Proto Labs Inc (PRLB) 2017 Q2 法說會逐字稿

Greetings, and welcome to the Proto Labs Second Quarter 2017 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

At this time, I'd like to turn the conference over to your host, Jason Frankman. Please go ahead, sir.

Thank you, Rob, and good morning, everyone.

This morning, before the market opened, Proto Labs issued a press release announcing its financial results for the second quarter ended June 30, 2017. The release is available on the company's website at protolabs.com.

Before we begin, I would like to remind everyone that our discussion will include statements relating to future results and expectations that are or may be considered forward-looking statements and subject to many risks and uncertainties that could cause actual results to differ materially from expectations. Please refer to our earnings press release and recent SEC filings, including our Annual Report on Form 10-K for information on certain risks that could cause actual outcomes to differ materially and adversely from any forward-looking statements made today.

Additionally, the results and guidance we will discuss include non-GAAP financial measures consistent with our past practice. Please refer our press release within the Investor Relations section of our company website for a complete reconciliation of non-GAAP to GAAP results.

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

Thank you, Jason. Good morning, everyone. Thank you for joining us on our second quarter conference call. With me today is John Way, our Chief Financial Officer.

The Proto Labs team produced another quarter of strong results. We reported record quarterly revenue of $82 million in the second quarter. This represented an increase 9.4% over the prior year, and in line with our guidance range for the quarter.

Adjusting for discontinued services and the impact of foreign currency, our revenue growth was 12.8% over the prior year. In addition to our revenue growth, we continue to serve a record number of product developers. Our unique product developers served increased 18.8% over the prior year to 16,174.

Looking at a breakdown by geography. Revenue in the US, our largest market, produced strong growth of 14.5% over the prior year. Revenue in Europe decreased 6.6% on a reported basis. Our year-over-year European revenue growth was impacted by several factors, including the discontinuance of the resin resale business in Q2 of 2016, and the negative impact of foreign currency exchange rates. Adjusting for those items, revenue growth was 3.6%.

Our growth in Europe is not achieving our desired levels and we're taking actions to improve the performance. Japan grew 8.2% or 11.5% in constant currency. Overall, the fluctuation in foreign currency exchange rate had a negative $900,000 year-over-year impact on our reported revenue.

In terms of revenue by service, injection molding increased 4.5% over the prior year. CNC machining grew 21.8% and 3D printing grew 19.5% from prior year. Our injection molding growth was soft in the second quarter, particularly in Europe. We're taking actions to capture more of the addressable injection molding market. Later in the call, I will address both the European performance and the recent announcement of our on-demand manufacturing offer, which we expect will help drive injection molding growth over the long term.

Our CNC machining service showed strong growth this quarter. This growth was partially driven by enhancements we've made to our manufacturing software. As we have discussed in the past, a portion of our R&D spend is invested in improving our manufacturing software. These software enhancements have allowed us to improve our manufacturing efficiency and adjust our pricing for certain part geometry resulting in revenue growth while maintaining margins.

3D printing also produced strong growth of 19.5%. This strong growth was driven by our operations in the Americas. Growth in Europe improved over the prior quarter, but continues to lag our internal target.

We achieved GAAP net income of $12.1 million in the second quarter or $0.45 per share. On a non-GAAP basis, net income was $13.1 million or $0.49 per share, which was in line with our guidance range for the quarter.

We continue to generate strong cash flow this quarter, with cash provided by operations contributing $20.6 million, resulting in an increase in our cash and investment balances of $16.6 million or $217.9 million at the end of the quarter. Overall, we are pleased with our financial performance this quarter. We produced revenue and earnings in line with our expectations and continued to serve an increasing number of product developers and generate strong cash flow.

We remain focused on our 2017 priorities, to drive productivity of our sales and marketing activities to attract more product developers, continue to expand the envelope of our existing services to be able to fulfill more of our customers' needs and achieve strong gross margins.

Our investments in sales and marketing continue to show positive results in the Americas, with revenue growth of 14.5%. With our largest region trending in the right direction, we're confident we can realize similar results in Europe and Japan. We continue to collaborate across regions sharing the experiences and lessons learned in the Americas to drive revenue growth in other regions, with a focus on Europe.

