Q2 2022 Proto Labs Inc Earnings Call
Greetings and welcome to the prototypes second quarter 2022 earnings Conference call. At this time all participants are on a listen only mode. A question and answer session will follow the formal presentation. If you would like to ask a question. Please press star one on your telephone keypad, if anyone should require operator.
Your assistance during the conference. Please press Star zero on your telephone keypad.
As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host Mr. Jason Franklin Vice President and corporate controller. Thank you. Please go ahead.
Thank you Donna and welcome everyone to Proto Labs' second quarter 2022 earnings conference call.
I'm joined today by rapid or Proto labs, 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 32022 of 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.
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 rich.
Court 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 rapid Dora Roberts.
Thanks, Jason Good morning, everyone and thank you for joining our second quarter earnings call.
Happy to report another strong quarter with revenue and EPS within or above our guidance ranges.
Despite ongoing supply chain challenges in the broader manufacturing industry and macroeconomic growth concerns.
<unk> comprehensive digital manufacturing offer continues to delight our customers.
Highlights of our second quarter performance includes strong growth in our CNC machining three D printing and sheet metal surfaces as well as another quarter of strong growth at hubs.
Both the Proto labs at hubs offers continue to resonate in the marketplace and we're now more excited than ever to bring the two offers together by the end of this year.
In addition, pricing optimization and cost controls drove sequential improvements in both gross and operating margins.
Okay.
While we're very pleased with the performance in our CNC machining <unk> printing cheap coal services.
Revenue in our injection molding service did not meet our expectations in the second quarter.
As was the case in the first quarter, our injection molding growth rate was negatively impacted by the absence of several large COVID-19 related medical orders that occurred in the first half of 2021.
In addition, we experienced many customers, placing unusually large orders in 2021 in order to stockpile inventory during that time of high uncertainty.
In 2022 that behavior has significantly reduced among our customers in line with macro inventory trends in the industries we serve.
Furthermore, the unprecedented surge of orders in 2021 led to record high backlog for us.
These extended lead times, coupled with system inefficiencies, we described in prior quarters impacted our customers.
We've addressed this operationally and our fastest lead times are fully available today.
We're focusing our go to market teams on targeted campaigns to inform and reengage impacted customers with our world class offerings.
We're still very confident in our competitive advantages of our injection molding service and are focused on providing great customer experience going forward as we returned to growth.
Okay.
Before I provide an update on our 2022 strategic priorities I'd like to take a few moments to address important actions that occurred during the second quarter of 2022.
First I am excited to announce that in early June after an extensive search process, Dan Schumacher was named Proto Labs' Chief Financial Officer.
Dan has been with Proto labs for five years.
And most recently served as interim CFO for six months.
Dan brings a strong pedigree of leadership experience and operational excellence Proto Labs' leadership team.
He is a great asset to the business and a great partner to me.
I'm very excited to work alongside him and all of our great employees as we continue to revolutionize manufacturing and delight our customers.
Okay.
Secondly.
I want to discuss our strategy for managing our portfolio of businesses and initiatives.
We're actively working to focus our investments in areas that promise the greatest return and.
And ultimately the greatest shareholder value.
Proto labs has the greatest opportunity for profitable growth through the integration of our manufacturing partner network and our internal digital manufacturer.
Our resources and investments are focused on opportunities with the highest potential return, which means making decisions to reallocate resources away from those areas that are no longer aligned with our long term objectives.
Consistent with that philosophy in May our board of directors approved a plan to cease operations in Japan and close our manufacturing facility in the region.
Proto labs entered Japan in 2009, but our Japanese business only grew to 3% of our total revenue over that period.
And did not meet our profitability expectations.
Our low touch E Commerce digital manufacturing business model did not resonate, especially well in a region where customers place enormous value in long term personal relationships.
This was a difficult decision that I did not take lightly.
And I truly want to thank all our employees in Japan for their hard work and loyalty to Proto labs over the years.
Affected employees in Japan will receive severance and other transition assistance.
We will ship final parts to customers through September .
Dan will provide details on the financial impact later in the call.
Next during.
During the second quarter Proto labs received another impressive piece of external recognition.
In June <unk> was awarded a manufacturer of the year for the manufacturing leadership Council or MLC or division of the National Association of manufacturers for.
<unk> has won numerous leadership awards from the MLC over the years.
And this is the first time, we've taken home the top price.
