Proto Labs Inc - Quarter Report: 2015 June (Form 10-Q)

. H 

UNITED STATES

 SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

or

Commission File Number: 001-35435

Proto Labs, Inc.

(Exact name of registrant as specified in its charter)

(763) 479-3680

(Registrant’s telephone number, including area code)

                   Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.               

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                    

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐   Yes   ☑   No

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 26,136,434 shares of Common Stock, par value $0.001 per share, were outstanding at July 30, 2015.

Proto Labs, Inc.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2014.

Forward-Looking Statements

Statements contained in this report regarding matters that are not historical or current facts are “forward-looking statements” within the meaning of The Private Securities Litigation Reform Act of 1995. In some cases, you can identify forward-looking statements by the following words: “may,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. These statements involve known and unknown risks, uncertainties and other factors which may cause our results to be materially different than those expressed or implied in such statements. Certain of these risk factors and others are described in Item 1A. “Risk Factors” of our Annual Report on Form 10-K as filed with the SEC. Other unknown or unpredictable factors also could have material adverse effects on our future results. We cannot guarantee future results, levels of activity, performance or achievements. Accordingly, you should not place undue reliance on these forward-looking statements. Finally, we expressly disclaim any intent or obligation to update any forward-looking statements to reflect subsequent events or circumstances.

Overview

We are a leading online and technology-enabled, quick-turn, on-demand manufacturer of custom parts for prototyping and short-run production. We manufacture parts for product developers and engineers worldwide who are under increasing pressure to bring their finished products to market faster than their competition. We utilize injection molding, computer numerical control (CNC) machining and additive manufacturing to manufacture custom parts for our customers.

We believe custom parts manufacturing has historically been an underserved market due to the inefficiencies inherent in the quotation, equipment set-up and non-recurring engineering processes required to produce custom parts. Our proprietary technology eliminates most of the time-consuming and expensive skilled labor conventionally required to quote and manufacture parts. Our customers conduct nearly all of their business with us over the Internet. We target our products to the millions of product developers and engineers who use three-dimensional computer-aided design (3D CAD) software to design products across a diverse range of end-markets.

Our primary manufacturing product lines currently include Protomold, which is our injection molding product line, Firstcut, which is our CNC machining product line, and Fineline, which is our additive-manufactured (3D printing) product line. We continually seek to expand the range of size and geometric complexity of the parts we can make with these manufacturing processes, to extend the variety of materials we are able to support and to identify additional manufacturing processes to which we can apply our technology in order to better serve the evolving preferences and needs of product developers and engineers.

Protomold

Our Protomold product line uses our 3D CAD-to-CNC machining technology for the automated design and manufacture of thermoplastic, metal, or liquid silicone injection molds, which are then used to produce custom injection-molded parts on commercially available equipment. Our Protomold product line is used for prototype, on-demand and short-run production. Prototype quantities typically range from 25 to 100 parts. Because we retain possession of the molds, customers who need short-run production often come back to Protomold for additional quantities typically ranging up to 100,000 parts or more. They do so to support pilot production while their tooling for high-volume production is being prepared, because they need on-demand manufacturing due to disruptions in their manufacturing process, because their product will only be released in a limited quantity, or because they need end-of-life production support. These additional part orders typically occur on approximately half of the molds that we make, typically accounting for approximately half of our total Protomold revenue.

Firstcut

Our Firstcut product line uses commercially available CNC machines to cut plastic or metal bars and blocks into one or more custom parts based on the 3D CAD model uploaded by the product developer or engineer. Our efficiencies derive from the automation of the programming of these machines and a proprietary fixturing process. The Firstcut product line is well suited to produce small quantities, typically in the range of one to 200 parts.

Fineline

Our Fineline additive manufacturing product line, often referred to as 3D printing, includes stereolithography (SL), selective laser sintering (SLS) and direct metal laser sintering (DMLS) processes, which offer customers a wide-variety of high-quality, precision rapid prototyping. These processes create parts with a high level of accuracy, detail, strength and durability. The Fineline product line is well suited to produce small quantities, typically in the range of one to 50 parts.

