Proto Labs (PRLB) Victoria Holt on Q2 2016 Results - Earnings Call Transcript

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Proto Labs, Inc. (NYSE:PRLB)

Q2 2016 Earnings Call

July 28, 2016 8:30 am ET

Executives

Jason Frankman - Controller, Proto Labs, Inc.

Victoria Holt - President & Chief Executive Officer

John A. Way - Chief Financial Officer

Analysts

Troy D. Jensen - Piper Jaffray & Co. (Broker)

Brian P. Drab - William Blair & Co. LLC

Ben Hearnsberger - Stephens, Inc.

Robert Burleson - Canaccord Genuity, Inc.

Jim Ricchiuti - Needham & Co. LLC

Operator

Greeting, and welcome to Proto Labs Q2 2016 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Jason Frankman. Thank you. You may begin.

Jason Frankman - Controller, Proto Labs, Inc.

Thank you, operator, and good morning, everyone. This morning before the market open, Proto Labs issued a press release announcing its financial results for the second quarter ended June 30, 2016. The release is available on the company's website at protolabs.com.

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

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

In addition, to supplement the GAAP numbers, we have provided revenue growth on a constant currency basis for both total revenue and revenue earned through legacy operations, adjusted consolidated statements of operations and adjusted net income and basic and diluted net income per share information on a non-GAAP basis.

The non-GAAP adjusted consolidated statements of operations. And non-GAAP adjusted net income, each exclude the cost of stock compensation, amortization of intangibles, impairment on assets associated with discontinued manufacturing processes, charges related to the exit of facilities and unrealized foreign currency activity. We believe that these non-GAAP metrics provide meaningful supplemental information are indicative of our core operating results and are helpful in assessing our historical and future performance. A table reconciling the GAAP information to the non-GAAP information is included in our financial release.

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

Victoria Holt - President & Chief Executive Officer

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

Revenue in the second quarter of 2016 was a record $75 million for the company. This represented an increase of 17% over the prior year second quarter, and was at the low-end of the range of our guidance for the quarter.

Alphaform, the German company we acquired in the fourth quarter of 2015, contributed $4.8 million in revenue. Excluding Alphaform, legacy revenue in the second quarter was $70.2 million, 10% above the revenue in the same period of 2015. Revenue in the Americas increased 6%. Revenue in Europe, excluding Alphaform grew 26% on a constant currency basis. Revenue from Japan was up 29% in constant currency.

Turning to revenue by service: injection molding totaled $44.8 million in the second quarter, an increase of 12% over the prior year; CNC machining revenue grew 7% year-over-year; revenue from 3D printing was up 29%, excluding Alphaform.

This was a challenging quarter for the company, particularly as it relates to revenue growth in the Americas. While we're still growing in this region, the rate is below our historical levels and our expectations. The lower year-over-year growth was a reflection of a difficult economic environment, as well as some disruption to our sales team in the U.S.

Given the nature of our business with a very diverse and fragmented customer base and the early stage in the company's life cycle, it's difficult to identify a single economic indicator which consistently and clearly tracks the fluctuation in our revenue growth. However, there are several factors which are impacting our growth and demonstrate some correlation. U.S. industrial production remains weak. Consumption of cutting tools, an indicator of utilization of U.S. machining shops, has declined 9% through May 2016 compared to the prior year. And finally, many customers have indicated delays in projects as a means to control expenses.

In terms of our U.S. sales force, as we mentioned in our last call, our former Head of Global Sales left Proto Labs. We've also made some changes to sales management in the U.S. These changes have offered us an opportunity to take a good hard look at our sales operations; what is working, what isn't, and what best practices could we implement to drive demand and revenue.

We recognized that Proto Labs needs to evolve to capitalize on the market opportunity, augmenting our existing model of responding to inquiries with a larger, more strategic presence with our customer base. We're currently recruiting for a Chief Revenue Officer who has experience with strategic and proactive sales processes, focused on targeted customers. We've engaged a search firm and are going through the interview process now.