The award recognizes our all around excellent set of small to medium sized manufacturer.
Proto labs joins an esteemed alumni group of recent manufacturer of the year Award winners that includes Universal Robotics, Inbev IBM and Merck.
<unk> continues to be recognized externally on a regular basis for our best in class digital manufacturing capabilities.
This is a testament to the great work that our employees do and the value we provide to our customers.
Now, let me remind you of our 2022 strategic priorities to continue to guide us as we deliver on our mission to empower companies to bring new ideas to market by offering the fastest and most comprehensive digital manufacturing service in the world.
Our first priority is accelerating our revenue growth through expanded offerings pricing optimization and integrating the hubs network into our ecommerce experience.
As I mentioned earlier, we saw very strong growth in our CNC machining and three D printing services.
<unk> growth was also solid in the quarter.
Going forward, we're focused on accelerating growth in our injection molding service.
Regarding the integration of the Proto labs and hubs offers into one E. Commerce platform, we continue to make good progress.
With a dedicated focus on the customer experience. We're on track and we'll have the initial integrated CNC machining released by the end of the year.
We are very excited to provide a unified digital experience combining our digital manufacturing with our digital network, bringing together the strengths of Proto labs hubs will provide our customer offering that no one else in the market replicate with unrivaled breadth of manufacturing capabilities lead times and prices furthering our industry leadership and profit.
<unk> growth.
Our next priority in 2022 is to delight our customers.
And we continued to deliver on our strong on time delivery quality rates, while offering the fastest lead times in the industry.
Our best in class speed and reliability allows Proto labs department with customers as they innovate and create new and improved products products like electric vehicles to reduce carbon emissions medical devices to help people live Fuller more active lives.
Habitats to help astronauts live and explore the lunar surface and.
In advanced prostatic lens that help athletes compete.
Many of our customers are working to change the world for the better and we're proud to collaborate alongside them towards that objective.
Our third priority is to be the digital leader at scale.
By increasing our levels of automation in the factory and back office.
We are pleased with sequential improvements in both gross and operating margins in the second quarter and will continue to optimize price and drive diligent operating efficiencies to continue this trend.
We will continue to drive the organization to deliver on our target gross margins of 50% and internal digital manufacturing and 25% to 30% through the hubs manufacturing partner network.
Our next priority for 2022 is to be a great place to work.
Proto labs employees drive the success of our company and we will continue to invest to recruit and retain the best talent.
I am very encouraged by the energy and passion, our employees have demonstrated by collaborating.
To make a positive impact on all of us at Proto labs, and the communities that we live in.
During the quarter several employee led groups organized cross functional team building activities and initiatives to raise donations for various charities.
Thank you to the Green team the diversity equity and inclusion leadership Council protocol givers and many others for your continued efforts there truly inspirational.
With these clear priorities in place.
I'm confident in our ability to execute on both our short term and long term objectives. The combination of Proto labs best in class rapid digital manufacturing services and hubs outsourced manufacturing partner network is a unique and winning model in a rapidly growing market.
While we may face near term disruption in macroeconomic uncertainty we remain confident in our long term strategy and are focused on execution.
With that Dan will now take you through our second quarter financial results and our outlook for the third quarter.
Thanks, Rob and good morning, everyone. We are pleased with our financial results in the quarter, including record quarterly revenue and non-GAAP earnings per share above our guidance range.
Before I walk through our financial results in detail I'd like to highlight the financial rationale behind our decision to exit Japan.
After 13 years of operation, Japan represented 3% of our total revenue in 2021 or $13 million.
And the same amount of time, our Americas, and Europe business had grown to over five times that size and.
In addition between 2009 and 2021.
Core Lab's, Japan achieved profitability in only four of those years based on this we determined that we could achieve higher potential returns by investing additional capital time and resources in other areas of the business.
Now onto the numbers, our second quarter financial results begin on page seven of the presentation.
Second quarter revenue of $126 9 million was within our guidance range and represents a three 1% increased year over year or five 4% in constant currencies.
Hubs generated $11 $3 million of revenue in the second quarter, representing growth of 26, 3% year over year.
With the strengthening of the U S dollar throughout the second quarter, we experienced a $2 7 million unfavorable impact to revenue in the quarter slightly above our guidance of $2 5 million.
Second quarter revenue by region as summarized on slide 11.
In the Americas, our largest region second quarter revenue grew five 6% year over year.