While Europe has unique market -- has a unique market environment, and have a different set of circumstances. Many of the initiatives we have deployed in the Americas can be tailored and deployed in Europe. The ability to effectively drive change starts with the leadership. And as we were in the Americas, we were under-invested in sales management in Europe.

As we discussed earlier this year, we brought on Dirk Rathsack, our VP of Sales in January. Dirk has been assessing sales processes, the team and recruiting new sales management. We've hired new leaders for the central and southern regions of Europe, with both individuals starting in September. This is a critical step in driving change and achieving improved results.

I'd also like to address the leadership change that was announced during the quarter. After serving the business for 12 years, John Tumelty, VP, GM of Europe has decided to move on to the next stage of his career. John was hired to launch our business in Europe in 2005 and through his strong leadership has built the business to where it is today. We're actively recruiting John's successor who will lead our European operations and take the business to the next level. John remains committed to the business and the employees. He will continue to lead our European operations and execute our strategies in the region, while ensuring a smooth transition to the next leader.

Our second priority is continuing to expand the envelope within our existing services. We have been steadily expanding our service offering with the additions of overmolding and insert molding and injection molding and PolyJet technologies in 3D printing over the past few quarters. We will also be launching the Multi Jet Fusion 3D printing technology during the third quarter.

We are very excited about our July 17 launch of on-demand manufacturing, the low volume production part coupled with the opening of our metrology lab. We have served low volume production applications for years, but we've been servicing both the prototype and the on-demand injection -- on-demand manufacturing injection molding business with the same offering, without acknowledging that an engineer looking for a prototype part has different needs than the business and supply chain leaders who are evaluating partners to produce their injection molding parts for production.

In order to capitalize on the market opportunity, we tailored our offering with different features and pricing that better meet the unique needs of production customers. These specific needs include mold ownership, our competitive piece part pricing for managing the financial performance of their product and ability to produce (inaudible) quality inspection and services. Proto Labs' new on-demand manufacturing offer addresses each of these factors, including the launch of a suite of quality inspection services. In addition to serving -- better serving our customers, our on-demand manufacturing and metrology services together allow us to better access a large low volume manufacturing market. For perspective, about a third of our total global revenue is injection molded part with the majority of those part already meant for end-use production.

With our on-demand offer, we are now able to extend our differentiated low priced molding capabilities to more production cases where low volume and responsive supply is required.

Quality documentation is a key component for end use parts. In true Proto Labs digital fashion, Proto Labs has launched a digital inspection report in addition to offering traditional inspection services. A digital inspection report uses state-of-the-art technology, coupled with a digital thread of data from the customers' CAD files to generate automated inspection report.

Adoption of this new technology is uncertain, but we are excited to be working with our customers to link the digital thread back into their supply chain operations. The ability to capture share in this market space may take some time as our customers have traditionally thought of us as the prototype vendor and production parts are often procured by different individuals within our customer's organization. We expect modest near-term growth from this launch, as we continue to ramp up the full offer and make inroads with new contacts in supply chain management.

Regardless, we are excited about the opportunity created by our on-demand manufacturing offer and the potential to impact the longer-term growth rate of our injection molding service over time. We continue to utilize our voice of the customer feedback and knowledge of the market to guide our envelope expansion as we aspire to provide a complete solution for our customers.

I will provide further details on continued envelope expansion as the year progress.

And finally, gross margin remained strong and was consistent with Q1 gross margins of 56.5% as projected. We remain focused on improving our gross margin in 3D printing business in Europe. This initiative has multiple facets, including increasing sales to leverage existing capacity, improving operating discipline, upgrading certain technologies and adding new specialty materials, which carry higher margin.

We expect these improvements to show steady improvement in our 3D printing margins in Europe. We remain very excited about the opportunities in front of us as the market evolves to a digital manufacturing environment. We remain focused on helping our customers to get their products to market as efficiently and effectively as possible and we will continue to explore additional opportunities to help them achieve their goals.

And with that, I'd like to turn the call over to John.

Thank you, Vicki. Revenue in the second quarter was a quarterly record $82 million, an increase of $7.1 million or 9.4% over the same quarter in 2016. The second quarter of 2016 included $1.5 million of revenue related to resin resale, metal injection molding and magnesium injection molding, services we have discontinued. Adjusting for the impact of these discontinued services and the negative impact of foreign currency of $900,000, revenue growth was 12.8%.

