Proto Labs, Inc. (PRLB) Q4 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to Proto Labs Q4 and Full Year 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to Daniel Schumacher, Director of Investor Relations. Thank you. You may begin.

Thank you, operator, and good morning, everyone. With me today is Vicki Holt, our President and Chief Executive Officer; and John Way, our Chief Financial Officer. This morning, before the market opened, Proto Labs issued a press release announcing its financial results for the fourth quarter and full year ended December 31, 2018. The release is available on the company's Web site at protolabs.com. Before we begin, I would like to remind everyone that our discussion will include statements relating to future performance 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. The results and guidance we will discuss include non-GAAP financial measures, consistent with our past practice. Please refer to our press release within the Investor Relations section of our company Web site 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?

Thanks, Dan. Good morning, everyone. Thank you for joining us on our fourth quarter conference call. I will begin the call with our fourth quarter and full year 2018 financial results as well as key accomplishments for 2018. Next, John will provide a more in-depth view of our fourth quarter and 2018 financials. Then, I will give an overview of our priorities for 2019. And finally, John will provide our financial outlook for the first quarter of 2019. After that, we will gladly take your questions. Proto Labs had another strong quarter of revenue growth. However, fourth quarter financial results did fall below our expectations. This shortfall was primarily driven by the financial performance of our recent acquisition of Rapid Manufacturing and to a lesser extent inefficiencies associated with the relocation of our CNC operations to a new facility. We reported revenue of 113 million in the fourth quarter, representing growth of 20% over 2017. These results were on the lower end of the guidance range of 112 million to 117 million that we provided on our third quarter earnings call in October. We saw a strong start to the quarter. However, sales softened as we progressed through the quarter. As we’ve discussed in the past, December is a difficult month for us to predict and this year was no exception. The revenue and earnings growth from our acquisition of Rapid Manufacturing is not meeting our expectations. In the quarter, we prepared our customer-facing teams in the U.S. to sell our full suite of products and services, including sheet metal and an expanded CNC offer beginning January 1st. This involved merging all customer accounts, reallocating the accounts to the sales force and training each sales team on the expanded service offering they would sell on January 1st. This disruption had an impact on the revenue from the Rapid services in the quarter. As we look at fourth quarter revenue by geography, the U.S., our largest market, produced revenue growth of 23.9% over the prior year, including the results from the Rapid acquisition. Europe produced year-over-year revenue growth of 5.6% in constant currency. Revenue softness in Europe was driven by a slow December and slower than expected demand for our injection molding service, particularly in the automotive industry. Our Japan region grew 26.5% in constant currency. On our Q3 call, we described our distribution partnership with Misumi in Japan. We are pleased with the progress of this partnership as it has continued to accelerate demand and order volume for Proto Labs in Japan. Moving to revenue by service. Injection molding produced record revenue and increased 7.3% compared to the fourth quarter of 2017. CNC machining was a strong growth driver throughout 2018. In the fourth quarter, year-over-year growth was 25.4%. We experienced strong organic CNC growth in all regions. Fourth quarter 3D printing revenue was also a record quarter and increased 23.6% from the prior year. And finally sheet metal contributed $6 million of revenue in the quarter. Turning to earnings. We reported fourth quarter non-GAAP EPS of $0.74 per share, representing growth of 28% over the fourth quarter 2017. Although we grew earnings 28% year-over-year, our fourth quarter earnings per share were below our expectations. Our ability to quickly manufacture and reliably deliver