Q3 2019 Earnings Call

October 24, 2019

A brief question answer session will fall fall presentation.

This conference is being recorded.

She walked you may begin.

Thank you Rob and good morning, everyone with me today as Vicki Holt, our President and Chief Executive Officer, and John away, our Chief Financial Officer.

This morning for the market open Proto labs issued a press release announcing its financial results for the third quarter ended September Thirtyth 2019. The releases are available on the company's website Proto labs Dotcom. In addition, not prepared a slide presentation is available online at the web address provided.

Our press release.

Well, we began I would like to remind everyone that our discussion will include statements relating to future performance and expectations that are where maybe 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 FCC filings.

During 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.

Please refer to our press release and the accompanying slide presentation within the Investor Relations section of our company website for our complete reconciliation of non gap the GAAP results.

Now I'd like to turn the call over to Vicki Holt, President and Chief Executive Officer, Proto Labs Vicki.

Thanks, Dan Good morning, everyone. Thank you for joining us on our third quarter conference call I will begin with an overview of our overall business performance in the quarter and John will provide a detailed look at our third quarter financial performance as well as our outlook for the fourth quarter.

Our business grew year over year in the third quarter. Despite an industrial environment that has continued to soften.

Consistent with what we've said in the past our businesses negatively impacted by a decline in manufacturing activity and industrial production.

2018, with a very strong year for Proto labs for our customers and for manufacturing and industrial activity.

If you recall tax reform, just going into effect and business confidence in investment, we're both higher than current model.

Did demonstrate the impact at the economy to our business our top 100 customers grew nearly 20% in the first nine months of 28 team.

In the first nine months this year revenue generated from the same 100 customers was essentially flat.

All these customers remain key Proto labs.

Customers, but their investment level has varied due to the economic environment.

A rapid manufacturing business in new Hampshire declined 14.3% compared to the prior year.

As we look at third quarter revenue by geography.

The Americas, our largest market produced revenue growth of 2.4% over the prior year.

Excluding the acquired services, our legacy services in the Americas grew 5.0% year over year.

As it relates to customer industries, we saw strong performance in medical and aerospace.

And year over year declines in automotive manufacturing computer electronics.

Our Japan region grew 7.4% in constant currencies.

Transitioning to revenue by service injection molding revenue increased 2.8 per cent compared to the third quarter 2018.

CNC machining declined 1.5% year over year impacted by foreign currency exchange rate and a decline in our acquired CNC services.

Third quarter 2018, CMC organic revenue growth was 29% and produced a record quarterly Proto labs record.

Creating a difficult comparisons to the most recent corridor.

The Threed printing market continues to expand and we continue to rapidly produced threed printed parts with outstanding quality and repeatability.

Two particular threed printing technologies that have been extremely successful for us recently, our metal threed printing offer and multi jet fusion technology.

These technologies expand our keep our ability to deliver production solutions.

Our offerings continue to provide exceptional value to customers as industry demand for metal threed printing and multi jet fusion carts gross.

We will continue to aggressively pursue new and differentiated threed printing technologies to serve our customers as the Threed printing market continues to evolve and expand.

Lastly sheet metal contributed $5.3 million revenue in the quarter, representing a decline of 18.2% year over year.

As we stated previously a rabbit acquisition has not met our expectations.

Following the acquisition in December 27 team, we spent 2018 adjusting the offer and manufacturing operations to one which is aligned with an e-commerce scalable digital manufacturing model.

Consequently in 2019, we moved away from some complex business.

We are experiencing some success in our crop cross selling efforts with greater than 20% increase in the number product developers using the acquired services.

However, the drop an average order value was greater than anticipated.

Even with the increase in product developers utilizing the acquired services.

The penetration into our existing account base is in the single digits.

Well the opportunity remains strong we're finding that unseating existing sheet metal vendors in this difficult macroeconomic environment has proven to be a challenge.

