Proto Labs, Inc. (NYSE:PRLB) Q2 2023 Earnings Call Transcript

Proto Labs, Inc. (NYSE:PRLB) Q2 2023 Earnings Call Transcript August 4, 2023

Proto Labs, Inc. misses on earnings expectations. Reported EPS is $-0.01461 EPS, expectations were $0.3.

Operator: Greetings and welcome to the Proto Labs’ Q2 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Mr. Jason Frankman, VP and Corporate Controller. Thank you Mr. Frankman. You may begin.

Jason Frankman: Thank you, [Camilla] and welcome, everyone, to Proto Labs’ second quarter 2023 earnings conference call. I’m joined today by Rob Bodor, Proto Lab’s President and Chief Executive Officer; and Dan Schumacher, Chief Financial Officer. This morning, Proto Labs issued a press release announcing its financial results for the second quarter ended June 30, 2023. The release is available on the company’s website. In addition, a prepared slide presentation is available online at the web address provided in our press release. Our discussion today 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 and the accompanying slide presentation at the Investor Relations section of our company website for a complete reconciliation of GAAP to non-GAAP results. Now, I will turn the call over to Rob Bodor. Rob?

Rob Bodor: Thanks, Jason. Good morning, everyone, and thank you for joining our second quarter earnings call. This morning, we reported revenue and earnings within our guidance range. While economic conditions are challenging, amplified by the continued contraction of global manufacturing, our uniquely broad customer offering fulfilled through the combination of our internal digital factories and network manufacturing partners allow us to offer customers a differentiated value proposition and serve their various needs despite the economic pressures our customers are facing. Our lower price, longer lead time offers through the factory and network see particularly high demand in the current software economic conditions. Our quick turn offers tend to be in highest demand in strong growth economies alongside continued demand for longer lead time offers to meet our customer’s production needs.

As we discussed in the prior quarter, we are operating in a challenging and uncertain manufacturing environment with both U.S. and Eurozone manufacturing indices reporting three year lows in June. Similar to what we saw in the first quarter, driven by the macro climate, demand for longer lead time lower priced offerings has continued to outpace demand for our quick turn offerings. Notably, our network revenue grew 80% year-over-year in the quarter. The network offer has significantly expanded our addressable market with a wider envelope of manufacturing capabilities and a broad range of lead time and pricing options. As a result, it continues to gain traction with customers and share in the market. While our quick turn offers saw continued slower demand in the quarter, we anticipated this overall demand mix and despite this headwind, improved our consolidated growth and operating margins sequentially.

We also continue to generate positive cash flows that are best in class in our sector. As global manufacturing conditions improve, we expect growth in both network and factory offers. In order to continue to drive growth and maintain or improve our profitability in this challenging environment, we are focusing on items we control. First, we will continue to drive growth in our longer lead time lower priced offerings through both the Hubs network and the factory. Network revenue again surpassed our expectations in the quarter and in the first half of 2023 grew 75% over the first half of 2022. Our network offer continues to thrive as customers gravitate toward expanded manufacturing capabilities and more economic options for custom prototype and low volume production parts.

Next, we continue to invest to innovate and expand our customer offer through research and development initiatives. Our industry leading profitability and positive cash flow generation enable us to invest for future growth. Most recently, we launched accelerated anodizing and chromate plating in our digital factory CNC machining service. This is a very commonly requested secondary offer for machine parts. Our new offer combines Pro Labs unmatched speed at scale with traditional finishing processes, a first for the industry. A Pro Labs customer can now have fully anodized or plated CNC machine parts on their desk within a few days of placing an order. Previously, we only offered finishing through the network, but as part of building out the most comprehensive custom CNC offer, we now offer finishing through the factory at lead times that no other manufacturer can match.

Aside from expanding our offers, we are also ensuring that our costs continue to flex with sales volumes. We are controlling factory costs while maintaining the world’s fastest lead times. At the end of the second quarter, our manufacturing headcount was down 9% year-over-year, commensurate with our volumes. We will continue to align staffing levels with volumes in our manufacturing facilities while continuing to invest in growth, including our high growth network offer. As economic conditions and manufacturing demand recover, we anticipate our factory performance will improve as customer preferences and needs shift and more customers take advantage of our world class lead times consistent for our quality and high on time reliability. In addition, as the factory longer lead time business becomes material to our overall factory offer, it will provide an offset to any pressure to the quick turn business.

We also expect strong network growth to continue in any macro climate driven by its wide range of capabilities and lead time options. The combination of factory and network is what allows Pro Labs to serve all customer use cases in any economic climate. Because we acquired hubs in 2021 and now offer the combination of both fulfillment avenues, our current business performance is stronger than if we had only provided quick turn offers to customers. The network offer continues to gain traction with customers with the expanded envelope capabilities and broader range of lead time and pricing options. The number of customers utilizing both factory and network services continues to grow well. We are realizing the value of the hubs acquisition and our expanded customer offer and we are still in the early stages of capturing the total opportunity in the market that our strategy unlocks.