high-quality parts is valuable to meet the needs of our customers. In order to ensure we are able to reliably provide this value, we need to invest in capacity ahead of demand. As we’ve worked through integration activities in 2018 and particularly in the fourth quarter, we made investments in the acquired Rapid operations both in terms of headcount and equipment to ensure we have the capacity to meet the demand we expect from this business. Our earnings were impacted by the Rapid operations as we continue to add capacity to serve anticipated first quarter growth at a time when our revenue was underperforming. During the quarter, we relocated our CNC operations in North America to a new facility. The move took place over a six-week period and involved the relocation of 295 CNC mills and related production equipment. We were able to fulfill orders and meet our on-time delivery metrics during the move with no injuries to our employees. However, we underestimated the impact on productivity during the move resulting in increased costs in the form of higher staffing and overtime. And finally, we saw a strong start to the quarter in terms of revenue and as such we invested in production and support to accommodate the higher demand for our services. As sales tapered off during the quarter, we were unable to adjust the cost structure without jeopardizing our commitment to our customers as we begin 2019. We expect that continued growth in our business will effectively utilize the capacity we created in the fourth quarter. These factors, combined with revenue at the low end of our guidance, led to the EPS shortfall in the quarter relative to our guidance. John will provide a more in-depth look at our financial results. Moving to our full year performance, 2018 was a tremendous year for Proto Labs. We continued to evolve to better serve the needs of our customers while growing profitability and creating significant shareholder value. Our full year 2018 revenue of $445 million represented 29% growth over 2017 and was toward the upper end of the guidance range of 425 million to 450 million provided at the beginning of the year. Our full year non-GAAP EPS grew 42% to $3.04 per share exceeding our guidance of $2.70 to $2.90 a share that we provided at the beginning of the year. In addition to very strong growth in revenue and profitability, we also invested for the future in 2018. We expanded our capacity in a number of ways, most notably the move to a new state-of-the-art CNC machining digital manufacturing facility in Minnesota. We also reengineered the process flow and added capacity to our operations in New Hampshire that came with the Rapid acquisition. And we look to capitalize on the synergies of the combined businesses in 2019. We continue to be recognized as a leader in the manufacturing industry. Our sheet metal operations recently earned national recognition winning the FABRICATOR's 2019 Industry Award, an award that recognizes our quick turn production capabilities, lean manufacturing efforts and overall evolution of our digital manufacturing sheet metal offer over the past year. This adds to our award from Frost & Sullivan for operational excellence in 2018. Another way we’ve invested for the future is through partnerships. In 2018, we initiated partnerships with several well-respected corporations and academic institutions. In December, we announced our participation as a founding member of MIT’s Additive and Digital Advanced Production Technologies, or ADAPT, along with Autodesk, EOS, General Motors, Volkswagen and others. ADAPT is a consortium focused on scaling new manufacturing technology through research and education bringing together the best minds in industry and academia. We are excited to be part of ADAPT and help further initiatives in 2019 and beyond. The ADAPT relationship add to our previously announced affiliations with GE Additive, HP, [indiscernible] and Misumi. Our challenges in the fourth quarter were primarily related to our recent acquisition of Rapid and inefficiencies as a result of the CNC move. The on-demand nature of our business and the commitment to our customers requires us to invest in capacity ahead of volume. These investments were necessary to support our long-term growth and we are confident that the investments will yield positive long-term return. John will now provide an in-depth look at our Q4 and full year 2018 financials.