We are working through this process with a sense of urgency, but will not compromise the quality of the executive we add to the team. We're not waiting for the arrival of the CRO to drive improvements in sales execution. The sales force is currently reporting to the General Managers in the region with assistance from me and Bill Dietrick, our Head of Marketing.

To address our sales force effectiveness, we have engaged a sales consulting firm to enhance the training and development of our Sales Managers and frontline sales staffs. We've developed a road map to enhance our sales process, so we can develop more deep and strategic relationships with both our existing large customers, and drive new large customer relationships. We began recruiting additional Sales Managers to improve our sales person to manager ratio. And we've revised our operational sales metrics to allow us to – a more rapid reaction to leading indicators on sales performance.

The turnover, combined with implementation of this approach, has resulted in some disruption among our sales team. We're confident that these enhancements will result in sales productivity improvement once the best practices are adopted by the team.

Despite our challenges in the Americas, our 3D printing business continued to grow nicely. This growth has been achieved in a quarter in which we moved our SLS and our DMLS manufacturing processes to the new facility. We're now in the process of moving stereolithography manufacturing, which will be completed in the third quarter. I'm very proud of the job done by our team, which accomplished these transitions seamlessly, without disruption to customer service.

With the completion of these moves, we have vacated one of our original manufacturing facilities and bought out the remaining term on the lease. We also continue to experience strong revenue growth in Europe. We believe we're benefiting from our presence in Germany and the positive brand recognition and marketing lift resulting from the Alphaform acquisition.

Revenue in Japan demonstrated solid growth, reflecting increased demand and timing of orders. Japan remains on track to move to its new facility in the third quarter. We expect continued strong growth for both Europe and Japan for the remainder of the year.

Our envelope expansions planned for 2016 remain on track. We continue to make progress with the soft launch of our overmolding, taking customer orders on a regular basis to optimize our software and process. Customers are very pleased with our quality and are looking forward to a full launch in Q4. In CNC machining, we've added titanium and we're in soft launch of 5-axis milling.

Moving on to other financial highlights, our gross margin improved 180 basis points from the first quarter to 56.4% in the second quarter. The gross margin improvement was realized in our Alphaform business as well as our legacy U.S. and European operations. Non-GAAP net income was $12 million in the second quarter, or $0.45 per share. This was a penny miss from our guidance and was due to slightly lower profitability at Alphaform resulting in a higher than anticipated effective tax rate.

John will provide more detail on our financial performance in his remarks. But before I turn the call over to him, I'd like to summarize where I believe Proto Labs is currently and how I see the outlook. Despite our challenges in this quarter and the impact of the economy on our business, we remain confident that our market is indeed large and diverse and the fundamentals of our business remain unchanged.

We offer robust and valuable business solutions to our customers. Our technology, scale and business model are differentiated, compelling, and have significant barriers to entry. We are laser focused on improving our sales processes, developing our sales professionals and upgrading our sales leadership talent to restore the growth rates in the Americas to meet our target. I'm confident in the actions we've taken this past quarter, and the actions we will taking in the coming quarter will result in steady progress towards that goal.

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

John A. Way - Chief Financial Officer

Thank you, Vicky. Revenue in the second quarter was $75 million, an increase of $11 million or 17% over the same quarter in 2015. Legacy revenue in the first quarter came from 13,519 unique product developers. This represented a 14% increase over the second quarter of 2015. Our unique product developer account does not yet include Alphaform as this information is not available in a comparable format at this time.

Average revenue per product developer decreased 4% compared to the second quarter last year. The decline in revenue per product developer is reflective of the mix of our business with strong growth in 3D printing and lower growth in our injection molding and CNC machining businesses.

Gross profit for the quarter was $42.2 million, an increase of $4.7 million over the comparable quarter of the prior year. Gross margin was 56.4%. Alphaform represented a negative 310 basis point impact on our gross margins in the quarter. Excluding Alphaform, gross margin on the legacy business was 59.5% as compared to 58.4% in the first quarter, and 58.7% in the second quarter of 2015.