The difficult environment went out last forever and as we create a differentiated service in the market like integrating sheet metal into our customers buying experience, while achieving market leading on time delivery results with stated lead times, we will ultimately drive the necessary volume through these operations.

We're very confident we have to rate actions in place to improve the performance of these acquired services.

I have personally I did personally responsible for several major business turnarounds in my career and the key to success are are a keen focus on the earnings drivers of the business.

In Proto labs case this reside in driving the cross selling across our vast customer base and developing innovative ways to flex costs with the variable ability of demand, which is inherent in an on demand manufacturing business.

Our actions underway in both these areas, which I am confident will yield results.

In summary, due to a weakening macroeconomic environment and difficult comparisons after a tremendous 2018 for Proto labs are 2019 year over year growth rates have been lower than historical level.

When does this optimism in capital investment in our geographic markets increased we believe Proto labs will demonstrate tremendous growth because of our scalable model and the value we bring to our customers.

Our third quarter unique product developer served increased to 21471 or growth of 3.3 per cent compared to the prior year with strong growth in threed printing continuing to allow us to engage with their customers earlier in the product development cycle.

Our non-GAAP gross profit for the quarter was $60.5 million, resulting in adjusted gross margin of 51.5% in the third quarter down sequentially from 52.6% in the second quarter of 2019.

Sequential gross margin compression of 110 basis points in third quarter was due to the following factors.

As we've stated in the past it is difficult to adjust our cost structure in the short term when volumes are lower than anticipated.

Adjusted operating expenses totaled $35.1 million or 29.9% a total revenue for the third quarter of 2019. This compares to $37.1 million or 32% of revenue in the second quarter, a reduction of $2 million.

The largest component of the sequential decline relates to the second quarter seasonality of marketing spend including expenditures associated with several trade shows.

The net result was adjusted EBITDA on a quarter of $32.3 million or 27.5% revenue an improvement of 80 basis points over the second quarter.

Our third quarter 2018 effective tax rate was lower due to favorable results in an IRS tax on it.

non-GAAP EPS was down 10 cents per share compared to third quarter of 2018.

Today, we have repurchased $50 million under our stock repurchase program, resulting in 50 million remaining available under the plan.

We ended the quarter with the cash and marketable securities balance of $155 million on September 30.

Now I'd like to provide our expectations for the fourth quarter of 2019.

We estimate foreign currency will not have a significant impact on our fourth quarter revenues compared to the prior year.

Moving to earnings guidance in the fourth quarter each year, we incur holiday pay during the Thanksgiving and Christmas holiday seasons their results and increased labor costs.

Our non-GAAP add backs for the quarter will include stock compensation costs of approximately $2 million and amortization of $900000.

We currently estimate our non-GAAP tax rate to be approximately 20, 122% in the fourth quarter.

Taking into consideration all the above we expect our quarterly non-GAAP EPS to be between 59, and 67 cents per share in the fourth quarter.

Thank you.

Well now be conducting a question answer session.

Participants using speaker equipment, it maybe necessary to pick up your handset for pressing the sarkies.

One moment, please while we pull for questions.

Thank you. So first question is from the line of Brian Drab with William Blair. Please proceed with your question.

Hi, good morning, Thanks for taking my questions.

So I guess the difficult macro environment is a well understood and well publicized so maybe just getting into some of the details of the business first.

And I'm wondering if you could I didnt hear a number for rapid overall sequential.

You know that that business would kind of.

Decline or flatten out sequentially when it should be ramping.

Impacted by that as well, so it's up and I'm confident we'll get customer feedback there very pleased with the service Theres nobody else out there that offers you a three day lead times on on sheet metal parts, but I'd say, it's a matter of turning those customers and taking share in a macro environment.

The local mom and pops around the quarter. They they now have capacity and they can't service that business. So we got to take that share on from knows in in what is a more difficult macro environment.

And Brian for that the numbers on that it's it's down 9% care about a million dollars.

Okay sequential essentially.

About a million 9% [noise] okay.

And then you know you talked about the pressures on gross margin.

Can you talk about.

