Proto Labs Inc - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES

 SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2016

or

For the transition period from                      to                      

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.  ☑Yes ☐No

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).  ☑Yes ☐No

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: 26,420,518 shares of Common Stock, par value $0.001 per share, were outstanding at July 27, 2016.

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, 2015.

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 that 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 most recent 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 manufacturer of quick-turn, on-demand 3D printed, CNC-machined and injection-molded custom parts for prototyping and low-volume production. We provide “Real Parts, Really Fast” to product developers and engineers worldwide, who are under increasing pressure to bring their finished products to market faster than their competition. 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 Injection Molding (Protomold), CNC Machining (Firstcut) and 3D Printing (Fineline). 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.

Injection Molding (Protomold)

Our Injection Molding (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 Injection Molding (Protomold) product line is used for prototype, on-demand and low-volume production. Prototype quantities typically range from 25 to 100 parts. Because we retain possession of the molds, customers who need low-volume production often come back to Proto Labs’ Injection Molding product line for additional quantities typically ranging up to 10,000 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 Injection Molding (Protomold) revenue.

CNC Machining (Firstcut)

Our CNC Machining (Firstcut) product line uses commercially available CNC machines to cut plastic or metal blocks or bars 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 CNC Machining (Firstcut) product line is well suited to produce small quantities, typically in the range of one to 200 parts.

3D Printing (Fineline)

Our 3D Printing (Fineline) includes stereolithography (SL), selective laser sintering (SLS) and direct metal laser sintering (DMLS) processes, which offers customers a wide-variety of high-quality, precision rapid prototyping and low volume production. These processes create parts with a high level of accuracy, detail, strength and durability. 3D Printing 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 conducted in three geographic markets consisting of 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 markets is derived from our Injection Molding (Protomold), CNC Machining (Firstcut) and 3D Printing (Fineline) product lines. Revenue within our Japan market is derived from our Injection Molding (Protomold) and CNC Machining (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:

Excluding product developers and engineers gained through the acquisition of Alphaform, we served 13,519 unique product developers and engineers during the three months ended June 30, 2016, an increase of 14.4% over the same period in 2015. We served 20,240 unique product developers and engineers during the six months ended June 30, 2016, an increase of 17.7% over the same period in 2015.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of raw materials, employee compensation, benefits, stock-based compensation, equipment depreciation, 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.

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 3D printed, CNC-machined, CNC-turned and injection-molded custom parts for prototyping and low-volume production. In order 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 and interest income on cash balances and investments. 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.

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 we expect our effective tax rate to remain relatively constant.

Results of Operations

The following table summarizes 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, 2016 and 2015

Revenue

Revenue by product line and the related changes for the three months ended June 30, 2016 and 2015 were as follows:

Revenue by geographic region, based on the billing location of the end customer, for the three months ended June 30, 2016 and 2015 is summarized as follows:

Our revenue increased $11.0 million, or 17.2%, for the three months ended June 30, 2016 compared to the same period in 2015. By geographic region, this revenue growth was driven by a 5.2% increase in United States revenue and a 57.5% increase in international revenue, which includes $4.8 million in revenue from our acquisition of Alphaform in October 2015, in each case for the three months ended June 30, 2016 compared to the same period in 2015.

By product line, this revenue growth was driven by a 12.1% increase in Injection Molding (Protomold) revenue, a 6.8% increase in CNC Machining (Firstcut) revenue, and a 66.9% increase in 3D Printing (Fineline) revenue, in each case for the three months ended June 30, 2016 compared to the same period in 2015. Alphaform revenue by product line includes $1.4 million in Injection Molding (Protomold) revenue, $2.1 million in 3D Printing (Fineline) revenue and $1.3 million of Other revenue, in each case for the three months ended June 30, 2016. 

Our revenue growth during the three months ended June 30, 2016 was the result of an increase in the volume of the product developers and engineers we served as well as revenue gained through our acquisition of Alphaform. During the three months ended June 30, 2016, excluding product developers and engineers gained through the acquisition of Alphaform, we served 13,519 unique product developers and engineers, an increase of 14.4% over the same period in 2015. Average revenue per product developer or engineer, excluding product developers and engineers gained through the acquisition of Alphaform, decreased 4.1% during the three months ended June 30, 2016 when compared to the same period in 2015.

Our revenue increases were primarily driven by increases in sales personnel and marketing activities and revenue earned as a result of our acquisition of Alphaform in October 2015. 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.