Our revenue this quarter came from serving 16,174 unique product developers, an 18.8% increase over the second quarter last year. Average revenue per product developer decreased 4.5% compared to last year due to the strong growth in our CNC and 3D printing services shifting the business mix.

Gross profit for the quarter was $46.4 million, an increase of $4.1 million or 9% over the comparable quarter of the prior year. Gross margin was 56.5%, consistent with the first quarter and in line with our guidance. Our 3D printing business in Europe had a negative 220 basis point impact on our overall gross margins for the quarter and continues to be a priority and an area of opportunity.

Operating expenses totaled $30 million or 36.5% of total revenue in the second quarter of 2017, representing a sequential increase of $ 2.4 million. This increase includes continued investment in sales and marketing to drive revenue growth, continued investment in research and development to drive our envelope expansions and other software enhancements and an increase in the equity compensation resulting from our annual employee equity grant and the addition of two new Board members in the quarter.

Within our operating expense, sales and marketing expense was $14.6 million or 17.8% of revenue. These expenses included trade show activity that is seasonally higher in the second quarter across all regions each year.

Our operating income increased 10.4% to $ 16.4 million or 20% of revenue in the second quarter compared to $14.9 million or 19.8% of revenue in the same quarter last year.

Net income totaled $12.1 million, resulting in diluted earnings per share of $0.45. Adding back the after-tax cost for stock compensation, amortization of intangibles and adjusting for the non-recurring legal settlement and the effect of the unrealized gains on foreign currency, our non-GAAP diluted earnings per share in the quarter were $0.49.

We continue to produce strong cash flow, generating $20.6 million in cash from operating activities. Capital spending was $5.5 million during the second quarter. We also repurchased $1.7 million of our stock in the open market.

With the continuous strong cash generation of our business, our cash and investment balances increased $16.6 million during the quarter to $217.9 million from June 30, 2017.

Now I would like to turn to our expectations for the third quarter. We currently expect Q3 revenue to be in the range of $83 million to $88 million. This revenue guidance reflects the following factors. We don't anticipate a significant impact of foreign currency on our year-over-year Q3 revenue growth. Q3 of last year included approximately $1.2 million of revenue related to our discontinued metal and magnesium injection molding business. Adjusting for the impact of discontinued services, this guidance represents revenue growth of 8% to 14%.

Moving to the earnings guidance. We estimate gross margin to be in line with Q2, as we look at the near-term, the improvements we make in European 3D printing margins will be at least partially offset by investments related to the launch of on-demand manufacturing and our metrology lab. We estimate sales and marketing will approximate 17% of revenue. Our non-GAAP add backs for the quarter will include stock compensation costs of approximately $2.2 million and amortization of $100,000. We currently estimate our tax rate to be approximately 32% to 32.5% in Q3.

Taking into consideration all the above, we expect our quarterly non-GAAP EPS to be between $0.48 and $0.54 per share in the third quarter.

That concludes our formal remarks. Now Vicki and I will be happy to take your questions. Rob, can you please open up the line for Q&A.

(Operator Instructions) Our first question comes from the line of Brian Drab with William Blair.

Good morning, thanks for taking my questions. I wonder if you could just start with the new service and offering for production. Can you offer customers pricing that is more attractive than the pricing they could find elsewhere and maybe at a traditional injection molder and maintain the roughly 60% gross margins that you typically generate in the injection molding business historically?

So, when a customer looks at an injection molder, we'd like to position it in terms of total cost of ownership. So there is the cost of the tooling. And in our case, often the cost of our tooling is extremely competitive. As you know, we produced our tools in aluminum tooling, we guarantee that tooling for life as it wears out, we will -- kind of a new tool and move forward, so our tooling cost tends to be very cost effective. The other piece of course is piece part price. And in our on-demand manufacturing offer, we're going to be working in the mold designed to make sure we're designing the mold with the right cavitation and the right design to optimize that piece part price for production.

So in total, we believe we will be able to offer the customer for low volume on-demand manufacturing offers a total cost of ownership that's very competitive. And you couple that with our responsiveness, we think it's a very, very attractive value for customers.

And in terms of the margin that you think you'll be able to generate on there relative to historical?