In Europe second quarter revenue grew three 9% year over year in constant currencies.
Transitioning to revenue by service, our CNC and <unk> printing services continue their strong performance year to date with second quarter revenue growth up 17, 7% and 12, 6% year over year in constant currencies, respectively.
Sheet metal revenue growth was also strong at nine 4% year over year.
As Rob noted our injection molding business has underperformed expectations in the first half of 2022.
We are actively working to drive demand.
Injection molding revenue declined five 6% year over year in constant currencies.
We served 24058 unique product developers in the second quarter up three 5% year over year consistent with revenue growth.
Turning to slide 15, and our detailed income statement.
Overall second quarter non-GAAP gross margin increased 20 basis points sequentially to 45, 9%.
Gross margin improvement was driven by higher volume price optimization, and prudent cost management and our manufacturing facilities.
<unk> gross margin in the second quarter was 26, 4% compared to 24, 2% in the first quarter of 2022.
The sequential improvement was largely driven by increased volume and improvements pricing algorithms.
In the second quarter hubs lower margin outsourced manufacturing model represented 180 basis point drag on our overall gross margins as it continues to grow faster than our internal digital manufacturing services.
Total non-GAAP operating expenses were $42 3 million in the quarter.
Down $600000 from first quarter of 2022.
Wages and contractor expenses declined slightly sequentially as head count was below expectations throughout the second quarter. This.
This was partially offset by an increase in hubs operating expenses as hubs continues to invest in go to market initiatives as well as an increase in professional services.
Regarding the eventual exit of our Japanese operations the decision to close Proto Labs, Japan business resulted in a $5 2 million.
And GAAP operating expenses during the second quarter, including $2 $2 million of employee severance $1 $2 million related to the write down of fixed assets <unk>.
$900000 of facility related charges.
$600000 in goodwill impairment charges.
$300000 and other closure related charges.
These expenses have been excluded from our non-GAAP financial results to enable clean comparisons to prior and future periods.
See slide 15 in the appendix of our accompanying slide presentation for GAAP to non-GAAP reconciliations.
Moving to taxes.
Our non-GAAP effective tax rate in the second quarter was 21, 1% compared to 23, 3% in the prior quarter and 26, 7% in the second quarter of 2021.
Our non-GAAP a fast effective tax rate was lower compared to prior periods due to release of reserves for uncertain tax positions.
Second quarter non-GAAP diluted net income and income per share was <unk> 46.
Representing a sequential increase of eight <unk> per share.
This sequential increase was driven by higher volume gross margin improvement in the Americas, and hubs and lower selling general and administrative head count.
non-GAAP earnings per share were above the high end of our guidance range, primarily due to lower head count and a lower tax rate due to the reserve release.
Transitioning to cash flow and balance sheet highlights on slide 16, we generated $13 3 million in cash from operations in the second quarter. We also deployed capital in the form of share repurchases in the second quarter in order to offset dilution from stock based compensation.
We repurchased $5 2 million in shares during the quarter.
At June 30, we had $110 1 million in cash and investments on our balance sheet and we remain debt free.
Now I'll provide our outlook for the third quarter of 2022 as outlined on slide 18, we.
We expect to generate revenue between 121 and $129 million in the third quarter, representing year over year growth of up to 7% in constant currencies, excluding the impact of the closure of Japan.
This guidance incorporates July performance.
Current demand trends and typical seasonality patterns.
We expect foreign currency to approximately a $2 $9 million unfavorable impact on revenue compared to the third quarter of 2021.
The closure of our Japan operations are expected to have a $1 $8 million negative year over year impact on our revenue growth.
Moving to earnings guidance.
We anticipate non-GAAP add backs in the third quarter to include stock based compensation expense of approximately $3 8 million and amortization of expense of $1 5 million.
We anticipate the closure of Japan to negatively impact our non-GAAP gross margins in the third quarter. We currently estimate our non-GAAP effective tax rate will be between 23 and 24% in the third quarter.
In summary, we expect third quarter non-GAAP earnings per share between <unk> 36 and 44.
That concludes our prepared remarks, Rob and I will now gladly take your questions.
Thank you the floor is now open for questions. If you would like to ask a question. Please press star one on your telephone keypad at this time a confirmation tone will indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.
Once again that is star one to register a question at this time.
The first question is coming from Brian Drab of William Blair. Please go ahead.