During the second quarter of 2016, we made the decision to discontinue offering two manufacturing processes within our Injection Molding (Protomold) product lines, including Metal Injection Molding (MIM) and Magnesium Thixomolding (Thixo), as well as exit our non-core resin resale business, which was acquired from Alphaform in October 2015. MIM, Thixo and resin resale in aggregrate represented approximately 1.8% of revenue during the three months ended June 30, 2016.

International revenue was not materially impacted by foreign currency movements for the three months ended June 30, 2016 compared to the same period in 2015. The effect of pricing changes on revenue was negligible for the three months ended June 30, 2016 compared to the same period in 2015.

Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue increased $6.3 million, or 23.8%, for the three months ended June 30, 2016 compared to the same period in 2015, which was faster than the rate of revenue increase of 17.2% for the three months ended June 30, 2016 compared to the same period in 2015. The increase in cost of revenue resulted from the growth of the business, including the Alphaform acquisition, and was due to raw material and production cost increases of $2.0 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 $1.3 million, which included $0.1 million of accelerated depreciation of leasehold assets. We expect additional expense related to the accelerated depreciation of leasehold assets of approximately $0.5 million through the end of 2016 resulting from our plans to vacate existing facilities and move into new facilities in the U.S. and Japan in 2016.

Gross Profit and Gross Margin. Gross profit increased from $37.6 million, or 58.7% of revenues, in the three months ended June 30, 2015 to $42.2 million, or 56.4% of revenue, in the three months ended June 30, 2016 primarily due to increases in revenue offset by the cost of revenue as discussed above. Gross margin decreased primarily as a result of additional costs incurred related to the integration of Alphaform as well as increases in investments of additional manufacturing capacity, the impact of fluctuations in foreign currency exchange rates and accelerated depreciation of leasehold assets.

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

Marketing and Sales. Marketing and sales expenses increased $2.0 million, or 20.5%, during the three months ended June 30, 2016 compared to the same period in 2015 due primarily to an increase in headcount resulting in personnel and related cost increases of $1.3 million and marketing program cost increases of $0.7 million. The increase in marketing program costs is the result of our focus and concentration on funding those programs that have proven to be the most effective in growing our business.

Research and Development. Our research and development expenses increased $1.4 million, or 32.3%, during the three months ended June 30, 2016 compared to the same period in 2015 due to an increase in headcount resulting in personnel and related cost increases of $1.1 million, operating cost increases of $0.2 million and professional services cost increases of $0.1 million.

General and Administrative. Our general and administrative expenses increased $3.8 million, or 60.6%, during the three months ended June 30, 2016 compared to the same period in 2015 due to an increase in headcount resulting in personnel and related cost increases of $1.5 million, stock-based compensation cost increases of $0.1 million, professional services cost increases of $0.4 million and administrative cost increases of $1.8 million. The administrative costs in the three months ended June 30, 2016, include asset impairment charges of $0.5 million as a result of our decision to discontinue MIM and Thixo manufacturing processes as noted above, and accelerated depreciation and facilities-related charges of $0.3 million resulting from our plans to vacate existing facilities and move into new facilities in the U.S. and Japan in 2016. As a result of our decision to vacate facilities, we expect additional administrative expense related to the accelerated depreciation of leasehold assets of approximately $0.2 million through the end of 2016.

Other Income (Expense), net. We recognized other income, net of $1.1 million for the three months ended June 30, 2016, an increase of $1.1 million when compared to other expense, net for the three months ended June 30, 2015. Other income, net included $0.8 million in foreign currency exchange gains for the three months ended June 30, 2016 compared to $0.2 million in foreign currency exchange losses in the same period of the prior year. The increase was primarily due to the amount of foreign-currency denominated cash balances abroad and movements in underlying exchange rates at the end of the period.

Provision for Income Taxes. Our effective tax rate of 32.9% for the three months ended June 30, 2016 increased 0.4% when compared to 32.5% for the same period in 2015. The increase in the effective tax rate is primarily due to changes in domestic deductions for which the company qualifies in the quarter ended June 30, 2016 when compared to the quarter ended June 30, 2015. As a result of a decrease in income before income taxes, our income tax provision decreased by $0.3 million to $5.3 million for the three months ended June 30, 2016 compared to our income tax provision of $5.6 million for the three months ended June 30, 2015.

Comparison of Six Months Ended June 30, 2016 and 2015

Revenue

Revenue by product line and the related changes for the six months ended June 30, 2016 and 2015 were as follows:

Revenue by geographic region, based on the billing location of the end customer, for the six months ended June 30, 2016 and 2015 is summarized as follows: