the year. We are just a little bit slower than what we had expected. We see no reason why we won't be able to over time move the alpha form 3D printing business to margins that are comparable to what we have in our legacy 3D printing business. So, we -- no reason why we can't get there, but as we look at the trajectory after six months into integration, we think it'll be pushed out maybe a quarter or so to really get to that [area].

So, you'll lose money but at a lesser rate in the second half?

Correct. Correct.

And then --

It'll be steady improvement in margins.

And then presumably be profitable in 2017?

Yes.

Correct.

Yes.

And so the core level of revenues at Alpha is going to be what? Like $3 million or $4 million a quarter?

Yes.

About four. Yes.

Yes, and about four. And --

And growing.

And then growing as we turn on the 3D printing marketing and sales.

That's great. Thanks a lot.

Thank you.

Thank you. At this time, I would like to turn the call back over to management for closing comments.

Thank you again for joining us today. I want to thank our employees around the world for their continued passion in executing our strategy. We remain very confident about our outlook for enhanced revenue growth and profitability during 2016 and beyond, and we look forward to updating you next quarter. Thanks very much.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a great day.