As anticipated, we saw improvement in the gross margins in our Alphaform business, as well as our legacy operations in both the United States and Europe this quarter. These improvements reflect the manufacturing efficiencies achieved through our Lean/Continuous Improvement process that we recently embarked upon.

Our operating expenses were $27.4 million or 36.5% of total revenue for the second quarter of 2016. These expenses include non-recurring expenses of $873,000 related to the exit of our metal and magnesium injection molding operations and expenses associated with the exit of facilities in North Carolina and Japan.

Adjustment for those items, operating expenses were $26.5 million or 35.4% of revenue. Sales and marketing expense totaled $11.5 million or 15.3% of second quarter revenue. We invested $5.8 million or 7.8% of revenue in research and development in the quarter.

Operating income was $14.9 million in the second quarter of 2016, compared to $17.3 million last year. Adjusting for the non-recurring items previously mentioned, stock-based compensation and amortization, our adjusted non-GAAP operating income was $17.7 million or 23.6% of revenue, compared to $19.1 million or 29.9% of revenue in the prior year. The reduction in operating margin relates to the dilution from the Alphaform acquisition, increased investments in sales and marketing and research and development and the increased general and administrative cost associated with infrastructure investments, consulting costs, and cost associated with our additional facilities.

Our effective tax rate was 32.9% in the second quarter. This tax rate was higher than anticipated due to the mix of our earnings by geography. Specifically, we incurred losses at Alphaform this quarter. Until we show consistent profitability in this business, we are required to carry evaluation allowance and potential future tax benefits associated with these losses, resulting in a higher effective tax rate in the current period.

Net income totaled $10.7 million resulting in diluted earnings per share of $0.40. Adding back the after tax costs of stock compensation, amortization and intangibles, and adjusting for the non-recurring items and the effects of the unrealized gain on foreign currency, our non-GAAP diluted earnings per share in the quarter were $0.45.

Alphaform represented a $0.03 negative impact on our earnings per share. During the second quarter of 2016, we generated cash from operations of $20 million. Capital expenditures were $14.1 million in the quarter with $8 million related to facilities. This resulted in an increase in cash and investments of $7.1 million from the end of the first quarter to $164.3 million at June 30, 2016.

Now, I'd like to turn to our expectations for the third quarter. We currently expect Q3 revenue to be in the range of $73 million to $78 million representing revenue growth of 7.5% to 15% over the prior year. This revenue guidance reflects a $1.2 million reduction of revenues compared to the second quarter related to the discontinued resin distribution, and metal and magnesium injection molding services.

We anticipate a headwind next quarter from foreign currency primarily related to the British pound estimated at $1 million year-over-year and $500,000 sequentially. In addition to the foreign currency impact, the Brexit decision is creating some uncertainty in Europe that is difficult to predict. On a longer horizon, we feel the potential impact will be partially mitigated due to the manufacturing presence established in Germany as a result of the Alphaform acquisition.

Moving to earnings guidance, we will incur some expenses that were not present in the second quarter. These expenses include duplicative costs associated with our facilities moved in Japan, consulting cost associated with our sales force activities in the Americas, the addition of sales managers and staff and related recruiting costs, including the search for our Chief Revenue Officer.

Additionally, stock compensation cost for the quarter will be approximately $1.8 million. We currently estimate our tax rate to be approximately 32.5% to 33% in Q3. Taking into consideration all the above, we expect our quarterly non-GAAP EPS to be between $0.42 and $0.46 per share in the third quarter.

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

Question-and-Answer Session

Operator

Our first question comes from the line of Troy Jensen with Piper Jaffray. Please state your question.

Troy D. Jensen - Piper Jaffray & Co. (Broker)

Vicki, I guess, I wanted to focus on the sales disruption comment you made. I think all of us knew about Jackie's departure, but can you just kind of quantify how much turnover has happened in your sales organization?

Victoria Holt - President & Chief Executive Officer

Yeah. Thanks, Troy. Yeah. We've had – there's been a couple of changes in sales management; the sales leader in North America and one of the sales managers, who actually had an illness. And so with that, if you think about our sales force, it's a relatively young sales force. We added a lot of sales people in 2015 and even in the first part of 2016. And the sales manager to salesperson ratio is very important and that relationship is important.

Now we did bring in a couple of really strong sales managers in the second quarter. They're new. They're good. They're getting their feet on the ground. So that, coupled with the new sales processes that we're putting in place and the discipline around moving sales through the sales cycle from point of upload, all the way through to close and the stages that they move through and some of the metrics that we're now measuring, which are more leading indicator metrics around the quality of the calls, the relationships, the quality of the interactions that are taking place, is just causing a little bit of disruption.

As you think about it, change always causes a degree of disruption, particularly as people are adopting new practices, learning how to master and really use those practices effectively. So we're in a bit of a transition period, but I'm really pleased to see that we're starting to get some excitement among the sales team with the tools and the training that we're giving them; and I think we're going to see some good traction from that.

Troy D. Jensen - Piper Jaffray & Co. (Broker)

All right. Understood. And then, maybe a couple for John. Can you just talk about linearity through Q2? I mean, was the quarter kind of always tracking a little light or did something happen in the last month?

John A. Way - Chief Financial Officer

Yeah. I think it was tracking light pretty much throughout the quarter. And I think there were pockets where we saw some nice uplifts in orders and had strong growth in Europe and Japan. But for the most part, it was tracking relatively light through the quarter.

Troy D. Jensen - Piper Jaffray & Co. (Broker)

Okay. Then, my last question and I'll cede the floor, if I look at your 3D business, it looks like it's been about $9.1 million for each of the past three quarters, and this is after reporting just spectacular growth post the acquisition. So, curious to know why you're seeing such a slowdown in sequential growth here in the 3D business? And I get the Alphaform business, maybe that's fallen off, but maybe can you separate FineLine versus Alphaform?

John A. Way - Chief Financial Officer

Yeah. I think if you recall the conversation related to Alphaform, we acquired some contracts that we knew that we had to run off related to the large volume production of 3D printed parts. So we had revenue both in the fourth quarter and the first quarter related to those contracts that, as we wound those down, that's getting reflected in those numbers. So if you look at the progression of the legacy business, it's continuing to progress and grow; and grew about $400,000 in the quarter.

Victoria Holt - President & Chief Executive Officer

Yes.

Troy D. Jensen - Piper Jaffray & Co. (Broker)

All right. That's fair. Well, good luck in the second half.

Victoria Holt - President & Chief Executive Officer

Thank you.

John A. Way - Chief Financial Officer

Thank you.

Operator

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

Brian P. Drab - William Blair & Co. LLC

Hey. Good morning.

Victoria Holt - President & Chief Executive Officer

Good morning, Brian.

Brian P. Drab - William Blair & Co. LLC

Okay. First, just on the G&A sequential step up, and I may have just missed this, but what explains the big step up sequentially and what are you expecting for G&A as a percentage of sales for the year at this point?

John A. Way - Chief Financial Officer

So I think there's a couple of things related to G&A to talk about. One is the non-recurring expenses. So we had a charge related to our MIM and thixo equipment as we discontinue those businesses, as well as some costs associated with the exit of facilities in North Carolina. And then, we've also got (24:40) in Japan as well, as we entered into our new facility. So we've got some duplicative costs in Japan, as we were executing the move and exiting the old facility. So we've got some of those costs there.

In addition to that, we built the budget this year assuming higher revenue growth than we're experiencing. And developed a plan related to executing to achieve that growth. That included certain projects related to R&D and other integration of Alphaform and other matters like that. And we've been executing on those. But as a result of that, our spending levels are a little bit higher assuming that we would have higher revenue and that's something we're going to have to adjust here in the back half of the year.

Brian P. Drab - William Blair & Co. LLC

Okay. So it sounds like a lot of these non-recurring expenses continue into the third quarter you mentioned. And they actually – some new ones are going to be hitting in the third quarter, at least they're stepping up. But as we move into fourth quarter and the beginning of next year, is it fair to assume that we're going to have less of this non-recurring, going on that will be down with Japan, the consulting related to sales, the recruiting cost, the MIM and thixo, we're past that. I mean this is kind of an unusual period.