Hi, good morning, Thanks for taking my questions.
Good morning, Brian Good morning on injection molding. So it's declined during some quarters the sequential declines.
Basically flat, but it declined sequentially for the last four quarters or.
So is there any specific reason.
Or that you can point to or can you give us some confidence that that business, specifically with is going to turnaround in the second half.
Trying to figure out how to how to model. This business now at this point.
Yeah. So when you look at.
And when you look at it year over year right.
A year ago, we had.
A number of Covid related orders that didn't recur, but as you look more broadly.
During that period, we saw.
An unprecedented surge of orders across.
Many customers across many industries right as companies were.
We're stocking reserve inventory to whether the supply chain disruptions at the time.
And and.
And so.
And in addition to that the impact of that for our business.
Specifically was that was that that surge in orders was coming at a time when there was.
Difficulty and in direct labor head count right. There was a shortage of direct labor head count and the timing was such that we have recently launched our new systems.
And we had some inefficiencies.
Due to those systems right that we've talked about and so all of those together.
Impacted our on time and led to record backlogs for us that took several quarters to resolve.
Since then we have made.
Significant improvements operationally across all of that.
We introduced automation in the factory, which is.
Improved our operational efficiency and also.
Reduced our need for the same kind of level of direct labor as we scale revenue and we improved made improvements to our systems and made those more efficient. So today, we stand totally ready to take all orders. We can offer all our world class lead times, we can make molds in a day.
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And so we're much better positioned actually to deal with that level of demand.
And we were a year ago.
So we're.
Working right now to re engage those customers that were impacted.
And our go to market teams are are in the process of doing that.
Two to help us continue to drive demand.
So thanks.
Thanks for reviewing the year over year dynamics I guess, so you do feel like this is a business that.
Given those.
The actions that you just mentioned that this is going to increase sequentially.
Going forward or do you or is it or is there less surplus you know theres more uncertainty now just because of the macro environment as well I guess.
And then Ken can you make any statement on what.
Whether you see this injection molding business generating more revenue in the second half of 'twenty two than it did in the first half because it's just hard for me to.
Model. It now since the last time I understand the year over year dynamics, but the last three quarters have been $53 million to $54 million in that range. So.
Any any without any increased confidence I don't I don't know why I and the macro where it is I don't know why I would forecast anything above 53 or $54 million for injection molding.
So Brian we're still Brian were still feeling pressures from a macro perspective.
When we talk to economists.
They're talking about.
Increased inventories at our customers.
Resulting in less demand for from our perspective so.
We are working to improve.
From a go to market perspective, continuing to bring customers.
Into our injection molding service office offer, but it's uncertain right now with the macro headwinds.
Okay.
Yeah, that's fair Okay.
Got it and.
Okay.
And in that business.
Drill down a little bit.
It sounds like the challenge is more on the new molds business.
Rather than the parts business or is it also parts just because production is some of these bigger orders that you were talking about where production and parts business.
Yeah, well a lot of what were seeing was in parts right. Because we saw really strong surge in production parts business.
And that's that's what we're seeing not recur as Dan talks about.
There is evidence that our company's R. R.
Sitting on high inventories. So that's that's really where we expect some of the headwinds.
And then just the last question for me is just that.
Can you remind me what impact this dynamic.
The more challenge injection molding business has on overall company gross margin.
Yes.
So.
If we take a look at it our injection molding gross margins right have traditionally been around mid <unk> with the lower volume our injection molding gross margins were.
Round, 50% in the quarter.
Okay I'll get back in line I might have a couple more thank you.
Yes.
Thank you. The next question is coming from Jim Ricchiuti of Needham <unk> Company. Please go ahead.
Hi, Thanks, just some follow ups on the topic of <unk>.
Wrexham holding.
Yes, I'm curious are you seeing.
Any changes in the competitive dynamics in the market that might.
Contributing to some of the <unk> the.
The demand issues that youre seeing in this part of the business.
Yes.
<unk>.
Obviously, we're known for speed and we offer the fastest lead times in the world in injection molding.
In those in those lead times, we don't really run into competition during.
During the period that I described when we had the significant backlogs and our lead times were longer.
During that period.
Our customers.
Could look at other alternatives they are local molders.
So I think that's the dynamic that we're now really focused on on overcoming as we drive our go to market teams right to Reengage those customers.
Okay.