The outlook for for gross margin you know what do you expect gross margin to be.

In the fourth quarter and trending into 2020 as their gross margin expansion potential from here and how much.

Some challenges really managing the cost structure.

Downward with revenue being sequentially down so as we're looking at gross margin it probably would be a little bit lighter than than where we are currently in the fourth quarter.

We we are focused on on gross margin across each of our services, we're going through our budgeting process right now and looking at the actions and building up the plans for for 2020.

We will be looking to drive improvement in the gross margins, but what we're going through the work right now.

Fully flesh out those plans.

Okay, and then I'll just ask one more for now, but how what have you seen in October in terms of demand relative to.

The third quarter and and in October last year.

Yes, I think what we've seen in demand is that it's pretty it's consistent with the guidance that we put out.

So we feel comfortable with.

At this point with the revenue guidance, we just.

Yes, David.

Alright, okay. Thanks, very much I'll follow up later.

Thank you. Our next question is from the line of Andrew They've got to gas free with Feldberg. Please proceed with your question.

Good morning, I, just want to ask sort of follow up on one area. You mentioned in terms of the aerospace business slowing down.

Do you think that's a temporary blip I know the solve this morning, I also mentioned something of a push out.

They're around or is there anything specific that you can highlight.

Yes, I think it as a temper a temporary blip, we see on strong activity, we have a very strong value proposition in aerospace and remember where we play in aerospace it's not so much commercial aircraft. It's in space. It's in on a satellite communications debts, and drones and lots of lots of that.

It's just in that particular quarter it was.

Basically flat or down very slightly so, whereas we're still confident that that's got long term legs and lots of R&D activity and low volume production in that space for us.

Got it and in terms of a the rapid business I know I'm focusing on down a bit but just to sort of a question in terms of how do you see thats progressing.

I guess in Q4 as you're dealing with the issues in the macro side and also the sheet metal business overall, but do you see this business returning to growth.

Starting in Q4 year over year I know last year started declining or is it really just a 2020 event.

So you know we.

Significantly change the offer and then focusing on the cross selling efforts with Proto labs customers and teaching them really how on our offer with sheet metal and the expanded CNC offer.

I will work for them. So that takes time, we also ran a macroeconomic environment where.

Cautious on the forecast there recognizing we got to be able to in addition, create a much more integrated customer experience and that will take us a little time.

Got it last question the low volume does this versus prototyping have you seen sort of a bigger pulled back from there a at this point.

So we've seen Cros are you talking particularly about in the injection molding service Gotta, we wrap.

Yes, there are we stated offer for on demand manufacturing and we continue to see that on that growth an injection molded molding witnessed by the larger orders that were starting to see come through in that space. So we feel comfortable that but our prototyping business and injection molding is growing as well so.

I would say that between the two they're growing at its comparable rates.

Got it thank you.

<unk>.

Some of the production supplies and repair and maintenance so we hadn't in some of our facilities thing in the U.S., but.

Metal and the CMC component the operations.

Allergens and sure that makes my sense combination of Thats.

Alright, and then I.

I guess.

You too much I see we saw some deleverage and sales and marketing this quarter.

It sounds like it may have been seasonal with some trade events, but also said that you made some some and comments items will be more intentional so just be curious.

Ultimately, maybe not in fourth quarter, but is there any leverage and you'd be operating lines. Here that you guys can do to maybe offset the sluggishness in the in the Dublin.

Yeah, I think we're continuing to look at at.

Sales and marketing I think.

Prudent with with some of the.

Marketing spend but yeah I think we are continuing to look to to drive that volume growth. The GE an area GNS area is an area. We'll we'll continue to look at continue to scrub and and we'll manage that line item and we continue to work on driving the productivity of our sales team I mentioned before we're using.

Using data and analytics in order to have our sales team focusing on the opportunities that have the greatest lifetime value for us.

So that's industry segments and types of customer companies were taken more.