Yes. Brian, I think as we look forward, we're in the launch stage and big component of this is going to be the volume of parts and the length of time those parts are ordered. In the near term, as we're looking at it, we think we'll be able to maintain those margins. And as more and more of the revenue comes from the production of the parts, we think that there is opportunities for efficiency both in how we build the mold, as well as in the operational process. I think time will tell, but the way we're currently modeling is margins roughly in the same range we're looking at today.

Okay. And then in terms of the number of parts that we're talking about, when you say low volume production on your white paper that was on your -- you put up on your website like four years ago, talking about like 40,000 parts in terms of an upper threshold. What type of volumes do you expect to do in this business?

It really very varies. I mean, our sweet spot is generally 10,000 parts or less, but we've got some programs where customers will ask us to (inaudible) parts that are in the hundreds of thousands range. So we're not targeting those applications where very large volume production in the millions, but in 10,000, 20,000 range, we've got competitive very total cost of ownership value propositions.

Okay. And then one more quick one on this topic and then I will get in the queue. But does the customer -- when you say that they own the mold, does the customer have the option to take the mold outside of your facility?

Technically they will, but I think as we look at this and as we've had dialog with customers, it really is more of an accounting matter. The mold ownership allows them to capitalize the mold and treat it differently from accounting perspective versus if they don't own and they generally have to expense it. So what we've found is, it's more about the accounting than it is about actually physically taking the mold.

Our next question comes from the line of Troy JensenTroy Jensen with Piper Jaffray.

So I just wanted to add in a little bit on injection molding. It was only up 4.5% year-over-year. You kind of couple that with the fact that you guys have launched over molding and insert molding, sure there's just not a huge contribution from those two just yet, but can you discuss why you think that's growing significantly less than the CNC business that was up 22%?

Yes. So first, what I would say is that the injection molding market from a size point of view is quite large. The prototyping piece of it is the smallest piece of the total opportunity in injection molding. So we really feel that the launch of on-demand manufacturing in injection molding is a very important step that we're taking to effectively compete for share in on-demand manufacturing production part. And that's a step that I think is going to continue to evolve. We believe that the inspection reports, this suite of inspection report is a very important service to capture more of that market, but we also believe there'll probably be other things that we will need to add in order to be able to deliver a total solution and effectively drive share gain in that segment.

But I think there is -- that's part of the issue that we're dealing with is that prototyping piece is a small subset of what is total opportunity, and we've got to position ourselves to complete and take share there.

Okay, understood. Another question too, maybe (inaudible) one I guess. Sales and marketing and 17.4% of sales, that's the highest it's been in about six years for the company. So can you talk about how much more investments there, what are the investments exactly and how far would you continue to expand on the sales and marketing line?

Yes. We talked a lot the last couple of quarters about the investments that we're making in sales and marketing. So they've been in the area of sales management in order to drive the improvement in the selling process and the behaviors of our sales team. It's been in the areas of actually increasing the level of experience of the sales people we've been hiring, beginning to bring in sales people who will be able to better carry on those consultative selling conversations with our customers, particularly when we prepare for things like on-demand manufacturing, which is more complex sale.

And it's been continuing to invest in the -- our tools, Salesforce.com, and the capability to really do the kind of work within that system to allow us to optimize the productivity of the sales force. A lot of that is behavior change. And unfortunately, we're in the situation where the investment will have to take place before the results occur. However, we believe that we will be controlling these costs of scope going forward. And as you'll see in some of our guidance -- and guidance going forward to expect that sales and marketing as a percent of sales and that 17% range going forward is probably a pretty good estimate.

Okay, perfect. The last one and I'll see the floor. John, I know you don't like giving guidance outside of just one quarter forward, but if you -- last year December quarter was down 7.5% sequentially, was that an anomaly and would you expect to grow sequentially in the December quarter?

Yes. So I think as we talked about last year and even leading into this year, the economic environment and uncertainty at the end of the year -- last year our orders just dropped off. And we do think it was an anomaly, we're seeing a different environment this year. So I would expect this. I'd almost excluded and kind of go back to some of the earlier periods when trying look at it.

Our next question comes from the line of Steven Dyer with Craig-Hallum.

It's actually Greg Palm on for Steve today. I want to start with maybe a follow-up on the introduction of the on-demand injection molding. I know you announced the service a weeks ago, but I believe it's actually been live since the beginning of the month. So curious what the feedback has been to-date? Was it a service that a lot of your customers were asking for, what was kind of the major rationale for the introduction?