John A. Way - Chief Financial Officer

Yes. So we will have duplicative costs in Japan and as well as costs associated with the move through the third quarter. And we'll have some of those consulting cost and recruiting costs related to our sales force that will be in the third and probably a little bit in the fourth quarter, as well. But yeah, there is an unusual spike in those costs that will normalize.

Brian P. Drab - William Blair & Co. LLC

Okay. And then in the first quarter, you saw a material decline in orders from roughly 20 customers of your top 100 customers, at one point you explained it in this context. And I'm wondering, A, how did orders from those customers compare with the first quarter – in the second quarter. And then, B, regardless of what those specific customers did, can you share a comparable analysis from the top 100 from 2Q 2015 versus 2Q 2016. And then, if I could add a C, as well, I mean, what industry verticals still are the sources of weakness?

Victoria Holt - President & Chief Executive Officer

Okay, Brian. Yeah. So, basically when you look at those top customers that showed some weakness in the first quarter, we see a similar weakness. They're kind of flattish compared to first quarter, but when you look at it compared to prior year, we're still seeing that year-over-year weakness with those specific customers in those specific verticals. And that brings – it brings you to the look of the vertical.

So when you look at our industry verticals – I'll just focus on the Americas since that's really where we're having the challenging year-over-year growth below our expectations. I mean, we're still growing, still grew 6%, but as you know, that's far below our expectation. So when you look at it in the Americas, there are a few industry verticals that are pretty consistent with those customers that actually show year-over-year decline. So these would be – yeah, particularly segments like, and these are small segments for us, but they're indicative of the economic climate. Segments which is plastic, rubber or die-casting injection molders or machine shops, who often outsource particular prototype and low volume production to us. Well, when they're underutilized, they're going to have the capacity to do that in-house. So those are way down.

And then you'll see things like industrial and commercial equipment essentially flat year-over-year. Yeah, but normally, with us we're seeing growth in those segments. So you'll see a few of them, again, indicative to those economic indicators that we mentioned, such as industrial production being docked down, the fact that cutting tools are down through may 9% versus prior year, indicative of kind of a slowdown in these machining of parts and tooling.

Brian P. Drab - William Blair & Co. LLC

Okay. Okay. Thanks. And can you talk about what percent of your business roughly is tied to production parts versus product development? And how that industry minus how that looks across the different segments obviously that impacts injection molding the most?

Victoria Holt - President & Chief Executive Officer

Right. So, production parts is part of our injection molding, it's not half of the injection molding segment. So therefore, it's about a third of our sales revenue, is what we call production part. Now, it's very difficult for us to tell within that segment – within that piece, this is where customers would order additional part from a tool we've already made. Now, sometimes that might be still part of the commercialization process, and might want a 1,000 pieces to do the structure testing on it, for example. And we have no way of really knowing that. But generally we believe a lot of the large orders that take place with production from existing tool and goes into production.

Brian P. Drab - William Blair & Co. LLC

Okay. So, just to be clear, you're saying obviously 16% (30:07) of sales, roughly, is injection molding, about half of that is parts business; so about...

Victoria Holt - President & Chief Executive Officer

Correct.

Brian P. Drab - William Blair & Co. LLC

...of 30 points of the total. We don't know how that breaks down, but is there any – I always assume that like roughly half of that, so like 15...?

Victoria Holt - President & Chief Executive Officer

I bet it's more than that. I would assume it's more than that. I would assume it's a little bit more than that. So, I...

Brian P. Drab - William Blair & Co. LLC

Is there anything – okay. Sorry.

Victoria Holt - President & Chief Executive Officer

I would assume it's...

John A. Way - Chief Financial Officer

The majority.

Victoria Holt - President & Chief Executive Officer

...the majority of that 30% we think is production.

Brian P. Drab - William Blair & Co. LLC

Okay. Okay. And then within CNC and 3D printing, is there anything you'd consider production making end use part?

Victoria Holt - President & Chief Executive Officer

There's probably some, but small. I mean, I would think in CNC and 3D printing, you're talking 5% or less would go into production part.