Pro Labs has the broadest fulfillment capabilities in our industry allowing us to serve our customers and grow profitably in any economic conditions. Now for a quick update on our 2023 priorities halfway through the year. As a reminder, our priorities are first, to drive revenue growth, particularly in our largest services, injection molding and CNC machine and second, to increase shareholder value through expanding profitability in the factory and the network. [One] investment we are making in revenue growth is an investment in sales leadership talent. We’ve recently hired a new vice president of sales to lead the Americas and also strengthened our sales management in Europe. Injection molding revenue in the second quarter was down sequentially.

As we have discussed in prior calls, injection molding is highly impacted by macro conditions due to its higher proportion of production use cases. We continue to pursue various go-to-market strategies and other service line improvements to drive growth. We have seen solid performance in injection molding orders fulfilled through the combination of our internal factories and manufacturing partners. We are winning more orders that leverage our combined factory and network injection molding offer as evidenced by a recent project we completed for an automotive lighting solutions provider. Working with [One] supplier was important for this automotive customer. This customer came to Pro labs in search of a custom manufacturing partner that could support a program from prototyping to production.

The customer benefited from the speed of our digital factory service to rapidly prototype their designs and then moved into production with our network, evidence of Pro Labs serving multiple use cases across the product lifecycle for a customer. The customer required large and complex injection mold parts which are outside of our digital factory capabilities and in the past we would not have won this program. But because of our digital network offers expanded injection molding capabilities, Pro Labs won the business and we manufactured all molds and parts for this customer through both fulfillment avenues. The combined factory and network offer unlocks significant value for this customer allowing them to get to production quickly with validated and tested designs all from a single manufacturer.

Our next priority growth area, CNC machining, is performing well with growth in the second quarter largely driven by our network offer. We continue to innovate on our digital factory capabilities and expand our customer offer most recently launching, accelerating, and analyzing in place. Pro Labs offers unmatched breadth in CNC machining and as a customer preferences shift and expand we are well positioned to be the single source supplier for all our customers CNC machining needs. We have tangible evidence that customers value one single partner for their custom CNC part needs. One specific customer Airbus recently turned to Pro Labs for help with a new transportation project in development. Airbus needed a manufacturing partner that could move very quickly from prototyping to production and the Pro Labs combined offer made us the perfect candidate.

We delivered quick turn prototype parts through the factory and Airbus then transitioned to our digital network to manufacture higher production volumes. Our factory and network combination eliminated the need for Airbus to request multiple quotes from multiple manufacturers simplifying and accelerating their supply chain. Another example of the power of Pro Labs combined factory and network. The next priority for 2023 is to increase shareholder value through expanding profitability in the factory and in the network. We surpassed our expectations for earnings in the second quarter. We achieved this despite the shift in the mix of our business toward longer lead time, lower priced offerings and the accompanying pressure on margins. We accomplished this through improved automation and productivity that enabled us to reduce overall headcount, reduce overtime and reduced reliance on contract labor.

Given customer preferences for lower priced offerings in this economic cycle we expect continued pressure on operating margin improvements throughout 2023 and will continue to focus on operating efficiencies as we have throughout this year. Our focus on operating efficiencies and our customers secured us two pieces of external recognition in the quarter highlighting our leadership in digital manufacturing. First, Pro Labs was awarded Company of the Year for digital manufacturing by Frost and Sullivan who commended our visionary innovation, performance and customer impact. In addition, Pro Labs was honored with the Manufacturing Leadership Council’s Manufacturing Leadership Award in the digital supply chain category. The MLC highlighted our combined factory and network offering.

We will continue to focus on serving our customers with the most comprehensive digital manufacturing offer in the world and receiving external awards like this is a strong endorsement of our continued industry leadership. In summary, we have little control over macro conditions and end market demand, but these short term challenges should not cloud the advantages of our business model. The combination of our factory and network offers has allowed us to perform better than peers in the current environment and we believe it will allow us to outgrow the market longer term. Particularly as our factory offer becomes less reliant on the quick term business that is sensitive to economic conditions. Let me once again highlight that our network offer continues to take market share with 80% growth in the quarter.

We are well positioned to weather economic volatility due to Pro Labs affecting class profitability and strong cash flow generation. This also enables us to continue to invest in innovation to expand our customer offer and expand additional share of wallet. Through any economic climate, we are a great long term strategic partner for our customers and believe we will deliver value for shareholders over the long term. I’d like to thank every Pro Labs employee for their contributions in the first half of 2023. Although we are operating in a difficult environment, the efforts and commitment of our employees enable us to continue to perform and grow profitably. Dan will now cover our second quarter financials in depth and provide our outlook for the third quarter of 2023.