Thank you, Vicki. Revenue in the fourth quarter was $112.8 million, an increase of $18.6 million or 19.7% over the same quarter in 2017. Our revenue growth this quarter includes our acquisition of Rapid Manufacturing. Foreign currency represented a $500,000 headwind in the quarter. As we discussed in our Q3 earnings call, the new revenue recognition accounting standards adopted in the beginning of 2018 require us to recognize work in process at the end of each quarter as revenue. This change resulted in $1.3 million of revenue being pulled into Q3 from Q4. Additionally, we ended the fourth quarter with less work in progress than we began the quarter resulting in a $1.2 million decrease to revenue. The total sequential impact in the fourth quarter was a decrease of $2.5 million accounting for this sequential decline from Q3 to Q4 in our revenue. As a reminder, the sequential impact was accounted for in our fourth quarter guidance and establishes a new quarterly seasonality pattern for 2019. Turning to product developer growth, our fourth quarter unique product developers served increased to 20,400 or 18% growth compared to the prior year. Gross profit for the quarter was $59.2 million, an increase of $6.3 million over the comparable quarter of the prior year. Gross profit declined $3.2 million sequentially. The primary drivers of the sequential decline include the following. A $1.4 million reduction related to the sequential decline in revenue driven by the revenue recognition adjustment. Our revenue softness related to our acquired services combined with the impact of adding capacity through our operations acquired with Rapid in anticipation of increased volumes in the first quarter resulted in a $1.5 million decline in gross margins quarter-over-quarter. The remaining decline is attributable to the inefficiency in our CNC operations due to the move and lower than anticipated volumes at the end of the quarter, offset by growth in our other operations. The combination of these factors resulted in gross margin of 52.5% for the quarter, a sequential decrease from the 54.1% we recorded in the third quarter. As we look at year-over-year, gross margins decreased 370 basis points from 56.2% in the fourth quarter last year. Year-over-year gross margin compression in the fourth quarter was due to the following factors. Rapid represented 230 basis point headwind to our consolidated gross margins in the fourth quarter of 2018 compared to Q4 2017. Inefficiencies and higher than anticipated costs related to the CNC move, including running two concurrent facilities for a short period of time, represented about an 80 basis point headwind. The remaining decrease was due to the challenge of flexing our cost structure with the timing of revenue in the quarter. Operating expenses totaled $39 million or 34.6% of total revenue for the fourth quarter of 2018, up $1.6 million from Q3. As a percent of revenue, this was higher than last quarter’s 32.4% and lower than 36.2% in Q4 of 2017. The sequential increase in our operating expenses consisted of the following. As we stated on the call last quarter, sales and marketing was artificially low in Q3 due to timing of start dates and other expenses. We also attended tradeshows and continued to invest in incremental headcount in support of our growth objectives, and that result was investing 15.6% of revenue in sales and marketing during the quarter. We included the cost of move and other costs associated with our new CNC facility in general and administrative expense totaling $600,000. Our reported operating expenses also included a benefit of approximately $800,000 due to lower incentive compensation expense. With the fourth quarter not achieving our expected results, our incentive compensation expense was adjusted downward from the third quarter levels across all of our operating expense categories. GAAP operating income increased 7.4% to $20.2 million or 17.9% of revenue in the fourth quarter. On a GAAP basis, our tax rate was 10.4%, down from 17.6% in the third quarter of 2018. The lower tax rate was due to a $1.2 million reduction in our tax expense due to the finalization of our accounting related to U.S. tax reform. These items were adjusted in our non-GAAP results as they were true-ups related to our original tax reform estimate. On a non-GAAP basis, the tax rate decreased from 19.6% in the third quarter to 18.3% in the fourth quarter due to higher R&D credits and favorable expenses in finalizing our 2017 tax return. On a GAAP reporting basis, net income totaled $19.3 million resulting in diluted earnings per share of $0.71. Adjusting for the after-tax costs of stock compensation, amortization of intangibles, unrealized foreign currency gains and tax items specific to tax reform, our non-GAAP diluted earnings per share in the quarter was $0.74, representing a 27.8% increase over the prior year and a sequential decrease of $0.12 per share. On a per share basis, a breakdown of the sequential decrease in non-GAAP EPS is as follows; revenue recognition, old revenue and the corresponding gross profit from the fourth quarter to the third quarter resulting in a negative sequential impact of $0.04 per share. The challenges in the quarter related to the Rapid acquisition accounted for a $0.04 per share decrease. The cost of relocating our CNC operations and the related inefficiencies represented $0.04 per share unfavorable to our estimate of $0.02 to $0.03 per share we provided in our guidance. Our increase in operating cost during the quarter, including the investment of sales and marketing expense, offset by the benefit associated with lower incentive compensation, represented $0.03 per share headwind. These decreases were offset by a lower non-GAAP effective tax rate and favorable other income representing a benefit of $0.03 per share. Now turning to cash flow. We generated $38 million in cash from operations during the quarter. Capital spend in the fourth quarter was $25.2 million, including continued investment in our new CNC facility, as well as investment in equipment, systems and IT infrastructure. We also returned capital to shareholders by repurchasing $12.2 million or 104,600 shares of common stock. Shifting now to our full year results. Revenue for the full year 2018 was $445.6 million, a 29.3% increase over 2017. Gross profit in 2018 was $238.7 million or 53.6% of revenue compared to $193.8 million or 56.3% of revenue in 2017. The year-over-year gross margin compression was driven by the following factors. Rapid had a 200 basis point impact on our consolidated year-over-year gross margin. Investments to keep in front of the tremendous growth in our CNC service including the move into our new facility in the Americas had a 70 basis point impact. These headwinds were offset by improvements in our 3D printing gross margins in Europe representing a 50 basis point benefit. The remaining change consisted of investments in equipment, leadership and quality required to scale our operations and continued to deliver exceptional service to our customers. Our operating income for the year was $88.9 million or 20% of revenue compared to $72.2 million or 21% in 2017. And on an adjusted basis, our operating income was $103.1 million or 23.1% of revenue. This is a 23.2% increase from 2017. Now turning to cash flow. We generated $122.9 million in cash from operations during the year. Capital spending was $87.1 million during 2018, including $26 million on our new CNC facility that was placed in service in the fourth quarter. We also returned capital to shareholders by repurchasing 12 million of common stock during the year under our stock buyback program. We ended the year with cash and marketable securities balance of $155 million, up from $131 million at the end of 2017. Now, I’d like to turn the call back over to Vicki for an overview of our priorities for 2019.