So it has been a service our customers have been asking for. The suite of inspection reports has been on the top of the list, particularly for companies who are evaluating us for production parts, it's been a gap. And so launching that I think is a really important step. We've actually -- we start, as you know, with any service, we start in a beta launch, so we've actually been taking a few orders here and there and working through the service to make sure we can scale it for customers. We did put it out on our website in January, but did not advertise it until -- not in January, in June -- end of June beginning of July, but we did not start advertising until July '17.

Again to make sure that we've worked out any bugs in the service and make sure that there is an opportunity for us to be able to scale and service any demand. So it's gone quite well, we give our customers the opportunity when they go into our injection molding service to select, whether they want a prototype tool, or whether they want an on-demand production tool, or whether they'd like a quote for both. And we're finding a good uptick of companies who really do want to position themselves for on-demand manufacturing, and that allows our whole process, our analysis and design of the tool and our response in quoting to really tailor that response to a production-customers' needs. So, so far the response is good, it's very early, I mean, we're only few weeks into it, but we're pleased with the start of the program.

And how long should we expect some of these headwinds around the new services specifically, but also 3D printing in Europe to impact gross margins. I think previously you were hoping to maybe exit the year at 58% to 60%, or at least that's kind of in your target. So curious if and how much you're expectations around gross margins have changed.

Yes. So I think as we look at it and as we talked a little bit about it last quarter, the challenges in Europe in improving those gross margins are going to take a little longer than we anticipated. I think we're getting our operations in line and have made some significant improvements this quarter. But that market dynamics and pricing, we're still testing and trying to find the sweet spot to drive growth. And growth will be one of the major components of driving those improved gross margins. So I think that might take a little more time than we had previously anticipated.

I think as it relates to the new services that we launched, it's just the ramp up phase, as we bring on the new equipment and that equipment isn't at full capacity, has a little bit of a drag, it's not a huge drag. So I think the guidance we gave at the beginning in the year, a good chunk of that or the majority of that was predicated on improving those gross margins in Europe and that's going to take us into next year. We'll continue to focus on and continue to drive kind of sequential improvement as we look forward.

I know you gave gross margin guidance for Q3, but how do you look at the pace of improvement maybe over the medium term over the next maybe two to five, six quarters?

Yes. I think it's going to be gradual and we had a little bit of color on to John's comment. Proto Labs' positioning in 3D printing is to be the global leader in industrial 3D printing by focusing on really the three major things, by focusing on having the best resolution and quality our industrial 3D printed part, by having the strongest set of materials that meets the needs for the industrial customer and speed.

And we have that positioning here with our 3D printing business in North America, but we've got some work to do in Europe to get us to that point. And getting us to that point is going to be what's necessary to get to the margin profile that we have here in North America. So that's why I talk about that multifaceted approach that we're taking in order to drive that margin improvement. So it does involve the manufacturing productivity that John mentioned and we've made some good headwinds, and some good steps there to drive that forward. But there was also some additional technology upgrades that we need to make in order to be able to produce the resolution and the quality that we need to have in Europe. There is also the transfer of some of the specialty materials and on (inaudible) is a really nice, unique product that we offer here in North America. We need it to be transferring that into Europe as well. We need to continue to drive the discipline of our manufacturing team to execute on that kind of quality positioning and reliability positioning.

And the third component is driving that sales revenue, which as we continue to drive those other elements of our positioning, the sales revenue will come as well. So it's a process that's going to take us some time. So I would look at it as being gradual.

Okay, that's good color. I guess last one, do you have any sales headcount numbers that you can share with us both for the quarter and maybe a year-over-year basis? And just curious how long does it take for someone to sort of ramp up to get fully up to speed?

I can answer the last one, because I got that on the top of my head. So our ramping rate, they vary between 12 and 18 months for sales people. We're working hard on the on boarding programs that we're doing right now to try to see what we can do to accelerate that. But generally, it's 12 to 18 months for ramping.

Our next question is from the line of Jim Ricchiuti with Needham & Company.

I wonder if you could talk a little bit about your go-to-market strategy for this new on-demand service. Is there any change in the way you're going to approach this market? Have you set aside perhaps some dedicated sales folks that are calling on customers to market this service?

So, there's a couple things that that you'll see that are changing. First, there's a little bit of a change in some of our marketing mix. We're really trying to get ourselves positioned from a PR and a media point of view in the types of media where supply chain leaders live as opposed to where product developers and designers live. So there's a little bit of a shift in our marketing mix and a little bit of a shift some of that messaging in order to begin to attract and put ourselves in front of the new types of customers that we've got. There's also been a tremendous amount of sales training and our sales people have been working with focused accounts that they have that they believe are best positioned to use us for on-demand manufacturing. So there's profiling that's being done on those customers, and our sales people are being trained on how to engage in the kind of solution consultative selling that this type of offer brings it.

So we've been doing quite a bit of role playing and getting the team ready to have those kinds of conversations with customers. And then, of course, the changes in the website, so we will be lagging, customers who are actually looking to us for production early in the selling process to make sure that we are positioning ourselves to meet their needs and answer the questions that supply chain managers and operating leaders have, which are different than those that come from a product developer.

Are there some obvious verticals that you think this service, this new service is going to be may be getting some early traction with?

Yes. We've done some profiling of the segments. And we do believe that again med device is a very strong segment and industrial equipment is a very strong segment for us for on-demand manufacturing.

And curious about the strength you're seeing in the U.S., was that strength -- did you see that pattern throughout the quarter? And what are you seeing thus far this summer, the overall pace of demand that you're seeing?

So, yes, it was pretty steady through the quarter. Didn't see much of a shift and moving here in third quarter as we gave you guidance there and reflects that continuation in that kind of range. I think what we're seeing is a combination -- certainly stronger manufacturing, industrial manufacturing environment that we're working in right now. So that's a positive. I think we're seeing early indications of some of things we're doing in terms of driving productivity of our whole mix, our marketing mix our sales mix, and as well as the envelope expansions are good for us here. So I think it's continuing.

Final question just on the 3D printing business in Europe. If you take a step back, you had expectations for that business and things appear to be taking a little bit longer, you're making some changes to improve productivity to drive growth. I'm also wondering is the competitive landscape just more challenging in this market than you may be expected earlier on?

The competitive landscape is both more challenging and a bit different. There is -- when you look at price geometry and how pricing -- as we price based on geometry and what we're finding is that there's some nuances in the competitive environment around pricing by certain geometries that we're having to adjust. So, we're dealing with those nuances with the market, there tend to be in Europe, there tend to be some geometries that skew towards the larger parts that are 3D printed and we're having to make some adjustments to make sure we understand that competitive environment and are positioning ourselves well there. We're learning.

Our next question is from the line of Jon Fisher, Private Investor.

With Dougherty & Company still, so thank you. So, couple of bigger questions here. I appreciate the color that you provided on the injection molding segment and the end market dynamic, there was some good detail. But given the strength in CNC machining that you saw and the modest growth in injection molding, can you -- and in your overall positive outlook on the US environment and the strength that you've been experiencing thus far year-to-date, can you talk about the dynamics with that positive macro and why CNC machining is so strong as a segment and injection molding a little more modest on the growth side, any additional detail or dynamic that you can provide there?

So we did provide a little detail in our prepared remarks our about CNC machining. As you know, we always work on our software to try to find ways to make our manufacturing process more efficient and we -- our team, our software engineers have done some phenomenal work there and we've been able to bring some of that live into our production, which has allowed us to take cost out of certain geometries and allowed us to pass that through and still maintain margins. So there is some real share gain opportunities while delivering our customer some great value in CNC and that's driving some of that growth there.

And again, I mentioned on injection molding, we really feel there's things, that they're steps that we're taking that are going to improve the growth rates there by tapping into more on-demand manufacturing part.

And I guess I've heard on this call, pricing come up in the prepared comments and in the conversation a lot more than historically, I have heard the company talk about pricing. One of the things that you talk about is, you don't really -- the business doesn't compete on price to try and drive growth or trying to share or whatever. But I guess I'm wondering given pricing with some of the new products and services that you talked about pricing in Europe being tough and different and better pricing in CNC machining because of efficiencies. Is there a shift in the business strategy, in the growth strategy to maybe use price as more of a lever to try and drive a faster rate of growth or to try and take market share or be more competitive? Has something changed here over the last two or three years?

No, I don't think anything has changed. I think, as any good business does, it's aware of what's going on in the market from a pricing perspective. And looking at what we're providing versus what the pricing is in the market and making sure that we've got a compelling value proposition, price is one component of that. I think, as we look at it, there are certain pricing dynamics, particularly in Europe, that we've got to face and we've got to figure out how to make sure that pricing appropriately to drive the appropriate growth to deliver the margins.

So, I think that some isolated incident, I think as you look at the on-demand manufacturing offer, I think there is a price component there that those customers are looking for different dynamics. So, I think it just is more about the timing of what's going on in our product launches and our product lifecycle cycle, I don't think there is a change in the strategy of how we're approaching it.

We've always deployed (inaudible) pricing techniques to constantly look at different levers that we've got to build, to improve revenue and close rates. So we're constantly testing those things.

Okay. And then a final topic, just on the new metrology on-demand, how many pieces of new equipment do you have to address this opportunity? Kind of what is the current utilization and what -- how much business would you need before you would add another incremental piece of equipment and kind of what's the plan to take this offering beyond just North America?

So, we've got handful of machines that we've got, yet they're definitely underutilized. But I think we have to make sure that we're planning for that. I don't think it's a significant impact. I think it's -- the reason we mentioned it is, there are puts and takes in our business that are impacting our gross margin and just providing the messaging on and we're not anticipating a significant uptick in gross margins into the next quarter because we've had to make some of the investments here. I don't think it's a significant drag or a significant thing that we should be talking about customer's utilization.

And in terms of taking it to the other regions, the current plan is to launch on-demand manufacturing in Europe in Q1. So, plans are being made to put in place metrology lab in our Telford, UK facility as we move to the third quarter and get ready to launch that in Q1 of '18. And we haven't defined a timeline at this point in Japan we're working through that.

Our next question is from the line of Ben Rose with Battle Road Research .

Good morning, and thank you for taking my questions. Vicki, on lines of, I should say along the lines of the sales strategy, as I understand it, part of the push this year is to take a closer look at potential large accounts, and I realize that there's no single customer that accounts for a large percentage of sales, but could you maybe speak to some of the progress that you're making with some of your larger customers trying to get them to use more services?

Sure. So, just to put it in perspective, Ben, then the biggest part of the effort this year frankly is making sure that we're getting productivity from our sales team that's focused on our general focus accounts and what we call the (inaudible) get a lot of efficiency through that. So we're doing that using a lot of Salesforce.com tools and tools that allow our salespeople to really focus on the opportunities that are going to have the highest lifetime revenue opportunities for us, so we're using data and approaches to do that. That's the biggest part and getting the sales management in place and getting the coaching of the sales people around using those tools to drive their daily behaviors and using a very disciplined sales process in order to move from a prospect to a close in a more efficient manner. So that's the biggest part of our effort this year. But we continue to profile companies who where we can bring a strategic solution to those companies and really find ourselves embedded more in those.

And that process continues, we continue to identify companies that are targeted to play those positions, we're beginning to engage them in ways to determine if in fact we see them as that potential do they see us as that potential and that work continues. It's a process, relationship selling, does take time, and it also takes time to position the company in a new way within those companies.

So, but it's proceeding as we expected it would, but as I said earlier in the year, the biggest impact this year on the productivity improvement are the things that we're doing to drive improvement in -- changes in our sales people's behavior to have them move from prospect to close more efficiently and drive that revenue. And that's what I think is being impacted in the growth rate that we're delivering in the Americas.

On the 3D printing side, notwithstanding some of the margin challenges that have been discussed in Europe, there's still kind of a nice sequential uptick. Do you think looking out at this uptick that we're seeing is sustainable, A and then B, is there any discernible mix shift in terms of metal parts versus plastic parts?

Yes, I think this is a sustainable uptick, more and more engineers are getting experienced in 3D printing so, that's kind of driving growth rates there a little bit higher than our injection molding service. And I also believe that our positioning as a real strong leader in industrial 3D printing, put this in a position where customers like to work with us on programs where they really are looking to design for 3D printing. So, that's a positive. Our metal 3D printing (inaudible) is growing well, growing a little bit faster than (inaudible).