Dan?

Dan Schumacher: Thanks Rob and good morning everyone. Our financial results begin on Page 9 of the slide presentation. Second quarter revenue of $122.3 million was in our guidance range and down 1% year-over-year in constant currencies and excluding Japan. Hubs had another record quarter generating $20.2 million of revenue in the second quarter representing year-over-year growth of 79.7% in constant currencies. Our hubs network offer continues to resonate with customers driven by a broad range of capabilities and lead time options. Changes in foreign currencies represented a $500,000 unfavorable impact of revenue in the second quarter in line with our expectations. Second quarter revenue by region is summarized on slide 13. In the Americas, our largest region revenue declined 4.3% year-over-year a strong network growth was offset by a decline in the factory business.

In Europe, second quarter revenue grew 13.1% year-over-year in constant currencies driven by strong network offer growth. Transitioning to revenue by service. Second quarter injection molding revenue declined approximately 6% year-over-year in constant currencies and excluding Japan. We saw weaker demand for our factory offer sequentially especially in our medical, computer electronics and manufacturing end markets. Europe saw a larger sequential decline than the Americas. CNC machining revenue grew 3.5% year-over-year in constant currencies and excluding Japan driven by very strong network growth. Second quarter 3D printing revenue grew 6% year-over-year in constant currencies driven by growth in the network and in all geographies both in the factory and the network.

Sheet metals revenue declined 24% year-over-year in constant currencies in the quarter. As a reminder, we furloughed 25% of our sheet metal workforce in the second quarter in an effort to align cost levels with current demand. We served 23,377 unique product developers in the second quarter, a decrease of 2.8% year-over-year. Turning to Slide 17 in our detailed income statement. Overall second quarter non-GAAP gross margin increased 70 basis points sequentially to 44.1%. Consolidated margin expansion was driven by a higher network business gross margin slightly offset by the impact of the mixed shift to lower margin offers. Even with the lower volume, we were able to maintain similar factory gross margins quarter-over-quarter due to cost reduction initiatives.

Network gross margin in the second quarter increased to 31.2% from 22.2% in the first quarter of 2023. Our long-term target for network gross margin is still between 25% and 30%. In the second quarter we benefited from improvements to our sourcing algorithm and pricing efficiencies. Total non-GAAP operating expenses were $43.1 million in the quarter or 35.2% of revenue compared to $45.5 million or 36.2% of revenue in the first quarter of 2023. We gained operating efficiencies sequentially due to focused efforts to control costs as well as lower incentive compensation. As we continue to work through the exit of our Japan operation, we incurred non-operating expenses of $4 million in the second quarter primarily due to the release of a $3.9 million of cumulative form currency translation adjustment from other comprehensive income on the balance sheet.

This adjustment is included in our non-GAAP financial adjustments. Moving to taxes, our non-GAAP effective tax rate in the second quarter was 25.2% compared to 23.2% in the first quarter. The sequential increase in the non-GAAP effective tax rate was primarily due to a slightly lower R&D credit in the quarter. Second quarter non-GAAP diluted net income per share was $0.33 compared to $0.30 in the first quarter of 2023. The sequential earnings per share improvement was driven primarily by network growth and gross margin expansion as well as operating expense efficiencies. These sequential improvements were partially offset by the continued mix shift toward longer lead time lower priced offerings. Turning to cash flow and balance sheet highlights on Slide 18.

We generated $9.3 million of cash from operations in the quarter. Our business exhibits very strong cash flow generation enabling us to weather challenging economic climates better than peers and continue to invest in future growth. We repurchased 8.9 million of common shares during the second quarter. We will continue to purchase opportunistically going forward. Our balance sheet is still very strong. On June 30, 2023, we had $102.8 million of cash in investments on our balance sheet and zero debt. Turning to third quarter guidance as outlined on Slide 20. We expect to generate revenue between $118 million and $126 million in the third quarter. At the midpoint, this implies flat revenue year-over-year in constant currencies and excluding Japan.

The closure of our Japan operations is expected to have a $1.3 million negative year-over-year impact on our revenue growth. We expect foreign currency to have between a $1.5 million and $2 million favorable impact on revenue compared to the third quarter of 2022. Moving to earnings guidance, we anticipate non-GAAP add-backs in the third quarter to include stock-based compensation expense of approximately $4.6 million and amortization expense of $1.5 million. We currently estimate our third quarter non-GAAP effective tax rate will be 24% plus or minus 50 basis points. Considering this we expect third quarter non-GAAP earnings per share between $0.26 and $0.34. Now back to Rob for closing comments.

Rob Bodor: Thank you, Dan. Pro Labs is the most profitable and cash flow positive digital manufacturing company, allowing us to withstand challenging environments while investing in the future. Our best-in-class unique combined offer is gaining significant traction in the market. In the second half of the year, we will continue to improve on the things we can control and make progress on our focus 2023 priorities, which will enable long-term profitable growth and shareholder value creation. Thank you for your time today. That concludes our prepared remarks. Dan and I will now take questions.

See also Bruce Berkowitz’s Portfolio and Latest Trades and 20 Oldest Richest Families in America.

Q&A Session

Operator: Thank you. We will now be conducting a question and answer session. [Operator Instructions] Thank you. Our first question comes from the line of Jim Ricchiuti with Needham and Company. Please proceed with your question.

Jim Ricchiuti: Thank you. Good morning. First question is on the quarter, the current quarter, yes, seasonally Q3, weaker just due to the summer months, obviously, but I’m wondering if you have any kind of read through in either the U.S. or Europe, just may inform you of just any changes in demand trends, as you exited Q2.

Rob Bodor: Yes, what I would tell you, Jim, is what we’ve found as we’ve gone through COVID and post-COVID in terms of the supply chain disruption that abnormal seasonality ends up being normal seasonality. It’s hard to predict in this environment kind of seasonally how things are coming in. This comes from a couple of factors, right? We’ve seen in past periods around COVID where normal months in which people were taking a lot of vacation, they ended up not, and you ended up seeing some different type of seasonality pattern than you normally did. So we set the guide as we normally do. We looked at what our current demand was in July, and we looked at, what our upload rates are and so forth, and then did our best to project out from there what the guidance is. I don’t have any better information than that, Jim.

Jim Ricchiuti: Well, fair enough. You guys showed some nice improvement in the network gross margins in the current quarter. I’m just wondering how we should be looking at that, just relative to the goal you have out there, and maybe more broadly, just in general, how you’re thinking about gross margins in the current quarter.

Dan Schumacher: Yes, thanks, Jim, for recognizing that. We’re quite happy with that improvement in our network gross margins, and it comes from improvements that we made. We have a machine learning-based pricing algorithm, and we’ve continued to test and validate different pricing paradigms within that, and we’ve seen some nice improvement, which we’re happy with. And then also, we improved kind of how we’re sourcing our opportunities to our manufacturing partners to make sure that we’re really providing them with the best fit, and that’s also helping us expand our margins there. You asked about the target. We communicated a target of 25% to 30% gross margin for the network, and we’re still holding to that at this point because we want to continue to test and learn as we continue to go forward. But yes, very pleased with the performance in the quarter.

Jim Ricchiuti: And just broadly on gross margins in this current environment across the services, are you seeing any pricing pressure or things like that that we need to at least consider for the current quarter gross margins?

Rob Bodor: Yes, I think we expect things to be fairly consistent going into the next quarter. For sure, there is probably more pressure within the factory business on volume, but we’ve been successful in managing our variable cost as it relates to the plants. In our overall headcount in our plants is down 9%. So we’re adjusting as we go and as we see how this economy plays out.

Jim Ricchiuti: Got it, thanks very much.

Rob Bodor: Thanks Jim.

Operator: Thank you. And our next question comes from the line of Brian Drabb with William Blair. Please proceed with your question.

Unidentified Analyst: Good morning, Dan. Good morning, Rob. This is Blake on for Brian. Just wanted to quickly ask, what drove the decline in product developers? I know it was just a slight decline, but was it broad-based across all your markets or was it anything specific? Any additional color there would be great?

Rob Bodor: Yes, it was in general consistent with revenue, but I would say one caveat to that. Part of our growth in our network business is not just the growth in customers, which is very, very healthy. But our sales team within our hub’s business is very focused on larger and larger projects. And you can see from the 80% growth rate, they’re very successful at that. And so that’s the only difference, I think in terms of when you look at product developer decline versus our decline in revenue in constant currencies excluding Japan.

Unidentified Analyst: Got it. And then you guys mentioned, as longer lead time offerings grow, it should help offset any floneness and quick turn as that longer lead time gets to the size of the quick turn business and the factory. How close were you guys to that milestone? I feel like that was an important comment.

Dan Schumacher: Yes, so we’ve expanded our, as we talk about our comprehensive offering, we’ve expanded our lead time options both by offering the network options, which tend to longer lead times and also by introducing longer lead time options that are fulfilled through the factory. We’ve done that in our CNC business and our 3D printing business and the injection molding as well. And in CNC, at one point, we talked about it as flexible lead times. That was kind of the name we talked about when we launched it. So those are in place and they’re continued to gain traction.