Brian P. Drab - William Blair & Co. LLC

Okay, okay. I'll get out of the way here. Thank you very much.

Victoria Holt - President & Chief Executive Officer

Thanks, Brian.

John A. Way - Chief Financial Officer

Thanks, Brian.

Operator

Our next question comes from the line of Ben Hearnsberger with Stephens. Please state your question.

Ben Hearnsberger - Stephens, Inc.

Hi. Thanks for taking my question. I'm curious, when you think about planning for your 3D printing business over time, how do you think about growth in that segment maybe over the longer term?

Victoria Holt - President & Chief Executive Officer

So first of all, we're an on-demand manufacturer. So we really have to look at where the order activity is coming and how quickly that's ramping and what we're seeing from quoting activity in order to anticipate capacity additions. We've now got in place, in both North America and in Europe, substantial floor space in order to continue to add equipment.

So what we do in order to determine when we need to add another piece of equipment is we take a look at the current volume of orders, the quoting activity, the prospect growth, and the lead time associated with pieces of equipment to determine when it makes sense for us to add.

So we basically will be adding additional capacity as our demand continues to grow. And we've had good strong demand. As I mentioned, our 3D printing business is up 29% year-over-year in the second quarter. So we will be adding equipment in the individual processes as we see that demand occur.

Ben Hearnsberger - Stephens, Inc.

Is it safe to assume – and I know it's a smaller base, but is it safe to assume you expected 3D printing piece of your business to outpace your legacy business, of course, this year but over the next few years?

Victoria Holt - President & Chief Executive Officer

I think for the next couple of years, we really think that 3D printing plays a very important role in the product development life cycle and particularly in the concept phase. And it also is a very novel technology that engineers are excited to be able to utilize. So we're really happy to have that within our portfolio. It gives us that full pocket value from the customers. So we think that that will be growing and reaching something around 15% of our sales as it gets to more of an equilibrium.

Ben Hearnsberger - Stephens, Inc.

Okay. And John, can you give us the gross margins for the legacy business, including molding and milling, and then break out FineLine and Alphaform?

John A. Way - Chief Financial Officer

Yeah. So, Alphaform had a 310 basis points impact on our gross margins in the quarter. So that leaves the legacy business at 59.5%. And FineLine continues to operate in that, just above 50% range. So the injection molding and Firstcut are just a shade over 60%.

Ben Hearnsberger - Stephens, Inc.

Okay. And how does that for the legacy business, molding and milling, how does that compare to 2Q 2015?

John A. Way - Chief Financial Officer

So, it's up about 80 basis points.

Ben Hearnsberger - Stephens, Inc.

Okay. Do you see a lot of runway there? I know you're doing a lot of things around lean and some inventory planning. Do you see a lot of room to continue to grow that? I know it's very volume dependent, but...

John A. Way - Chief Financial Officer

Yes. It's a little volume dependent. But I think we're just beginning to implement our lean process improvement. Some of that will impact or reduce our inflationary costs and offset some of that to allow us to maintain. But we do see that there's opportunity that continues to drive margins there.

Ben Hearnsberger - Stephens, Inc.

Okay. And maybe one last one for Vicki. On the sales model, I know you mentioned there are some things that work and there are some things that are not working. Can you walk through some of the best practices as you look across your organization and some things you want to push out across the organization? And then, maybe some of the things you're trying to step away from?

Victoria Holt - President & Chief Executive Officer

Yeah. So, let me put it into two buckets. We have a historical approach that Proto Labs has used really since the beginning of the company's start-up and that is, marketing brings in prospects, and our sales team works to move those prospects and uploaders to a close transaction. And within that historic approach, there are some opportunities for more best practices than we've been deploying. And some examples that I'll use will be: the approaches that our sales managers need to be taking to coaching and mentoring and developing the sales team; the use of metrics in doing that, particularly leading indicator metrics that are really tied to the close rates; the use of moving a customer through sales stages in a sales cycle and measuring how each sales rep is moving their customer base through that – stages of the sales cycle and help coach them so they can continue to improve.

