Proto Labs Inc: Form 10-Q for the period ended Jun 30, 2024

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, 2023.

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 this Form 10-Q, as well as our most recent Annual Report on Form 10-K as filed with the Securities and Exchange Commission (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 one of the world’s largest, fastest and most comprehensive digital manufacturers of custom parts. Our vision is accelerating innovation by revolutionizing manufacturing. Our mission is to empower companies to bring new ideas to market by offering the fastest and most comprehensive digital manufacturing service in the world. We accomplish this by offering a variety of manufacturing capabilities fulfilled through a combination of owned manufacturing factories and a worldwide network of premium manufacturing partners. Our automated quoting and manufacturing systems are highly integrated with our manufacturing and fulfillment systems, which allow us to offer a vast array of manufacturing technologies in a variety of materials across a continuum of lead times and prices. Our technology-enabled digital engineering and manufacturing applications enable us to produce commercial-grade plastic, metal, and liquid silicone rubber parts in as fast as one day. We utilize injection molding, computer numerical control (CNC) machining, 3D printing and sheet metal fabrication to manufacture custom parts for our customers.

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, to the procurement and supply chain professionals seeking to easily and efficiently source custom parts, and to a wide variety of customers seeking to purchase custom made parts. We believe our use of advanced technology enables us to offer significant advantages at competitive prices to many customers and is the primary reason we have become a leading supplier of custom parts.

We have established our operations in the United States and Europe. Our primary manufacturing product lines currently include Injection Molding, CNC Machining, 3D Printing and Sheet Metal. We continually seek to expand the range of sizes and geometric complexity of the parts we can make with these 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 or incorporate into our manufacturing network in order to better serve the evolving preferences and needs of our customers. With the addition of the Protolabs Network in 2021, our global network of premium manufacturing partners significantly expands the breadth and depth of our manufacturing capabilities, enabling us to offer customers a wider variety of lead times and pricing options, and an expanded envelope of parts (complexity, size, etc.).

Key Financial Measures and Trends

Revenue

Our operations are comprised of two geographic operating segments in the United States and Europe. On May 27, 2022, the Company's board of directors approved a plan for the closure of our manufacturing facility in Japan and announced an intention to cease operations in the region. The Company dissolved its Japan operations in December 2023. Revenue is derived from our Injection Molding, CNC Machining, 3D Printing and Sheet Metal product lines. Injection Molding revenue consists of sales of custom injection molds and injection-molded parts. CNC Machining revenue consists of sales of CNC-machined custom parts. 3D Printing revenue consists of sales of 3D-printed parts. Sheet Metal revenue consists of sales of fabricated sheet metal custom parts. Our revenue is generated from a diverse customer base and our historical and current efforts to increase revenue have been directed at gaining new customers and selling to our existing customer base by increasing marketing and selling activities, including:

• expanding the breadth and scope of our products by adding more sizes and materials to our offerings;
• the introduction of our 3D Printing product line through our acquisition of FineLine in 2014;
• expanding 3D Printing to Europe through our acquisition of Alphaform in 2015;
• the introduction of our Sheet Metal product line through our acquisition of Rapid Manufacturing Group, LLC in 2017;
• continuously improving the usability of our product lines such as our web-centric applications; and
• providing customers with on-demand access to a global network of premium manufacturing partners through our acquisition of Hubs in 2021.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of raw materials, equipment depreciation, employee compensation including benefits and stock-based compensation, facilities costs and overhead allocations associated with the manufacturing process for molds and customer parts. We expect our personnel-related costs to increase in order to retain and attract top talent and remain competitive in the market. Overall, we expect cost of revenue to increase in absolute dollars.

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 mix of revenue by product line, pricing, sales volume, manufacturing costs, the costs associated with increasing production capacity, the mix between domestic and foreign revenue sources, the mix between revenue produced in our internal manufacturing operations and outsourced to our external manufacturing partners, and foreign currency 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 in each of these categories.

Our business strategy is to continue to be a leading online and technology-enabled manufacturer of quick-turn, on-demand injection-molded, CNC-machined, 3D-printed and sheet metal 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 in the future.