I understand that so Vicky how about for you I would love to hear just kind of qualitatively you thoughts on 2020, and I know there and I can get numbers from you specific guidance, but it doesn't seem like we're going to see a rapid recovery and I send data are coming into an election year. So I mean, yeah. In this initial thoughts on 2020 it'd be awesome.

Well, so I think you'll see that.

Through next year.

Alright, well good luck.

Thank you Thats right.

As a reminder to ask questions. You May proceed star one.

The next question comes from the line or tumor shooting with Needham and company. Please proceed with your question.

Good morning, one of the follow up other comments that you made about some cautious this that you're seeing and ROI on some of the R&D projects and normally I don't.

I wouldn't expect you would see that and slowing macro environment, particularly something that's fairly fairly modest slowing so I wonder if you could elaborate on that or maybe talk a little bit about perhaps which were articles you're seeing that in.

Yeah I.

Thank you know as we're looking at it Jim and I think that's why we gave good data point of our top hundred customers last year, we saw strong growth in in those tops wondered customers and this year, they're essentially flat and what that creates is <unk>.

We delivered strong growth in 2018.

So those customers having increased their spending level from where that was right in 2018. It it's flattened out more that's kind of creating some of that challenging and putting pressure on that topline percentage growth number.

Is that help.

Maybe we could just switch gears for a second and I'm also trying to reconcile the continued strength you're seeing in Threed printing and I mean, you called out a couple of areas metals.

The multi jet and the clearly those seem like good growth areas, but I'm wondering are you do you feel you're just taking share or is this is just part of the business the market just continuing to grow.

I think we've got a little bit of both going on we do have on a differentiated also with respect to quality and the consistency and reliability of our offer so when customers are looking for high quality industrial threed printed cards for their programs.

For the place to go so I think we're seeing some of that I do think customers are learning more and more how to use threed printing both in their product development cycle as well as how to design for Threed printing for production and I think Thats, what you see with the growth in our metal Threed printing and multi jet fusion, which are both technologies that are predictive, particularly.

Valuable for production type programs. So I think just a little bit of both on that's happening with that business.

[noise] Vicki last question can you say, which which market verticals you seem to be getting the most traction and metals and multi jet.

So.

And we're seeing it in aerospace in med device and also somewhat in.

Ah computer electronics in the multi jet fusion plastic area. So those would probably be the three industry verticals.

Okay. Thank you.

Next question is follow up from the line of Brian Drab with William Blair.

So.

I'm just looking at the the notes from the <unk> the last call on the expectation for gross margin.

More what has changed in terms of the.

Trajectory because you are you really cautious I think you know as you looked to the second half a year in terms of.

Revenue growth, but you were expecting gross margin to step up.

Sequentially. So is the biggest.

Factor there that's changed in the rapid business or is it.

I guess, a combination of that with increased caution on the overall topline trajectory.

Yeah, I think it's the you know it's easier to leverage costing in when revenue is increasing right as revenue is lighter than than we anticipated that you've got to pull cost back.

And and that's just had a bigger challenge. So I think it is the volume there and what we just expense in in rapid that's that's creating that cost.

Okay.

Okay, and then John can you just give us an update just the numbers on where alpha.

Gross margin is and where rapid gross margin is and what.

The overall headwind those are having not year over year, but just the overall headwind those have on.

Gross margin.

Yeah.

And and aware of is that I guess like last quarter Alpha was that a little over 20% gross margin, yes, very soon we dipped down into the mid teens.

Okay and student centered in Europe , and then in New Hampshire were in that 25% range.

Okay got it thanks very much.

Thank you at this time I'll turn the floor back to measure for closing remarks.

Thank you for joining us today, we're confident in the long term prospects and the strength of our business model. Our differentiated technology enabled digital manufacturing platform has demonstrated the ability to help companies an entrepreneur get their products to market faster than their competition, we continue to innovate with our service.

Brings and technology interface and features to enhance our customers experience I want to thank the Proto labs employees for their continued efforts as well as our customers for their support we look forward to updating you on our progress during our next call. Thank you.

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