And then just a question for John, just looking at kind of the overall capacity utilization that you have just kind of across, I guess in particular injection molding and CNC machining, could you give your kind of current thoughts on that utilization? And what might be a trigger going forward to make more sizable capital expenditures?

Yes. So, as you know, we're constantly monitoring how much capacity we have and we add equipment every quarter to make sure that we have the capacity that we need. As we look at it, the biggest thing that drives those capital expenditures, I think you're alluding to is floor space and facilities. As we look at them, we're looking at some solutions in the UK, because we have got mold storages actually taking up a good chunk of our floor space in the U.K. And if we can figure out a solution that I think we'll be able to there. That can extend that timing. So, we've been talking about potentially late this year, early next year for a facility in the U.K. We might be able to extend that by thinking through some different strategies on how to free up some existing floor space.

In the U.S., with our strong CNC growth that we're experiencing, we may be looking for a new facility here opportunistically really towards the end of this year, early next year to have something online towards the end of or middle to end of 2018.

So have a bigger impact on '18 (inaudible) on ' 17.

Yes.

Our next question comes from the line of Brian Drab with William Blair.

Just a couple quick follow ups. Excluding the discontinued services, was the growth in injection molding more like 8% I guess or high single-digit?

It's not quite 8%, it's probably closer to 7%, Brian.

Okay. I missed that number, what -- in terms of the discontinued services, 1 point something for second quarter last year?

Yes, it has the resin business in there, so the resin was flowing through other. That's maybe where we can follow up on them -- on that.

Got it. Okay. And then just wanted to ask also on the ramp of the low volume production business. Does that involve typically the customer coming in and qualifying your inspection process and some customization of your service for each customer in terms of the forms that you have to supply to them, et cetera?

I'm really glad you asked that question, Brian. So, very often when you get qualified as a production supplier, it does require some level of audit by the customer. Now, we can often get by without too much tailoring, but it is a step. So I think your point is, that's why we said we're very optimistic about this process and the value that it can deliver our customers. But the selling cycle is longer. It's a bigger decision for somebody to select a production partner for parts that are going into their end products than it is to select somebody who is going to produce a prototype tool for them in some parts from that. So, it is a process often requiring audits and several levels of sign off within customer companies in order to move yourself into that position.

So, that explains. The point of the question is of course what might take -- why would it take a relatively long time for this to ramp or sometimes for this business to ramp and that makes sense. And I imagine -- Vicki, maybe you could just and then I'll sign off after this one, but could you just talk a little bit about how this low volume production capability can help you build these relationships with some of the larger accounts, and this is something that I think a lot of the larger companies of course looking for and you didn't have this capability or this service kind of honed for them in the past and now you do, how is that going to help you build these relationships that you've been working on for a long time, and it's been going slower than expected, imagine this is a big step in the right direction.

Right. It is a big step and it's not just large companies. It could -- I mean we really in on-demand manufacturing. It could be companies with sales revenue in a $0.5 billion into $1 billion and are looking for a partner that's going to help them with low volume production of their part. But it is a tremendous value we can deliver customers. So customers have learned that we're a great partner for prototyping. It's a real hassle for them have to move to another company for their production parts. So, they have been pulling us to be able to provide more of that total solution, so they can go right seamlessly from Proto Labs in a prototype tool right into their production and tool and not have to change to a different supplier, because we don't provide this kind of quality inspection reports that they demand. So we're excited about this. I think this is going to bring a lot of value to our customer base. But I'm glad you asked the question about the kind of timing it takes for these kinds of changes. These are big decisions that customers make and we have to recognize that that selling cycle is a little bit longer.

At this time, I'll turn the floor back to Vicki Holt for closing remarks.

Great. Thank you again for joining us today. We remain very excited about the outlook for Proto Labs. Our differentiated technology-enabled digital manufacturing platform has demonstrated the ability to help companies and entrepreneurs get their products to market faster than their competition. We continue to innovate with our service offerings and technology interface and features to enhance our customers' experience.

I want to thank the Proto Labs employees for their efforts over this past quarter and I want to thank our customers for their support. We're committed to enhancing our revenue growth and driving greater shareholder value over the longer term and we look forward to reporting to you on our progress during our next call. Thank you.

This concludes today's conference. Thank you for your participation. You may now disconnect your lines at this time.