Marketing and sales. Marketing and sales expense consists primarily of employee compensation, benefits, commissions, stock-based compensation, marketing demand generation costs such as electronic, print and pay-per-click advertising, trade shows 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 demand generation costs targeted to increase our customer base and grow revenue.

Research and development. Research and development expense consists primarily of personnel and outside service costs related to the development of new processes and product lines, enhancement of existing product lines, development of software for internal use, maintenance of internally developed software, quality assurance and testing. Costs for internal use software are evaluated by project and capitalized where appropriate under ASC 350-40, Intangibles — Goodwill and Other, Internal-Use Software. We expect research and development expense to increase in the future as we seek to enhance our e-commerce interface technology, internal software and supporting business systems, and continue to expand our product lines.

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.

Closure of Japan business. Closure of Japan business expense is driven by our decision to close the Japan manufacturing facility and exit the Japan market. The expenses consist primarily of operating expense, including employee severance, write-down of fixed assets, facility-related charges and goodwill impairment charges.

Other Income, net

Other income, 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 foreign currency 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. Overall, our effective tax rate for 2024 and beyond may differ from historical effective tax rates due to increases in losses in foreign operations that are not eligible for tax benefits on account of valuation allowances, as well as any future tax law changes that may impact our effective tax rate.

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.

(dollars in thousands)

19

Stock-based compensation expense included in the statements of operations data above for the three and six months ended June 30, 2024 and 2023 were as follows:

(dollars in thousands)

Comparison of Three Months Ended June 30, 2024 and 2023

Revenue

Revenue by reportable segment and the related changes for the three months ended June 30, 2024 and 2023 were as follows:

(dollars in thousands)

Our revenue increased $3.4 million, or 2.8%, for the three months ended June 30, 2024 compared to the same period in 2023. By reportable segment, revenue in the United States increased $2.2 million, or 2.3%, for the three months ended June 30, 2024 compared to the same period in 2023. Revenue in Europe increased $1.1 million, or 4.4%, for the three months ended June 30, 2024 compared to the same period in 2023. Revenue generated from the Protolabs Network was $24.7 million and $20.2 million for the three months ended June 30, 2024 and 2023, respectively. International revenue was minimally impacted during the three months ended June 30, 2024 compared to the same period in 2023 as a result of foreign currency movements.

During the three months ended June 30, 2024, we served 22,456 unique customer contacts, which is a decrease of 3.9% from the same period in 2023. Our customer contacts served decreased compared to an increase in revenue. This was primarily due to our strategic focus to earn larger orders from our customers as we strive to be their supplier of choice by serving their custom parts needs through the comprehensive offer of our factory and the Protolabs Network.

Revenue by product line and the related changes for the three months ended June 30, 2024 and 2023 were as follows:

(dollars in thousands)

By product line, our revenue increase was driven by a 6.1% increase in CNC Machining revenue, a 1.3% increase in 3D Printing revenue and a 0.5% increase in Injection Molding revenue, which was partially offset by a 0.4% decrease in Sheet Metal revenue and a 46.8% decrease in Other Revenue, in each case for the three months ended June 30, 2024 compared to the same period in 2023.

Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue decreased $0.1 million, or 0.1%, for the three months ended June 30, 2024 compared to the same period in 2023, while revenue increased 2.8% for the three months ended June 30, 2024 compared to the same period in 2023. The decrease in the cost of revenue of $0.1 million was primarily driven by reductions in headcount and overtime leading to lower personnel and related costs of $0.8 million primarily in our digital manufacturing factory business during the three months ended June 30, 2024 compared to the same period in 2023. The cost reductions in our digital factories were the result of focused management of resources aligned to order volumes, partially supported by increased automation. Partially offsetting the lower personnel and related costs were increases in raw material in our factory business and production costs of $0.4 million primarily within the our digital network business as a result of higher revenue volumes and equipment and facility related costs of $0.3 million during the three months ended June 30, 2024 compared to the same period in 2023.

Gross Profit and Gross Margin. Gross profit increased from $53.1 million in the three months ended June 30, 2023 to $56.5 million in the three months ended June 30, 2024. Gross margin increased from 43.4% in the three months ended June 30, 2023 to 45.0% in the three months ended June 30, 2024.