Thanks, John. Now let’s look forward to our priorities for 2019. We are a leader in the digital manufacturing revolution and are excited to have the opportunity to enable our diverse set of customers spanning many industries to capitalize on emerging market trends. We have significant opportunities for growth in front of us. Capitalizing on this potential will require us to invest to meet the expanding needs of our customers. I will discuss these investments as we go through our priorities for the year. Our four areas of focus are first, to continue to evolve our go-to-market model; second, enhance our customer experience; third, improve our overall efficiency as a company; and finally, fourth, to improve the performance of the services acquired in the Rapid transaction to meet our revenue and earnings targets. Let’s discuss each of these priorities in more detail. Our first priority is the continued evolution of our go-to-market model. This has been a priority of ours for a number of years and one that will continue far into the future. We served over 45,000 product developers in 2018. Serving the breadth of this customer base efficiently requires us to continue to enhance our relationships with customers where our value proposition resonates most. Our sales and marketing teams will concentrate activities to further penetrate existing customer companies, attract new customers and accelerate existing revenue from our highest potential customers. Some of the specific investments in this area include expanding our investment in technical resources to assist our sales process. Our customers tell us they like our technical expertise in helping solve their problems and our data tells us this investment pays back in terms of improved close rates and customer retention. We will also be investing to further capture the voice of customer as we ensure we fully understand the greatest needs of our customers across such a large and diverse customer base. And we will also continue to use data and analytics to align our sales team with the most promising opportunities and will be investing in sales operations resources to utilize this data to increase revenue growth and sales efficiency. Next, improving our customer experience is an area of focus. As a digitally enabled e-commerce company, we want to make sure that we continue to evolve our customer interface to delight our customers. Our e-commerce platform was originally constructed 20 years ago intended to serve one product developer looking for one custom part off the Internet. Our customers and their needs have evolved significantly since then. And while our e-commerce experience has also evolved, we much continue to improve and allow for growth as well as the addition of new services in the future. As more competitors enter the market, we will continue to advance and provide a world class e-commerce experience for all our customers. Our third priority in 2019 relates to efficiency. As we continue to grow, we much become more efficient in our processes and systems to scale our operations to support the growth. Specifically, we will continue to realize efficiency benefits, continuous improvement initiatives through our Proto Excellence program. We will also leverage software and functionality and interconnectivity of our internal technology systems, which in turn improves our overall business efficiency. A more efficient Proto Labs will be positioned well for continued growth and success. As it relates to the second and third priorities, we invested 6.7% of revenue in research and development activities in 2018. These investments relate to improving our internal software in support of the business, broadening our part envelope in existing services, improving our manufacturing processes and researching new capabilities to support our customers. We expect to continue to invest in research and development activities as we progress through 2019. And finally, we’ve made significant investment in capacity automation, capacity and sales force capabilities to accelerate revenue and earnings growth within our sheet metal and expanded CNC offering, which were part of the Rapid acquisition. To-date, the growth is not meeting our expectation. In 2019, we will be laser-focused on getting the synergies and returns on the acquisitions and subsequent investments. I am very proud of what this company has accomplished in 2018, including nearly 30% revenue growth and very strong adjusted net income growth of 44%. As we celebrate our 20th anniversary, it is very impressive to look back and see how far we’ve come. It’s also very exciting to look ahead and see the numerous opportunities we have to assist our customers in capitalizing on the underlying market trends by servicing their prototyping and low volume production needs. Our 2019 priorities are aligned around serving our customers through enhanced relationship, improved customer experience and efficient operations. Focusing on our customers will help us drive growth and deliver strong shareholder return. Now John will provide our financial outlook for the first quarter of 2019.