Maybe just talk about the overall level of demand that youre seeing in the markets.
In light of that.
All of the concerns people have a bad macro how did how did that business track or trend as you went through the June quarter, and how what are you seeing thus far in Q3, and whether you want to deal with that by geographic region U S versus Europe .
But or even talk about it in terms of changes you might be seeing.
In any of your major vertical markets.
Yes, let me let me first say in.
On a constant currency basis.
Our services outside of injection molding grew 15% year over year.
So we're very happy with what happened there in terms of what we're seeing in markets like what we talked about from an injection molding perspective, where we had some larger COVID-19 orders in the last year. So some medical was.
On the lower.
<unk> declined slightly year over year, and then automotive was a headwind, but we saw things really strong from the end markets of aerospace and both industrial and commercial machinery.
Both were strong if.
If you take a look at.
Sure.
Our non-GAAP disclosures you can see that we had growth.
Constant currency growth across all regions.
So.
We were very pleased with that in the quarter.
Okay.
So just and going into Q3. The final question just any change in customer behavior, one way or the other.
Some of the markets.
Your larger markets.
Yeah.
Yes, I mean so.
We've gone through July we really haven't seen much much change right now in terms of end customer behavior.
Okay. Thanks, I'll jump back in the queue.
Okay.
Once again, ladies and gentlemen that is star one to register any questions at this time.
The next question is coming from Greg Palm of Craig Hallum. Please go ahead.
Yeah. Good morning, Thanks for taking the questions I wanted to follow up on that last question from Jim.
If I look sequentially from Q2 at the midpoint Youre guiding down you know call. It a couple of million basically offsets the impact from the exit from Japan, usually Q3 is up at least a couple of million two 3 million. So you said youre not really seen much of a change but guidance suggests maybe a little bit softer activity.
<unk> can you just maybe tie that out.
Missing something.
I think the question was if I'm seeing anything from any specific end market I'd read that by industry right.
Not hearing something different by industry, we set our guidance the.
The same way we have done always we are taking a look at what has happened through July .
And then taking into account.
What we're seeing from an upload trend what we are seeing seasonality.
And so.
That's how we built our guide and obviously with that rate as you can see from our guidance.
We're not seeing right now as strong as our sequential uplift Q2 to Q3 at least as we look through the initial results right.
So.
That's where that stands.
We're continuing from a macro headwind perspective to look at injection molding right and understand what's happening there in terms of.
Sure.
Customers.
With the amount of inventory that they have on hand today in and what that demand is.
Some might signal there that with that trend, we would see a bigger upward churn and injection molding if the macro market was different.
Okay. That's helpful. Thanks for.
Clearing that up is it relates to the Japan exit I think you said you know over time span only profitable four years can you say, whether it was profitable in 'twenty, one or was it profitable in recent quarters that we saw on a full run rate basis.
It was not profitable in 'twenty, one and it was not profitable this quarter.
And did you say the exit is going to have a negative impact on gross margins can you disclose what gross margins were in that region.
What I said is going to have a negative impact on gross margins in the next quarter. The reason is having a negative impact on gross margins next quarter as we have the equipment right. We have the depreciation we have a staff thats on production and we're slowly shipping out the final orders, we expect to add that.
<unk>.
At the end of August early September .
That's what's creating unusually negative gross margin for Japan.
Large enough to be a discontinued ops. So we can't completely remove it from from a reporting from that perspective, and thats why in that quarter. It has.
A negative impact.
From a P&L perspective, the biggest challenge and I talked about this is that Japan was only getting to a $13 million.
Revenue amount.
And with the amount of sales and marketing and <unk>.
And infrastructure that you need.
Overall that was Japan's challenge to get to profitability.
Yep understood Alright, I'll leave it there thanks and good luck going forward.
Thank you Craig.
Thank you at this time I would like to turn the floor back over to Mr boat or for closing comments.
Thank you for joining us on our second quarter earnings call.
We're pleased with our performance in the first half of 2022, particularly in expanding our earnings we have clear priorities in place and are focused on the execution of our strategy, which will lead to the long term profitable growth.
Thank you to our customers and shareholders for their continued support and to our employees for their continued efforts. We look forward to updating you on our performance next quarter have a great day.
Ladies and gentlemen, thank you for your participation and interest in <unk> Labs, you may disconnect your lines or walk off the webcast at this time and enjoy the rest of your day.
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