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

Marketing and Sales. Marketing and sales expenses increased $1.6 million, or 7.2%, during the three months ended June 30, 2024 compared to the same period in 2023. The increase in marketing and sales expenses was primarily driven by increases in personnel and related costs of $1.0 million, marketing demand generation costs increases of $0.3 million and other operating costs of $0.3 million during the three months ended June 30, 2024 when compared to the same period in 2023.

Research and Development. Our research and development expenses increased $0.8 million, or 8.1%, during the three months ended June 30, 2024 compared to the same period in 2023 primarily due to increases in personnel and related costs of $0.4 million, $0.2 million in professional services and $0.2 million of other operating costs.

General and Administrative. Our general and administrative expenses increased $0.8 million, or 4.9%, during the three months ended June 30, 2024 compared to the same period in 2023 primarily due to increases in stock-based compensation of $0.6 million, personnel and related costs increases of $0.5 million and $0.5 million in administrative costs and professional services, partially offset by decreases of $0.4 million in intangible amortization expense and $0.4 million of other operating costs.

Closure of Japan business. We had no expenses related to the closure of our Japan business during the three months ended June 30, 2024. Our decision to close our Japan business resulted in $0.1 million in operating expenses during the three months ended June 30, 2023.

Other income (loss), net. We recognized other income, net of $1.4 million for the three months ended June 30, 2024, an increase of $4.7 million compared to other loss, net of $3.4 million for the three months ended June 30, 2023. Other income, net for the three months ended June 30, 2024 primarily consisted of $1.5 million in interest income on investments and other income, partially offset by $0.1 million of foreign currency losses. Other loss, net for the three months ended June 30, 2023 primarily consisted of a $3.9 million foreign currency translation loss from the substantial completion on the closure of our Japan business, partially offset by $0.5 million in interest income on investments and other income.

Provision for Income Taxes. Our effective tax rate of 38.3% for the three months ended June 30, 2024 decreased 78.8% compared to 117.1% for the same period in 2023. The decrease in the effective tax rate is primarily due to the prior year one-time tax impact of the foreign currency translation loss on the closure of our Japan business. Our income tax provision of $2.8 million for the three months ended June 30, 2024 increased $0.2 million as compared to our income tax provision of $2.6 million to the same period in 2023.

Comparison of Six Months Ended June 30, 2024 and 2023

Revenue

Revenue by reportable segment and the related changes for the six months ended June 30, 2024 and 2023 were as follows:

(dollars in thousands)

Our revenue increased $5.4 million, or 2.2%, for the six months ended June 30, 2024 compared to the same period in 2023. By reportable segment, revenue in the United States increased $6.0 million, or 3.1%, for the six months ended June 30, 2024 compared to the same period in 2023. Revenue in Europe decreased $0.6 million, or 1.0%, for the six months ended June 30, 2024 compared to the same period in 2023. Revenue generated from Protolabs Network was $48.6 million and $37.5 million for the six months ended June 30, 2024 and 2023, respectively. International revenue was positively impacted by $0.9 million during six months ended June 30, 2024 compared to the same period in 2023 as a result of foreign currency movements, primarily the strengthening of the British Pound and Euro relative to the United States Dollar.

During the six months ended June 30, 2024, we served 34,338 unique product developers and engineers, a decrease of 3.9% from the same period in 2023. Our customer contacts served decreased compared to an increase in revenue. This was primarily due to our strategic focus to earn larger orders from our customers as we strive to be their supplier of choice by serving their custom parts needs through the comprehensive offer of our factory and the Protolabs Network.

Revenue by product line and the related changes for the six months ended June 30, 2024 and 2023 were as follows:

(dollars in thousands)

By product line, our revenue increase was driven by a 4.9% increase in CNC Machining revenue, a 1.0% increase in Injection Molding revenue, and a 1.3% increase in 3D Printing revenue, which was partially offset by a 8.7% decrease in Sheet Metal revenue and a 38.7% decrease in Other Revenue in each case for the six months ended June 30, 2024 compared to the same period in 2023.

Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue decreased $1.7 million, or 1.2%, for the six months ended June 30, 2024 compared to the same period in 2023, while revenue increased 2.2% for the six months ended June 30, 2024 compared to the same period in 2023. The decrease in cost of revenue of $1.7 million was driven by reductions in headcount and overtime leading to lower personnel and related costs of $2.3 million primarily in our digital manufacturing factory business during the six months ended June 30, 2024 compared to the same period in 2023. The cost reductions in our digital factories were the result of focused management of resources aligned to order volumes, partially supported by increased automation. Partially offsetting the lower personnel and related costs were increases in equipment and facility related costs of $0.6 million during the six months ended June 30, 2024 compared to the same period in 2023.

Gross Profit and Gross Margin. Gross profit increased from $106.9 million in the six months ended June 30, 2023 to $114.0 million in the six months ended June 30, 2024. Gross margin increased from 43.1% in the six months ended June 30, 2023 to 45.0% in the six months ended June 30, 2024.

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

Marketing and Sales. Marketing and sales expenses increased $2.3 million, or 5.1%, during the six months ended June 30, 2024 compared to the same period in 2023. The increase was driven by increases in personnel and related costs of $1.3 million, marketing demand generation costs increases of $0.5 million and other operating costs of $0.5 million during the six months ended June 30, 2024 when compared to the same period in 2023.

Research and Development. Our research and development expenses increased $1.3 million, or 6.3%, during the six months ended June 30, 2024 compared to the same period in 2023 primarily due to personnel and related cost increases of $0.4 million, professional services increases of $0.3 million and other operating cost increases of $0.6 million.

General and Administrative. Our general and administrative expenses increased $0.3 million, or 0.8%, during the six months ended June 30, 2024 compared to the same period in 2023 primarily due to increases in stock-based compensation of $0.9 million, personnel and related costs increases of $0.8 million and professional services of $0.6 million, partially offset by decreases in amortization costs of $0.7 million, administrative costs decreases of $0.6 million and other operating cost decreases of $0.7 million.

Closure of Japan business. We had no expenses related to the closure of our Japan business during the six months ended June 30, 2024. During the six months ended June 30, 2023, we recognized $0.2 million in operating expenses related to the closure.

Other income (loss), net. We recognized other income, net of $2.3 million for the six months ended June 30, 2024, an increase of $4.3 million compared to other loss, net of $2.1 million for the six months ended June 30, 2023. Other income, net for the six months ended June 30, 2024 primarily consisted of $2.6 million in interest income on investments and other income, partially offset by $0.3 million of foreign currency losses. Other loss, net for the six months ended June 30, 2023 primarily consisted of a $3.9 million foreign currency translation loss from the substantial completion on the closure of our Japan business, which was partially offset by $1.8 million in interest income on investments and other income.

Provision for Income Taxes. Our effective tax rate of 35.0% for the six months ended June 30, 2024 decreased 33.7% compared to 68.7% for the same period in 2023. The decrease in the effective tax rate is primarily due to the prior year one-time tax impact of the foreign currency translation loss from the substantial completion on the closure of our Japan business. Our income tax provision of $5.3 million for the six months ended June 30, 2024 increased $0.3 million compared to our income tax provision of $5.0 million for the six months ended June 30, 2023.

Liquidity and Capital Resources

Cash Flows

The following table summarizes our cash flows during the six months ended June 30, 2024 and 2023:

(dollars in thousands)

Sources of Liquidity

Historically, we have primarily financed our operations and capital expenditures through cash flow from operations. We had cash and cash equivalents of $96.1 million as of June 30, 2024, an increase of $12.4 million from December 31, 2023. The increase in our cash was primarily due to cash provided by operating activities of $35.8 million and proceeds from call redemptions and maturities of marketable securities of $10.4 million, which were partially offset by $6.8 million for purchases of property, equipment and other capital assets, and $26.9 million in repurchases of common stock.

We believe that our existing cash and cash equivalents together with cash generated from operations will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months.

Cash Flows from Operating Activities

Cash flows from operating activities were $35.8 million during the six months ended June 30, 2024 and primarily consisted of net income of $9.8 million, adjusted for certain non-cash items, including depreciation and amortization of $18.1 million, stock-based compensation expense of $8.5 million and changes in operating assets and liabilities and other items totaling $3.5 million, which were partially offset by deferred taxes of $4.1 million. Cash flows from operating activities were $31.9 million during the six months ended June 30, 2023 and primarily consisted of net income of $2.3 million, adjusted for certain non-cash items, including depreciation and amortization of $18.9 million, stock-based compensation expense of $7.4 million and a non-cash foreign currency translation loss of $3.9 million, interest on finance lease obligations of $0.6 million and changes in operating assets and liabilities and other items totaling $4.7 million, which were partially offset by deferred taxes of $5.6 million.

