Jason Frankman - Proto Labs, Inc. Victoria Holt - Proto Labs, Inc. John Way - Proto Labs, Inc.

Brian Drab - William Blair Troy Jensen - Piper Jaffray Greg Palm - Craig-Hallum Jim Ricchiuti - Needham & Company Jon Fisher - Private Investor Ben Rose - Battle Road Research

Greetings and welcome to the Proto Labs' Second Quarter 2017 Earnings 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. At this time, I would 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 get 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 practise. Please refer to 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 of 9.4% over the prior year and was 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 U.S. 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 Q2 of 2016, and the negative impact of foreign currency exchange rate. Adjusting for the items, the revenue growth was 3.6%. Our growth in Europe is not achieving our desired levels and we are taking actions to improve the performance. Japan grew 8.2% or 11.5% in constant currently. Overall, the fluctuation in foreign currency exchange rate had a negative $900,000 year-over-year impact on a 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 [Indiscernible] 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 continued to lag our internal targets. 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 continued 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 continue to serve an increasing number of product developers and generate strong cash flow. We remain focused on our 2017 priority, 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 fulfil more of our customers’ needs and achieve strong growth margins. Our investment 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 are 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 environment and had 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 leadership, and we were in the Americas we were under invested in sales management in Europe. As we discussed earlier this year, we brought on Dirk Rathsacks, our VP of sales in January. Dirk has been accessing 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 the 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 technology in 3D printing over the past few quarters. We will also be launching a multi-jet fusion 3D printing technology during the third quarter. We are very excited about our July 17 launch on-demand manufacturing, for low-volume production product 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 under the manufacturing injection molding business with the same offering without acknowledging that an engineer looking for a prototype product has different needs in the business and supply chain leaders who are evaluating partners to produce their injection molded 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 for competitive keystock pricing for managing the financial performance of their product and ability to produce right 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 [Indiscernible] services together, allow us to better access the large low volume manufacturing market. For perspective, about a third of our total global revenue is injection molded heart 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 price molding capabilities to more production cases when low-volume and responsive supply is required. Quality documentation is a key component for end used part. In true Proto Lab digital fashion Proto Lab 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 the digital spread of data from the customers had [ph] filed to generate automated inspection report. Adoption of this new technology is uncertain, but we are excited to be working with our customers to link this initiative has multiple facets including increase in sales to leverage existing capacity, improving operating discipline, upgrading certain technologies and adding new speciality in materials which carry higher margin. We expect these improvements to show steady improvement in our 3D printing margins in Europe. We’ve remained very excited about the opportunities in front of us as the market evolves to ad digital manufacturing environment. We remain focused on helping our customers get their products to market as efficiently and effectively as possible and 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 of $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 CMC and 3D printing services, shifting the business mix. Gross profit for the quarter was $46.4 million, an increase of $4.1 million, or 9.8% 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 marketing to drive revenue growth, continued investment in research and development to drive 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 tradeshow 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 to 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 continued strong cash generation of our business, our cash and investment balances increased $16.6 million during the quarter to $217.9 million on June 30, 2017. Now I’d like to turn to our expectations for the third quarter. We currently expect Q2 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 businesses. Adjusting for the impact of discontinued services this guidance represents revenue growth of 8% to 14%. Moving to earnings guidance. We estimate gross margin to be in line with Q2 as we look at the near term, the improvements we make in the 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 cost 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 happy to take your questions. Rob, can you please open up the lines for Q&A.

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Brian Drab with William Blair. Please proceed with your questions.

Good morning, thanks for taking my questions. I wonder if we 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 you know historically.

A customer looks at an injection molder, we like to – we like to position it in terms of total cost of ownership. So there’s 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 will cut a new tool and move forward. Our tooling costs can be very cost-effective. On the other piece, of course there is piece per price and in our on-demand manufacturing offer we are going to be working in the mold design to make sure we’re designing the mold with the right cavitation and the right design to optimize that piece per 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 is very competitive. And you couple that with our responsiveness, we think it’s a very very attractive value for customers.

In terms of margin that you think you’ll be able to generate on that relative to historical?

Yes, Brian I think as we look forward, we’re in the launch stage and a 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 are looking at it, we think we’ll be able to maintain those margin, and as more and more of the revenue comes from the production of the parts, we think that there’s 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 are currently modelling is in margins roughly in the same range that we are looking at today.

Okay. And just in terms of the number of parts that we are talking about when you say low volume production on your white paper, that you put up on your website like four years ago, --like 40,000 parts in terms of you know of the threshold -- what type of volumes do you expect to do in this business?

It really varies. I mean, our [Indiscernible] generally 10,000 parts are less, but we’ve got some programs where customers will ask specifically is parts that are in the hundreds, thousands range. So we are not targeting those applications where very large volume production in the million, but in 10,000, 20,000 range we’ve got a very competitive total cost of ownership value propositions.

Okay, and then one more quickly and just have to get back, I’ll 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 dialogue with customers it really is more of an accounting matter, the mold ownership allows them to capitalize the mold and treat it differently from an accounting perspective versus if they don’t own they generally have to expense it. So, what we’ve found is its more about the accounting than it is about actually physically taking the mold.

Okay. Got it. I’ll get back in line. Thank you.

Our next question comes in the line of Troy Jensen with Piper Jaffray. Please proceed with your question.

Yes. Congrats on a nice quarter Vicki and John.

Thanks, Troy.

Thanks, Troy.

Hey. So, I just still wanted to add in little bit on injection molding, it was only up 4.5% year-over-year. Do you kind of couple that with the fact they you guys have launch overmolding and insert molding shows not a huge contributions from those two just you add, but can you just discuss why you think that's growing significantly less than the CNC business that was up 22%?

Yes. So, first, what I would say that the injection molding market from a size point of view is quite large. The prototyping piece of it is a 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, the suite of inspection report is a very important service to capture more of that market, but we also believe there will 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’s – 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 compete and take share there.

Okay, understood. Another question to maybe or probably the one would be I guess, sales and marketing 17.4% of sales, so how it’s been in about six years for the company. So can you much more investments there? What are the investments exactly and how far would you continue to spend on the sales?

Yes. We talked a lot the last couple of quarters about 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 a consultative selling conversations with our customers and particularly when we care for things like on-demand manufacturing which is more complex sale. And it’s been continue 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 salesforce. A lot of that behavior change and unfortunately we are 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 as going forward and as you’ll see in some of our guidance going forward to expect that sales and marketing of the percent of sales in that 17% range going forward is probably a pretty good estimate.

Okay. Perfect. And 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 look 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 wasn’t anomaly, we’re seeing a different environment this year, so I would expect this – I had almost excluded and kind of go back to some of the earlier periods when trying to look at it.

All right. [Indiscernible]

Thank you.

Thanks, Troy.

Our next question comes from the line of Steve Dyer with Craig-Hallum. Please proceed with your question.

Good morning. It’s actually Greg Palm on for Steve today.

Good morning, Greg.

Hi, Greg.

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 few weeks ago, but I believe it's actually been lives 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?

Yes. So, it has been a service our customers been asking for. The suite of inspection report has been on the top of the list particularly for companies who are evaluating us more 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 started a beta launch so we’ve actually been taking the 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 June – end of June, beginning of July, but we did not start advertising until July 17, again to make sure that we worked out and -- in the service to make sure that there's an opportunity for us be able to scale and service any demand. So it’s gone quite well. We gave 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 upticks of companies who really do want to position themselves 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 need. So, so far the response is good. It’s very early. It really few weeks into it, but we’re pleased with the start of program.

And how long should we expect some of these headwinds around the new services specifically but also 3D print in Europe to impact gross margins. I think previously we’re hoping to maybe exit the year at 58% to 60% at least that kind of in your target. So curious if and how much your 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 that challenges in Europe and improving those gross margins kind of take a little longer than we anticipated. And I think we're getting our operations inline and that 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 those 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’ve launched, it's just that the ramp-up phase as we bring on that the new equipment and that equipment isn’t that full capacity. It has a little bit of a drag. It's not is not a huge drag. So I think the guidance we gave at the beginning of 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 it 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 improvements maybe over the medium-term over the next maybe two to five, six quarters?

I think that’s going to be gradual. We had a little bit of color on to John’s comments. Proto Labs positioning in 3D printing is to be the global leader in industrial 3D printing by focusing on the three major things. By focusing on having the best resolution and quality, industrial 3D printed parts by having the strongest set of materials that meet the needs for the industrial customer and speed, and we have that positioning here with our 3D printing business in North America, but we got some work to do in Europe to get us to that point and getting us to that point is going to be necessary to get 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 involves the manufacturer productivity that John mentioned that we’ve made some good headwinds, and some good steps there to drive that forward. But there's 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 a transfer of some of the specialty materials, and MicroFine Green is a really nice unique product that we offer here in North America. We need to be transferring that into Europe as well. We need to continue to drive 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 sometimes. 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 rates varied between 12 and 18 months for sales people. We’re working hard on the on-boarding program that's the work doing right now to try to see what we can do to accelerate that, but generally its 12 to 18 months for ramping.

Okay, great. I’ll ask follow-up maybe on the headcount number offline? Thanks.

Okay.

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

Thank you. Good morning. I think 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 and perhaps some dedicated sales folks that are calling on customers to market the service?

So there’s couple of things that you’ll see that are changing. First is a little bit of a change in some of our marketing mix, really trying to get ourselves position from a PR and 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 shift in some of that messaging in order to begin to attract and put ourselves in front of the new type of customers that we got. There’s also been a tremendous amount of sales training and our sales people have been working with focus accounts that they have that they believe are best position 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 dilution consultative selling that this type of offer brings it, so it’s been doing quite a bit of role-playing and getting that the team ready to have those kinds of conversations with customers. And then of course the changes in the website, so we will be wagging customers who are actually looking to us for production early in the selling process to make sure that we're positioning ourselves to meet their needs and answer the questions that supply chain managers and operating leaders have which is are different than those that come from a product developer.

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

Yes. We’ve done some profiling of these segments and we do believe that again met devices 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 you what are you seeing thus far this summer the overall pace of demand that you're seeing?

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

And just 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 drive growth. Also wondering if the competitive landscape just more challenging in this market than you expected earlier on?

Competitive landscape is both more challenging and its difference. There is – when you look part geometries and how pricing – as we price based on geometry and what we’re finding that there are some new answers in the competitive environment around pricing by certain geometries that we’re having to adjust, so we’re dealing with those answers with the market. They’re tend to be in Europe. They’re tend to be some geometry sets skewed toward the larger parts that are 3D printed and we’re having to make some adjustments to make sure we understand that competitive environment and position ourselves well there. So we’re learning.

Okay. Thank you.

Thank you. Our next question is from the line of Jon Fisher of Private Investor. Please proceed with your question.

Good morning. With Dougherty & Company still, so thank you. Couple of bigger questions here; appreciate the color that you provided on the injection molding segment and the end market dynamic that with some of the detail. But given the strength in CNC machining that you saw and the modest growth in injection molding, can you can – and in your overall positive outlook on the U.S. 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, 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 on 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 of 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 our of certain geometries and a lot of to past that through and still maintain margins. So there is some real share gain opportunities, as well as delivering our customers some great value in CNC and best driving some of that growth there. And again I mentioned on injection molding, you really feel those things that the steps that we’re taking that are going to improve the growth rates there by tapping into more on-demand manufacturing product.