Thanks, Vicki. We currently expect Q1 revenue to be in the range of 113 million to 119 million or growth in the range of 5% to 10%. This revenue guidance reflects the following factors. Our growth experienced in January, one item to note here is the early results of turning on sheet metal services to our entire sales force is not progressing as expected. We believe this is related to the level of comfort our sales force has in selling the service and we expect that it will improve as we progress through the year. In addition, we have only begun aggressively marketing these new services in January 2019 since we did not want to drive demand prior to having their required capacity in place to reliably service the demand at speed. As our customer awareness increases and our sales team matures, we expect revenue from these services to gradually grow. The other factor impacting our guidance is the uncertainty in the regions we operate related to Brexit in Europe and tariffs and the potential impact to our customers. We also anticipate a headwind of approximately $1.25 million to $1.5 million relating to foreign currency translation. Moving to earnings guidance. Our non-GAAP add-backs for the quarter will include stock compensation costs of approximately $3 million and amortization of $800,000. We currently estimate our non-GAAP tax rate to be approximately 22% in Q1. This represents about a $0.03 headwind to Q1 EPS compared to Q4. We will be investing in our go-to-market initiative and R&D activities, Vicki described earlier, representing $0.03 to $0.04 per share compared to Q4. Taking into consideration all of the above, we expect our quarterly non-GAAP EPS to be between $0.65 and $0.73 per share in the first quarter. In the fourth quarter, the Rapid acquisition did not perform to our expectations. We have a plan and our dedicated to improving their results for this portion of the business. However, achieving these results may take some time and this is reflected in our Q1 guidance. We will be updating you on this priority as the year progresses. We, as a leadership team, are focused on serving our customers and driving revenue and earnings growth over the long term. That concludes our formal remarks. Now Vicki and I would be happy to take your questions. Operator, can you please open up the line?