Cash flows from operating activities increased $3.9 million during the six months ended June 30, 2024 compared to the same period in 2023, primarily due to increases in net income of $7.5 million, stock-based compensation of $1.2 million and deferred taxes of $1.5 million, which were partially offset by decreases in changes in operating assets and liabilities totaling $1.2 million, interest on finance lease obligations of $0.6 million and depreciation and amortization of $0.8 million. The six months ended June 30, 2023 also included a $3.9 million non-cash foreign currency loss.

Cash Flows from Investing Activities

Cash provided by investing activities was $3.7 million during the six months ended June 30, 2024, consisting of $10.4 million in proceeds from call redemptions and maturities of marketable securities, which were partially offset by $6.7 million for net purchases of property, equipment and other capital assets.

Cash provided by investing activities was $7.8 million during the six months ended June 30, 2023, consisting of $14.0 million in proceeds from call redemptions and maturities of marketable securities, which were partially offset by $6.2 million for net purchases of property, equipment and other capital assets.

Cash Flows from Financing Activities

Cash used in financing activities was $26.9 million during the six months ended June 30, 2024, consisting of $26.9 million in repurchases of common stock, $1.9 million in purchases of shares withheld for tax obligations associated with equity transactions and $0.2 million for repayments of finance lease obligations, which were partially offset by $2.1 million in proceeds from exercises of stock options.

Cash used in financing activities was $29.7 million during the six months ended June 30, 2023, consisting of $30.1 million in repurchases of common stock, $1.4 million in purchases of shares withheld for tax obligations associated with equity transactions and $0.2 million for repayments of finance lease obligations, which were partially offset by $2.0 million in proceeds from exercises of stock options.

Critical Accounting Estimates

We have adopted various accounting policies to prepare the Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of these financial statements requires us to make estimates, judgements and assumptions. Our significant accounting policies and estimates are disclosed in Note 2 to the Consolidated Financial Statements included Pat II, Item 8 in our Annual Report on Form 10-K for the year ended December 31, 2023. There were no material changes to our critical accounting policies and estimates during the six months ended June 30, 2024.

Recent Accounting Pronouncements

For information on recent accounting pronouncements, see Note 2 to the Consolidated Financial Statements appearing in Part I, Item 1 in this Quarterly Report on Form 10-Q.

Foreign Currency Risk

As a result of our foreign operations, we have revenue, expenses, assets and liabilities that are denominated in foreign currencies. We generate revenue and incur production and sourcing costs and operating expenses in British Pounds and Euros.

Our operating results and cash flows are adversely impacted when the United States Dollar appreciates relative to foreign currencies. Additionally, our operating results and cash flows are adversely impacted when the British Pound appreciates relative to the Euro. As we expand internationally, our results of operations and cash flows will become increasingly subject to changes in foreign currency exchange rates.

We have not used forward contracts or currency borrowings to hedge our exposure to foreign currency risk. Foreign currency risk can be assessed by estimating the change in results of operations or financial position resulting from a hypothetical 10% adverse change in foreign exchange rates. We believe such a change would generally not have a material impact on our financial position, but could have a material impact on our results of operations. During the three and six months ended June 30, 2023, we recognized a foreign currency translation loss of $3.9 million in connection with substantially completing our closure of our Japan business. We recognized foreign currency losses of $0.1 million for the three months ended June 30, 2024 and 2023, respectively. We recognized foreign currency losses of $0.3 million and foreign currency gains of $0.1 million during the six months ended June 30, 2024 and 2023, respectively. The changes in foreign exchange rates had a minimal impact on consolidated revenue for the three months ended June 30, 2024 and a positive impact on consolidated revenue of $0.9 million as for the six months ended June 30, 2024 compared to the same period in 2023.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (Exchange Act)) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures are effective and provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported accurately and within the time frames specified in the SEC’s rules and forms and accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2023 includes a discussion of our risk factors. There have been no material changes from the risk factors described in our Form 10-K.