Okay. I guess I’ve heard on this call pricing come up in prepared comments and in the conversation a lot more than historically. I've heard the company talk about pricing. One of things that you talk about is you don't really -- the business doesn't compete on price to try and drive growth. We’re trying to share 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 and the growth strategy, its maybe use price is more of a lever to try and drive a faster rate of growth or they try and take market share or be more competitive. Has something changed here over the last two to 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 and particularly in Europe that we've got a pace and we’ve got to figure out how to make sure that we’re pricing appropriately to drive the appropriate growth to deliver the margins. So, I think that's an 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. I don’t think there’s a change in strategy of how we’re approaching it.

We’ve always deployed AD pricing techniques to constantly look at different levers that we’ve got to both – to improve revenue and close rates, so we’re constantly testing those things.

Okay. And then 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 how much business would you need before you would add another incremental piece of equipment and kind of what's the plan that to take this offering beyond just North America? Thank you.

So, we’ve got handful of machines that we've got. Yes, they are definitely underutilized, but I think we have to make sure they we’re planning for that. I don't think it's a significant impact. I think the reason we mentioned, there are puts and takes in our business that are impacting our gross margin and just providing messaging on. We’re not anticipating significant uptake 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 significant thing that we should be talking about as far as 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 Telford UK facility as we move to the third quarter and we get ready to launch in Q1 of 2018. And we haven't defined a timeline at this point in Japan. We are working through that.

Thank you.

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

Good morning and thank you for taking my question. Vicki on the lines of I should say, along the lines of the sale strategy as I understand a part of the push this year is to take a closer look at potential large accounts and I realize that there is no single customer that accounts for 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 in perspective, Ben, 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 real long tail, get a lot of efficiencies through that. So we’re doing that using a lot of salesforce.com tools and tools that allow our sales people 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 sale people around using those tools to drive their daily behaviors and using a very discipline 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 on 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 will 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 its 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 or change in our sales peoples behavior to have been move from prospect to close more efficiently and drive that revenue. Next one I think they impacted in the growth rates that we’re delivering in the America.

Okay. That’s helpful. 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 that 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, I mean, more and more engineers are getting experience in 3D printing, so that’s kind of driving growth rates there little bit higher than our injection molding service. And I also believe that our positioning as a real strong leader in industrial 3D printing puts us 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, DMLS is growing well, growing little bit faster than our plastics.

Okay. Thank you. 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 in 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 that we’re looking at some solutions in the UK because we have got mold storage is actually taking up a good chunk of our floor space in the UK 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 or early next year for a facility in the UK. 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 and opportunistically really towards the end of this year or early next year to have something online towards the end of our middle to end of 2018.

That will have a bigger impact on 2018 as well as on 2017.

Yes.

Okay. Thank you very much.

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

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

Yes. It’s not quite a – it’s probably close to seven, Brian.

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

Yes. It also has the resin business in there, so their resin was going through other that’s may be 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 said, we’re very optimistic about the 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 that is going to produce a Proto type tool for them and some parts from that. So it is a process often requiring audits and several levels of sign off within customer companies, I know you will move yourself into that position.

Right. Got it, so that explains – yes the point over the question is of course you know what might take, why will it take a relatively long time for this to ramp sometime for this business, to ramp and that makes sense and I imagine, [Indiscernible] 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 you know this is something that I think a lot of the larger companies well of course looking for and you didn’t have this capability or you know this service kind of honed [ph] for them in the past and now you do you know 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 slow you can expect to 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 and then we’ve really under their manufacturing expect [ph] these companies with sales revenues and $0.5 billion to a $1 billion and are looking for a partner that’s going to help them with low volume production of their part. So, but it is a tremendous value we can deliver to customers. So customers have learnt that we are a great partner for Proto typing. It’s a real hussle but then 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 Lab in a Proto type tool right into their production and tool and not have to change to a different supplier because we don’t provide the 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. In fact 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 be, we have to recognize that that following cycle is a little bit longer.

Okay, that makes sense. Thanks very much.

Thanks Brian.

Thank you. At this time, I will 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 customer’s 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 are 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 and you may now disconnect your lines at this time.