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

Hi. Good morning, guys.

Hi, Brian.

So looking at the numbers initially and listening to the comments about Rapid, it seemed like you’ve got 2 million revenue miss basically relative to your guidance and organic revenue growth was still low-double digits for the company overall in the fourth quarter. So at first I was feeling like you’re being a little hard on yourselves regarding what’s happening at Rapid. It doesn’t feel like a major miss. But, John, your guidance for 5% to 10% revenue growth for the first quarter I think is the most troubling thing that I heard on the call and that’s a deceleration. What are you seeing in January? Because it’s more understandable I think in the fourth quarter that you’ve had some challenges too given seasonality. But what are you seeing in January so far that has you thinking that you might end up only doing 5% revenue growth in the first quarter?

So I think there’s a couple of factors, the biggest of which is Rapid. So the growth that we were anticipating there is not materializing. So we started the quarter very slow in the Rapid services and we’re focused on that and we do have to drive that growth. I think the other thing, we ended the year soft in December and that carried into January as well. We talked about December being difficult to predict. Our seasonality pattern within the first quarter every year is January starts slow and starts to pick up through February and then we have a strong March. So as you recall, we have very little visibility with the seven-day roughly of backlog in some of our services. That’s the furthest we can see out. So our best month of the quarter is March. But just what we’re seeing in January impacted by the performance in Rapid let us to the guidance that we have provided.

Let me add a little color to that too. We are confident over the long term that we will be able to drive the revenue growth from sheet metal and our expanded CNC offerings to our customers. As we’ve said before, 70% of our base customers in the legacy business have said they buy sheet metal products. But it’s very early in actually fully launching and marketing that product offering. We just started heavy marketing in January. And of course given the slow start of the month in January, we didn’t start that heavy marketing until really the second and third weeks of the month. And so it’s slow in quoting, driving uploads, but we’re starting to see some increase there. It’s even slower in the close as our sales team and frankly our customer base gets comfortable with the new service. We expect that to gradually grow throughout the quarter, but right now we’ve got to really put our guidance in the form of what we’re seeing in terms of the actual uplift. And it’s a slow start to January.

So do you guys think that this rapid business which if I remember correctly was growing about 15% just on its own before you took ownership of it, do you feel like it’s just an integration issue and then you get back to that double-digit growth for Rapid and maybe even better than that the marketing power that you can put behind it and the sales power you can put behind it? It’s a little confusing that this thing that was 15% revenue growth would be stalling at this point.

Yes. It wasn’t on a consistent 15% revenue growth, let me put it that way, but it did grow in 2017 and early '18, but not quite at 15 but it was – what was going through that asset was growing. But let me add a little color to that. So when we acquired the business, the business did not have the level of automation and scalability that we need in Proto Labs to drive the revenue growth and to turn on our 40,000 individual product developers on this particular service. So we needed to invest in the scalability of that asset and frankly even how the offering is presented to make sure that it sits within Proto Labs model of a quick turn, highly scalable product offering. And so that’s a bit of a change. So it’s a change for the current sales people who are positioning that offering with current customers and it’s also a brand new offering for our legacy sales people who haven’t even sold sheet metal or an expanded CNC offering. So they’re having to learn that. In the fourth quarter we had our sales people out for many, many days of training both our legacy sales people as well as the New Hampshire sales people to train for that new offering. And we also need to help educate our customer base on what that offering is and how they can take advantage of that. That just takes a little bit of time. I’m very confident that we’ll be able to restore that business to double-digit growth rates. Our customers have told us sheet metal is very important to them and the expanded offering in CNC will be a great complement to our existing CNC business. So I’m confident in the long term. It’s just that we’ve got to really look to see how that ramp is going to take place from a timing point of view as we progress through each quarter of 2019.

Okay, got it. And then speaking of progressing through 2019, what do you think we should be modeling for gross margin as we progress through the year? And where could you exit the year in terms of gross margin?

Yes. So I think starting with Q1, I think gross margin will be highly dependent upon where revenue comes in. Right now I would model it roughly flat for a couple of reasons. One, the revenue will be the big variable but the CNC facility that we brought in, in Q4 we had one month of cost associated with that facility in our gross margin. We will have three months in Q1. And we’re also getting up to speed and getting our efficiency back as we’re operating in a new facility. So I’m comfortable that as we go through the year, those gross margins will improve in that facility. But I think we will have to absorb some of those costs here in Q1. I think Rapid also is something we would expect to improve as we progress through the year. I think right now if you ask me, volume is going to be a big component of where we end up. But I would see sequential improvement as we go through 2019. The magnitude of that I don’t know that I can really guide you to a specific number right now, but I would expect we continue to improve as we progress here.