So there's certain aspects of that, that blocking and tackling of driving that more transactional part of the sales activity, that we're really focused on improving. But longer term, the piece that we've got to start layering into our model is a stronger strategic selling engagement. We have been adding some strategic account managers to our team, but the approaches that we're taking, the sales process around strategic account management has not been deployed and a process has not been put in place to the degree that they need to get the success we need.

So we've now developed a roadmap of how we want to move that strategic selling model forward, and it will take us time to implement that. And then, will take us even more time to build the relationships with the customers that are going to bring the result. But it is that engagement, coupled with continued productivity improvement in our traditional model, that's going to allow us to restore the revenue growth rates in the Americas that we've seen in the past.

Ben Hearnsberger - Stephens, Inc.

Okay. Thank you very much.

Operator

Our next question comes from the line of Bobby Burleson with Canaccord. Please state your question.

Robert Burleson - Canaccord Genuity, Inc.

Hey, guys. So, just a couple of quick ones. I was wondering, on the cutting tools correlation that you mentioned, whether or not that's something that leads or lags, and by how much, your Firstcut business?

Victoria Holt - President & Chief Executive Officer

Yeah. Bobby, I don't know if it's a leading or lagging. What I will say is cutting tools are disposable. It's a disposable that's consumed by machine shops or injection molding tooling shops as they're making parts or tools. And the fact that it's down 9% tells you that those consumables – that segment is a little bit weak right now. So despite that, we grew in the Americas by 6%. So is it a leading or a lagging? Frankly, I don't know.

Robert Burleson - Canaccord Genuity, Inc.

Okay. And then, you called out, obviously, the sales disruptions as part of the impact in the Americas. And I'm wondering, can you quantify that in terms of how much growth you might have expected had you not had this transition that you're going through? Is there any way to kind of get a sense for the size of the impact?

Victoria Holt - President & Chief Executive Officer

I think it's impossible to really put a firm number on it. I will tell you, I do think there has been some disruption. Any time you have a leadership change disruption occurs, and any time you have new processes you're having to learn, new approaches, new metrics that you're being measured against, it's going to cause a degree of disruption. It's very difficult to actually be able to quantify that, but I think it's all about change management. I'm really sure that the changes we're putting in place are going to be positive changes.

We're seeing some real positive comments from our sales team. They like the better structure. They like the coaching they're getting. They're starting to see little better results on moving things through those stages that I mentioned, the stages of selling. So I think we're doing all the right things and we just have to stick to it and stay committed to the discipline of executing it, and I'm confident the results will be there.

Robert Burleson - Canaccord Genuity, Inc.

Okay. And then, Europe grew nicely, and you mentioned you're benefiting from German presence and your Alphaform brand. And I'm wondering sort of what's the conviction on continuing growth in utilization levels at Alphaform and the associated benefits to gross margin as we look at the balance of this year?

Victoria Holt - President & Chief Executive Officer

Yes. So, as you know, we turned on marketing as late as May in Alphaform. We didn't want to turn on marketing for the 3D printing Alphaform until we had all of our manufacturing processes with the kind of software that we use to optimize and be able to turn orders. So we turned that on in May; we saw a really nice jump in quoting. We're seeing a really nice jump in how order is coming through the web which are orders that are priced based on our geometry so we're feeling good about that.

But we still have a ways to go, but we're making some great progress. As you know some of our traditional customers who were under some very burdensome contracts fell offs, we've got to rebuild that sales revenue with revenue that we generate from our sales and marketing engine and from our web. And it's starting to happen, and so, it's just going to take a little bit of time.

Robert Burleson - Canaccord Genuity, Inc.

Okay. And then, just one last one. You're talking about how important the strategic engagement is with customers going forward. And I'm wondering, would there be potentially different pricing arrangements? If strategic customer decided to maybe use Proto Labs kind of at broadly signed up for your services till we get some kind of volume discounting? Or sort of – what are the incentives, I guess, the financial or economic incentives for the customers?

Victoria Holt - President & Chief Executive Officer

Yeah. We have such a valuable business proposition to the customers. So, we reduced their time to market, we can save millions of dollars in R&D and get them to revenue faster. We can take a look at economic models around low volume production that are completely different than paradigms they've seen before because of our strong digital business manufacturing model. So, I don't expect major discounting.

But the issues – the challenges we have is, we've got to engage the customers strategically for them to understand our business model and then understand what challenges are they having as a company, and how can Proto Labs, very differentiated digital business model help them solve those problems. That's the consultative selling approach. That is very different than coming in to a customer and saying, I make real parts really fast. What does that mean? We've got to really help the customers understand how our business model can help them solve their really significant tangible business issues and then have us deliver tangible sustainable business outcomes. That's the shift (43:34).

Robert Burleson - Canaccord Genuity, Inc.

Great. Thanks.

Victoria Holt - President & Chief Executive Officer

Yeah.

Robert Burleson - Canaccord Genuity, Inc.

Thank you.

Operator

Our last question comes from Jim Ricchiuti with Needham & Company. Please state your question.

Jim Ricchiuti - Needham & Co. LLC

Thank you. Vicki, I'm wondering as we see some of the actions you're taking in the Americas on the sales side to begin to try to accelerate growth, where will we see it initially? Will we see it more in the injection molding or in the CNC machining area? I'm wondering is one area of the business more of a leading indicator as you make these changes?

Victoria Holt - President & Chief Executive Officer

Yeah. So, I think you could see it in any one of the services. Remember our business model, we've got that product developers at the center of our universe. So what does that product developer need to take his product to market faster. In some cases, it will be 3D printing, in some cases, CNC machining, and other injection molding.

So, I think you'll see it across any of the services. All of them moving at the same pace. Same time is probably never going to happen. But the point, I think, we're going to be a lot more effective in meeting the needs of the customer and closing those individual opportunities as they come forward to us with some of the things, the blocking and tackling that were taking place here in the third quarter, late second and as we go into third quarter. So, you could see it in any of the processes.

Jim Ricchiuti - Needham & Co. LLC

All right. And then as far as bringing on, I believe you alluded to him as – that person as a Chief Revenue Officer. It doesn't sound like there is a – necessarily an eminent development there. But can you give us some sense what kind of timeline we're looking at?

Victoria Holt - President & Chief Executive Officer

Yeah. I wish it were eminent, but I'm not going to compromise quality for speed. We've got to get the right executive who's going to really give us leadership in this area for the years to come. So, yeah, I would think we'll have somebody in place, early in the first quarter. But we've just got to go through the process and get somebody in as soon as we can without sacrificing quality.

Jim Ricchiuti - Needham & Co. LLC

Okay. And the last question I have is just relating to Alphaform. How would you characterize the integration? Is it been somewhat more challenging or about as expected?

Victoria Holt - President & Chief Executive Officer

Good question. A bit challenging. We expected challenging, but it's a bit challenging. We did as we got into it. There is a little less automation than we had thought, so we couldn't quite turn on marketing as quickly as we'd wanted to. We had to get all of our software in place before we could do that, so that delayed us a little bit.

And of course, as you integrate all the financial systems across really the complex entities that we had to put in place, that was all pretty challenging. But I think we expected challenging and I will say, it's very much on track. The team is doing a great job. The Alphaform employees that we brought on board are fantastic. The enthusiasm that they all have for the growth potential is really, really high. Team spirit is really good, so the cultural combination has gone extremely well. So, there's – yeah, I think it's gone well, but I think we expected challenging.

Jim Ricchiuti - Needham & Co. LLC

Okay. Thank you.

Victoria Holt - President & Chief Executive Officer

Thanks.

Operator

Ms. Holt, I am showing now further questions at this time. Would you like to make any closing remarks?

Victoria Holt - President & Chief Executive Officer

Yes, please. Thank you. Thanks, again, for joining us today. I want to thank all of our employees for their continued hard work and dedication to Proto Labs. We remain confident about our long-term outlook and we look forward to updating you next quarter. Thanks very much for joining us.

Operator

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

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