Key Financial Measures and Trends

Revenue

The Company’s operations are comprised of three geographic business units in the United States, Europe and Japan, which we believe are three of the largest geographic markets where product developers and engineers are located. Revenue within each of our United States and Europe business units is derived from our Protomold, Firstcut and Fineline product lines. Revenue within our Japan business unit is derived from our Protomold and Firstcut product lines. Our historical and current efforts to increase revenue have been directed at gaining new customers and selling to our existing customer base by:

During the three months ended June 30, 2015, we served approximately 11,800 unique product developers and engineers, an increase of 28% over the same period in 2014. During the six months ended June 30, 2015, we served approximately 17,200 unique product developers and engineers, an increase of 31% over the same period in 2014. These product developers and engineers are served under all our product lines, including Fineline, which we added via our acquisition of FineLine Prototyping, Inc. in April 2014.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of raw materials, equipment depreciation, employee compensation, benefits, stock-based compensation, facilities costs and overhead allocations associated with the manufacturing process for molds and custom parts. We expect cost of revenue to increase in absolute dollars, but remain relatively constant as a percentage of total revenue.

We define gross profit as our revenue less our cost of revenue, and we define gross margin as gross profit expressed as a percentage of revenue. Our gross profit and gross margin are affected by many factors, including our pricing, sales volume and manufacturing costs, the costs associated with increasing production capacity, the mix between sales by product line, the mix between domestic and foreign revenue sources and foreign exchange rates.

Our gross margins vary between geographic markets due primarily to the costs associated with starting new factories, available capacity and our operating maturity in these markets. We believe that over time and with growth and maturity of our international business, gross margins will be generally consistent through all our markets.

Operating Expenses

Operating expenses consist of marketing and sales, research and development and general and administrative expenses. Personnel-related costs are the most significant component of the marketing and sales, research and development and general and administrative expense categories.

Our recent growth in operating expenses is mainly due to higher headcounts to support our growth and expansion, and we expect that trend to continue. Our business strategy is to continue to be a leading online and technology-enabled manufacturer of quick-turn, on-demand additive-manufactured (3D printing), CNC-machined, CNC-turned and injection-molded custom parts for prototyping and short-run production. For us to achieve our goals, we anticipate continued substantial investments in technology and personnel, resulting in increased operating expenses.

Marketing and sales. Marketing and sales expense consists primarily of employee compensation, benefits, commissions, stock-based compensation, marketing programs such as print and pay-per-click advertising, trade shows, direct mail and other related overhead. We expect sales and marketing expense to increase in the future as we increase the number of marketing and sales professionals and marketing programs targeted to increase our customer base.

Research and development. Research and development expense consists primarily of employee compensation, benefits, stock-based compensation, depreciation on equipment, outside services and other related overhead. All of our research and development costs have been expensed as incurred. We expect research and development expense to increase in the future as we seek to enhance and expand our product line offerings.

General and administrative. General and administrative expense consists primarily of employee compensation, benefits, stock-based compensation, professional service fees related to accounting, tax and legal and other related overhead. We expect general and administrative expense to increase in the future as we continue to grow and expand as a global organization.

Other Income (Expense), Net

Other income (expense), net primarily consists of foreign currency-related gains and losses, interest income on cash balances and investments, and interest expense on borrowings. Our foreign currency-related gains and losses will vary depending upon movements in underlying exchange rates. Our interest income will vary each reporting period depending on our average cash balances during the period, composition of our marketable security portfolio and the current level of interest rates. Our interest expense will vary based on borrowings and interest rates.

Provision for Income Taxes

Provision for income taxes is comprised of federal, state, local and foreign taxes based on pre-tax income. We expect income taxes to increase as our taxable income increases and our effective tax rate to remain relatively constant.

Results of Operations

The following table sets forth a summary of our results of operations and the related changes for the periods indicated. The results below are not necessarily indicative of the results for future periods.

Stock-based compensation expense included in the statements of operations data above is as follows:

Comparison of Three Months Ended June 30, 2015 and 2014

Revenue

Revenue by product line and the related changes for the three months ended June 30, 2015 and 2014 were as follows:

Revenue by geographic region, based on the billing location of the end customer, for the three months ended June 30, 2015 and 2014 is summarized as follows:

Our revenue increased $11.1 million, or 21.0%, for the three months ended June 30, 2015 compared to the same period in 2014. By geographic region, this revenue growth was driven by a 23.3% increase in United States revenue and a 13.7% increase in international revenue. By product line, this revenue growth was driven by a 10.1% increase in Protomold revenue, 28.4% increase in Firstcut revenue and 155.6% increase in Fineline revenue in each case for the three months ended June 30, 2015 compared to the same period in 2014. Fineline revenue for the three months ended June 30, 2014 commenced upon the completion of our acquisition of FineLine Prototyping, Inc. on April 23, 2014.