Just to clarify. John, when you say flat in the first quarter, you guess is in a flat gross margin [indiscernible] sequential or year-over-year?

Sequential.

Got it. Okay. I’ll follow up more later. Thank you.

Thanks, Brian.

Our next question is from Andrew DeGasperi with Berenberg. Please proceed with your questions.

Thanks. I guess my first question, injection molding seems to be holding up well despite the weakness you saw in Europe and I was just wondering do you feel confident with that business considering now they have a lot of low volume? Could that be more cyclical given what we’re hearing on the industrial side? And then I have a follow up.

Yes. So we’re pleased with what we’re seeing in terms of injection molding growth and actually also new mold growth within injection molding, which illustrates that we’re beginning to penetrate both prototype but also on-demand manufacturing applications for our customers. So we’re really pleased with that. The injection molding business can be somewhat cyclical. However, I should point out that there’s a significant amount of total available market there for us to capture and we bring a lot of value to customers both in terms of speed in prototyping, injection mold tooling but also total cost of ownership when you’re looking at low volume production. So we do have to – the industrial marketplace has an impact on that. When you look at injection molding, the medical market, the automotive market and consumer electronics are major industry verticals. Automotive is the one that sell the most softness here as we exited 2018. But with the breadth of customer base that we have, we still showed some really nice growth in injection molding. So over the long term, we feel confident that we’ll continue to be able to drive growth in that business and we’re starting to see the results of some of our on-demand manufacturing, marketing and sales effort.

Great. And as far as the relocation to Brooklyn Park, now you have a lot of space in both Plymouth and that facility. Just wondering, are you planning to add new machines in both? Are you seeing enough demand that you believe you’re comfortable to add more equipment there?

Yes, so that’s actually the positive side of the story that John told around little bit of the headwind on gross margins. We’ve added a lot of floor space. We almost doubled the floor space that we have available right now for CNC machine adds. We were cramming machines into every nook and cranny of Plymouth in order to make sure we can service customers’ needs as we expanded CNC. So we now have some space to be able to comfortably add more machines. We think that’s going to cover us for CNC growth in terms of floor space for the next three to five years in North America. And then the opportunity we have in the Plymouth plant to further expand our injection mold tooling milling capabilities, which is important as we grow our injection mold tooling business, but also we’re running out of space in our Rosemount facility where we do follow-on production parts. So we’re going to be able to move some of those injection mold parts production up to our Plymouth plant relieving some of the pressure we have for space down in Rosemount. So yes, it’s a short-term kind of margin impact that we see because we’ve absorbed a lot of new floor space and the cost associated with that. But now as we expand, we just need to add equipment. We don’t need to add that floor space here in the Americas in injection molding and CNC machining for the next few years and that’s really important.

Great.

And Andrew, we do add the equipment as we see demand and we can add it relatively quickly and be pretty nimble with that. We expect those services to grow and we’ll be adding equipment as the demand dictates.

Got it. And just quickly on the demand side as far as what you’re seeing right now. You’re not really seeing a lot of softness in the CNC and injection molding as of right now?

No, or the 3D printing. Our legacy business is pretty good. Now December tailed off particularly in Europe. It was a very weak end of December. The timing of the holidays was just horrible for Europe because of – they couldn’t even ship things that were available to ship because customers were all closed down in the beginning of January. So it was a really slow finish to December. But as we start this year, our legacy businesses are kind of moving as we expected them to be in the quarter. Our big shortfall is what we’re seeing in terms of what we had expected from the services we acquired from Rapid. It’s just a little bit slower than what we had thought we would see when we turned on marketing. I think it’s a combination of the complexity of selling this additional service and really getting our marketing message right to bring in the prospects and bring in the uploads from the customer base.

Right. So just 94% of revenues seems to be growing, demand is stable. There’s just issues with that 6% that you’re trying to get over. Okay. Thank you very much.

Yes.

[Operator Instructions]. Our next question is from Greg Palm with Craig-Hallum. Please proceed with your questions.

Good morning. Thanks. I was hoping you could maybe remind us how exposure do you have to the so-called overflow work for your customers? Presumably this could be some of the hit, but I didn’t hear you call this out specifically.

So you mean like work that they can’t do internally, like from their prototype --

Yes, so the customers that have specifically more CNC in-house capacity but maybe in the past they’ve outsourced to you guys.

Okay. I don’t think that’s a huge – a lot of our businesses is customers who use Proto Labs routinely for their CNC parts. So I’m not sure we’re getting a huge amount of overflow from companies who have in-house CNC. Now we probably in 2018 did get customers who may have wanted to purchase CNC parts from a traditional machine shop that might have been tight on capacity and then they came to us instead of that machine shop. So we do believe we picked up share. The numbers would tell you because the market didn’t grow organically the way our CNC business grew. So we definitely picked up quite a bit of share on CNC machining in 2018 and some of that might have been the fact that traditional machine shops really could not scale to the demand the way Proto Labs can scale, because they had trouble finding skilled labor like CNC machine has and Proto Labs doesn’t need to have that kind of labor. We can just scale by buying equipment.

Okay. Yes, I know you’ve – I think you called that out a number of years ago but maybe it’s not as important as part of the businesses. Maybe I thought or maybe [indiscernible]. So that’s why I was asking. In terms of investments, go-to-market, R&D capacity wise, it sounds like all are a focus but I guess what is top of mind in terms of near-term priorities?

Yes, as I mentioned, our priorities, we’ve got four key ones and clearly continuing to evolve our go to market which is the investment of sales and marketing in terms of use of data and really prioritizing all the opportunities. We have so many opportunities for growth. What’s most important to drive efficiency in our sales and marketing is focus on the ones that have the highest probabilities close as quickly as possible. And we’ve got a great wealth of data now because of just the history of being Proto Labs out in the marketplace that we can really tailor and become more efficient in driving that. So that’s clearly a driver. The other piece is our customer experience and that’s our e-commerce experience, and we are investing quite a bit in terms of R&D and – it comes in R&D investment in the form of software to continually upgrade that experience. And then the investments that we’re making in R&D to drive efficiencies. This is throughout our system. Remember we are a digital company, digital from end-to-end and being really efficient in how those systems interact with each other and the interconnectivity and those platforms so that we can be efficient and scale with our growth is an area of investment for us. And then the other priority really isn’t around investments in people or equipment. It’s more about capitalizing on the investment we made in '18 and that’s growing the Rapid Manufacturing service offering with our customers and that’s an execution from a sales and marketing point of view. And we’re going to be laser-focused on driving that revenue in order to capitalize on the investments we made in '18. So those are the priorities.

Understood. Sounds like a lot in your plate, but thanks for the help and good luck.

All right. Thank you.

We have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

Great. Thank you for joining us today. Proto Labs was founded in 1999 with a single injection-molding press in a garage. We’ve come a long way since then with approximately 1 million square feet of manufacturing space. In order to grow, we focused on increasing the breadth and depth of our service offering with customers. There’s still runway for growth in our current markets as well as opportunities to expand into new adjacent markets. We are excited about the outlook for Proto Labs in the next 20 years of operations. Our differentiated technology-enabled digital manufacturing platform has demonstrated the ability to help companies and entrepreneurs get their products to market faster than the competition. As we’ve done in the past 20 years, we will continue to innovate and evolve to enhance our customers’ experience. I want to thank the Proto Labs employees for all their efforts and accomplishments in 2018. I also want to thank our customers for their support. We are committed to driving greater shareholder value in 2019 and over the long term. We look forward to reporting to you on our progress during our next call. Thank you very much.

Thank you. This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.