Our revenue growth during the three months ended June 30, 2015 was the result of increased volume of the product developers and engineers we served. During the three months ended June 30, 2015, we served approximately 11,800 unique product developers and engineers, an increase of 28% over the same period in 2014. Average revenue per product developer or engineer decreased 6% during the three months ended June 30, 2015 when compared to the same period in 2014.

Our revenue increases were primarily driven by increases in sales personnel and marketing activities. Our sales personnel focus on gaining new customer accounts and expanding the depth and breadth into existing customer accounts. Our marketing personnel focus on marketing activities that have proven to result in the greatest number of customer prospects to support sales activity.

International revenue was negatively impacted by $2.2 million for the three months ended June 30, 2015 compared to the same period in 2014 due to the strengthening of the United States dollar relative to the British Pound and Japanese Yen, as well as the strengthening of the British Pound relative to the Euro. The effect of pricing changes on revenue was immaterial for the three months ended June 30, 2015 compared to the same period in 2014.

Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue increased $6.2 million, or 30.9%, for the three months ended June 30, 2015 compared to the same period in 2014, which was faster than the rate of revenue increase of 21.0% for the three months ended June 30, 2015 compared to the same period in 2014. The increase in cost of revenue was due to raw material and production cost increases of $2.3 million to support increased sales volumes, an increase in direct labor headcount resulting in personnel and related cost increases of $3.0 million and equipment and facility-related cost increases of $0.9 million.

Gross Profit and Gross Margin. Gross profit increased from $32.7 million, or 61.8% of revenues, in the three months ended June 30, 2014 to $37.6 million, or 58.7% of revenue, in the three months ended June 30, 2015 primarily due to increases in revenue offset by the cost of revenue as discussed above. Gross margin decreased primarily as a result of our Fineline product line having a lower gross margin than our legacy Firstcut and Protomold product lines and the impact of fluctuations in foreign currency exchange rates.

Operating Expenses, Other Income (Expense), net and Provision for Income Taxes

Marketing and Sales. Marketing and sales expenses increased $2.2 million, or 30.9%, during the three months ended June 30, 2015 compared to the same period in 2014 due primarily to an increase in headcount resulting in personnel and related cost increases of $1.8 million and marketing program cost increases of $0.4 million. The increase in marketing program costs is the result of our focus and concentration on funding those programs which have proven to be the most effective in growing our business.

Research and Development. Our research and development expenses increased $0.5 million, or 12.3%, during the three months ended June 30, 2015 compared to the same period in 2014 due to an increase in headcount resulting in personnel and related cost increases of $0.8 million and operating cost increases of $0.2 million, which were partially offset by professional services cost decreases of $0.5 million.

General and Administrative. Our general and administrative expenses increased $0.8 million, or 13.9%, during the three months ended June 30, 2015 compared to the same period in 2014 due to an increase in headcount resulting in personnel and related cost increases of $0.8 million, stock-based compensation costs increases of $0.2 million and intangible amortization expense increases of $0.1 million, which were partially offset by professional services cost decreases of $0.3 million.

Other Income (Expense), net. Other expense, net did not materially change during the three months ended June 30, 2015 compared to the same period in 2014.

Provision for Income Taxes. Our effective tax rate of 32.5% for the three months ended June 30, 2015 increased 1.4% when compared to 31.1% for the same period in 2014. The increase in the effective tax rate is primarily due to changes in the mix of projected income earned in domestic and foreign tax jurisdictions for the tax year ending December 31, 2015. As a result of the increase in our effective tax rate combined with increased income attributable to the fluctuations described above, our income tax provision increased by $0.6 million to $5.6 million for the three months ended June 30, 2015 compared to our income tax provision of $5.0 million for the three months ended June 30, 2014.

Comparison of Six Months Ended June 30, 2015 and 2014

Revenue

Revenue by product line and the related changes for the six months ended June 30, 2015 and 2014 were as follows: