Q3 2022 Proto Labs Inc Earnings Call
Greetings and welcome to the Proto Labs third quarter 2022 earnings call. At this time, all participants are in a listen only mode.
A question and answer session will follow the far more presentation.
Anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded.
My pleasure to introduce your host Jason Frank Mann, Vice President and corporate controller, Mr. Franklin you may begin.
Thank you Ron and welcome everyone to Proto Labs third quarter 2022 earnings conference call.
And today by Rob Indoor <unk>, 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 third quarter ended September 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 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.
Now I will turn the call over to rapid or Rob.
Thanks, Jason.
Good morning, everyone and thank you for joining our third quarter earnings call.
This morning, we reported revenue and non-GAAP earnings per share within our guidance ranges.
Revenue came in near the bottom end of our guidance as strong growth in several areas of our business is being largely overshadowed by a decline in our injection molding revenue.
Predominantly due to the challenging macroeconomic climate.
The primary headwind in injection molding is a lower level of follow on parts orders.
These are orders for parts made from a previously purchased more.
Following significant growth in the third quarter of 2021.
<unk> revenue decreased 17% this quarter in constant currencies and excluding Japan.
As was the case in the first half of 2022.
Third former injection molding growth rate was negatively impacted by the absence of several large parts of orders that occurred last year. Additionally.
We saw fewer production parts orders.
In the most recent quarter due to excess inventory buildup in the market at a time when many of our customers are experiencing softening demand and elevated inflation.
The macroeconomic and inflationary headwinds impacting injection molding parts orders.
Other manufacturing services, because injection molding has the highest relative proportion of low volume production compared to prototyping.
And the highest average number of parts per order.
I'm pleased to say that by contrast, our business outside of injection molding.
To grow double digits throughout 2022.
As I've said before I still firmly believe.
As much as ever today, we are very confident in the competitive advantages of our injection molding service and are committed to improving our performance.
Last quarter I mentioned, we were focusing our go to market efforts with targeted campaigns to inform and reengage customers.
Other planned actions will materially expand our offering in injection molding to drive growth.
Besides additional go to market enhancements and ecommerce user interface improvements.
We're expanding our lead time and pricing options available through our digital factories.
We will also leverage our manufacturing partner network to provide a more holistic injection molding service offering parts outside of our control manufacturing capabilities as well as additional pricing and lead time options.
In contrast, the follow on parts revenue third quarter mobile revenue was up slightly year over year in constant currency and excluding Japan.
We planned actions in place to continue to drive this growth, but recognize that we face some near term headwinds including macro uncertainty.
Though we are disappointed with our recent injection molding parts performance. There are many areas of our business that are performing very well in a challenging operating environment.
We reported yet another quarter of double digit growth in CNC machining and <unk> printed.
In particular, we are very pleased with the performance and the longer lead time portion of our CNC machining offer.
Our revenue is fulfilled by both the digital factory and the digital network grew over 40% year over year.
This is a great example of overlaps responding to the market.
Expanding our customer offering by launching a new service quickly to drive significant growth.
Now I'd like to shift away from our third quarter performance and take a few moments to reflect on the impact our business has on society.
Proto labs has many stakeholders, including shareholders employees customers and the communities in which we operate and others.
We get to partner with 55000 customers annually on very meaningful projects. Our mission is to empower companies to bring new products to market by offering the fastest and most comprehensive digital manufacturing service in the world.
We empower companies to change the world for the better on a regular basis Gen.
In general if there's an industry in which fast innovation and speed to market are a vital.
Proto labs is likely heavily involved.
Let me provide a few examples.
Yeah.
First.
Medical devices are a great example of the impact we have on society.
During the COVID-19, pandemic, we provided prototyping and low volume production for COVID-19 test kits lifesaving medical devices.
Personal protective equipment and more.
The World class speed and reliability of our digital manufacturing service allows customers to choose us to help them that one of the most severe public health and economic crises we've seen.
And we produced over 20 million parts in response.
Space exploration is another example.
Proto labs is helping NASA make a return to the moon and a voyage to Mars a reality.
<unk> with a trio of universities international competition to develop technology that could someday extract water on the surface.
Next up electric vehicle development.
Many companies are working to develop next generation of ease and charging infrastructure.
<unk> global reliance on fossil fuels in many cases, we're along for the ride is a quick turn supplier delighting, our customers and helping to fight climate change simultaneously.
Okay.
My last example is sustainable energy sources we.
We worked with the customer during the department of Energy's American made challenge.
Each entrants were tasked with finding a sustainable geothermal energy solution using U S based suppliers are.
Our customer one that competition.
Sustainability is another area in which there is a definite urgency in innovation and development, which is why many customers choose prophylaxis of supplier.
Clearly the work, we do and the parking manufacturer matter to our customers and to the world fighting the COVID-19 pandemic accelerated space exploration furthering an electric vehicle development enhancing sustainability or just a small sample of the areas in which we contribute.
<unk> partners with customers to accelerate the advancement of betterment of the communities, we live in and society as a whole.
Before I provide an update on our strategic priorities.
I'd like to address important third quarter business updates.
First I'm excited to announce that in September after an extensive search process OLED Rob boy.
<unk> was higher as Proto Labs', Chief Technology Officer.
OLED was previously CTO with digital River, a global ecommerce platform and software as a service company that provides online storefronts OLED brings a wealth of knowledge and experience as he takes on the leadership of our technology teams around the world. We're very excited to have all that on board and he has already had a positive impact on our.
Business.
Also on September we launched the first iteration of our integrated offer in.
In Europe .
We now offer CSD manufacturing for eligible parts through the combination of our internal digital manufacturing.
Our digital network of manufacturing partners, we began the rollout in Europe , and we will continue to test and iterate in.
In the coming months, we will offer customers more expanded capabilities through the digital network and we plan to expand the integrated offer to the Americas in early 2023.
And finally <unk>.
<unk> U S injection molding facility was named the 2022 best plant by industry week.
Edging out final isn't such as GE appliances flex and others.
According to industry week, our injection molding facility was awarded best plant.
It is on the leading edge of efforts to increase competitiveness enhance customer satisfaction and create stimulating and rewarding work environments.
Now, let me provide an update on our strategic priorities for 2022.
Our first priority is accelerating revenue growth our primary focus areas for investment in the near term are driving injection molding growth and continuing to expand our integrated offering.
Other areas of our business, we're making great progress on accelerating growth CNC machining and <unk> printing have grown double digits year to date hubs continues to grow rapidly.
To accelerate growth, we must delight our customers our second priority.
During the third quarter, we delivered strong on time delivery and quality rates, while maintaining the industry's fastest lead times.
New in 2022.
Our cross functional customer experience counsel has made great progress throughout the year gathering customer and employee feedback.
And are working to continually improve the experience across the entire customer journey. These efforts have led to a substantial increase in our NPS score so far in 2022.
Our next priority is to be the global leader at scale.
We continue to launch enhancements to our digital manufacturing technologies that enable us to produce more complex parts and increase automation.
We expanded our automation in the quarter.
However, we measure success in this priority with gross and operating margins in the most recent quarter the decline in injection molding created a significant headwind to our margins.
Injection molding.
One of our higher margin services margin services with lower volume it becomes challenging to absorb fixed costs over.
As we plan for the end of 2022 and on into 2023, we will control spending based on volume levels and demonstrate discipline as we focus our investments we're working to drive efficiency by realigning resources to invest in our biggest growth opportunities.
Our fourth priority is to be a great place to work during the third quarter, we rolled out expanded development resources, including our Metro ship program and expanded leadership training to ensure our employees had the support skills and environment, they need to achieve their goals and ours.
Proto labs employees globally are aligned around our strategic priorities and are working to focus our investments while accelerating our growth.
Despite near term disruptions and macroeconomic uncertainty we are confident in our long term strategy and are focused on executing these four priorities as.
As we enter 2023, we will continue to invest responsibly for the long term in a way that is adapted to the current economic environment.
The combination of Proto labs best in class digital manufacturing services and hubs digital manufacturing partner network is a unique model that will win in the long run.
With that Dan will cover our third quarter financial results and our outlook for the fourth quarter.
Yeah.
Thanks, Rob and good morning, everyone.
Our third quarter financial results begin on page seven of the presentation.
Third quarter total revenue of $121 7 million was within our guidance range and represents a two 9% decrease year over year.
Excluding revenue in our Japanese operations third quarter revenue increased one 6% in constant currencies.
Hubs generated $12 1 million of revenue in the third quarter, representing growth of 38, 5% year over year.
In constant currencies hubs revenue grew 51%.
Changes in foreign currencies continued to negatively impact global revenue growth and represented a $4 1 million unfavorable impact to revenue in the quarter.
Then an expected $2 9 million impact.
Third quarter revenue by region as summarized on slide 11.
In the Americas third quarter revenue decreased one 2% year over year.
In Europe third quarter revenue grew 14% year over year in constant currencies track.
Transitioning to revenue by service.
As Rob noted revenue from ingestion injection molding parts has underperformed expectation in the first three quarters of 2022, and we are working to drive growth in this area.
Overall third quarter injection molding revenue declined 12, 3% year over year in constant currencies, causing overall revenue to come in near the low end of our guidance range.
Third quarter, CNC machining and three D printing revenue grew 12, four and 11% year over year in constant currencies, respectively.
Sheet metal grew eight 3% year over year in constant currencies.
We serve 23816 unique product developers in the third quarter up one 5% from the same period a year ago.
Up four 4% excluding Japan.
Turning to slide 15, and our detailed income statement.
Overall third quarter non-GAAP gross margin decreased 110 basis points sequentially to 44, 8%.
Sequential gross margin change was primarily driven by lower volume in injection molding and a continued headwind from the closure of our Japan business.
<unk> gross margin in the third quarter was 26% compared to 26, 4% in the second quarter of 2022.
Total non-GAAP operating expenses were $40 9 million in the quarter or 33, 6% of revenue compared to $42 3 million or 33, 4% of revenue in the second quarter of 2022.
The sequential decline in operating expenses was driven by a $1 $2 million gain on the sale of an R&D facility in the Americas that was no longer in use and lower incentive compensation accruals.
These decreases were partially offset by continued investment at hubs.
Regarding the closure of our Japan business, we shipped final orders out of our Japanese facility in September and continue to incur expenses associated with the shutdown through the end of the third quarter.
The Japan business closure resulted in $1 2 million and GAAP operating expenses during the quarter, including a $100000 of employee severance and $1 $1 million related to the write down of fixed assets.
Consistent with the previous quarter. 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 GAAP to non-GAAP reconciliations.
Moving to taxes, our non-GAAP effective tax rate in the third quarter was 22, 4% compared to 21, 1% in the prior quarter.
Our non-GAAP effective tax rate was higher compared to the prior quarter due.
Due to a one time release of reserves for uncertain tax positions in the previous quarter that did not repeat.
Third quarter non-GAAP diluted net income per share was <unk> 40, compared to <unk> 46 in the prior quarter.
Due primarily to overall volume and lower internal manufacturing gross margin.
Transitioning to cash flow and balance sheet highlights on slide 16.
We generated $25 million in cash from operations in the third quarter year to date cash generated from operations is up 60% over 2021.
Evidence of the strength of <unk> unique digital manufacturing model.
We've repurchased seven 8 million in shares during the quarter as we continue to purchase Opportunistically.
At September 30, we had $113 9 million of cash and investments on our balance sheet and we remain debt free.
Now I will provide our outlook for the fourth quarter of 2022 as outlined on slide 18.
We expect to generate revenue between 107 and $115 million in the fourth quarter.
This guidance incorporates October performance and typical seasonality patterns.
We have received feedback from key customers that demand levels are uncertain, given the challenging macro environment.
The closure of our Japan operation is expected to have a $3 $5 million negative year over year impact on our revenue growth.
We expect foreign currency to have approximately a $4 2 million unfavorable impact on revenue compared to the fourth quarter of 2021.
Moving to earnings guidance, we anticipate non-GAAP add backs in the fourth quarter to include stock based compensation of approximately $4 million and the amortization expense of $1 5 million.
We currently estimate our non-GAAP effective tax rate will be approximately 10% in the fourth quarter due to the release of an accrual for an uncertain tax position that was resolved in November .
In summary, we expect fourth quarter non-GAAP earnings per share between 18.
In 2006.
That concludes our prepared remarks.
Robyn I now gladly take your questions.
Yeah.
Thank you we will now be conducting a question and answer session.
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Thank you.
Our first question comes from Brian Drab with William Blair.
Alright good.
Good morning, Thanks for taking my questions.
First I just wanted to ask on gross profit.
No there is.
It's one of the key issues is just some deleveraging on lower volume.
What do you see in the near term in terms of gross profit margin is there more pressure to Tom there potentially as a.
Second revenue to step down.
Correct, Yes, we expect more pressure into the fourth quarter, just based on the lower revenue.
Okay.
And our U.
Are you, making any any comments today Dan around.
You know the plan you have for 'twenty three.
For gross margin.
We're we're putting.
Part of the planning cycle right now so we're putting together that and finalizing that but we won't be talking about 2023 on this call.
Oh got it okay. So.
Can you just a higher level question then in terms of Proto labs. Two pointed out can you just remind me and everyone where where are we in terms of integration of all the different components rapid hubs the timing of this and.
Are we done or is there more to.
How much longer to go.
Sure Brian So.
As I mentioned on the call.
We launched the first component of our of our integrated offer.
In the quarter.
And we're starting to see.
Some nice progress with that so this is the.
What we're now enabling is for a customer to be able to.
See in a unified way parts that can be fulfilled through our digital factory or through the digital network.
And in order with.
With that broader range of lead time and pricing options.
We just launched that we're starting in Europe with <unk>.
Kind of a select set of geometries, and we're gonna be accelerating that rollout over the coming months to bring that to the U S and to expand to our entire range of offerings.
We're pretty excited about that.
How does the user know what the select set of geometries isn't because it just you're you're accommodating any random designed someone can come up with what does that mean.
Sure. So you upload your your custom geometry, and your cat file and.
When the when the network ops.
Options are available they are presented to you and you can select them in order.
Okay.
Okay, and then just one last one how.
How much of hubs business today is still Europe .
As in Europe versus outside of Europe .
It's roughly 50 50 with the U S.
Yeah, Okay, Okay I'll get back in line best of luck. Thank you. Thanks, Brian .
Thank you. The next question comes from Greg Palm with Craig Hallum.
Yes, hi, good morning, Thanks, I guess, maybe you can dig in a little bit on.
What you're seeing in October I mean, the Q4 guide is there's quite a bit worse than normal seasonality. So what exactly are you seeing then in October that gives you this amount of caution.
Yes, I mean, we're doing our normal work that we do in terms of looking at what our order trend rates have been.
In October I think.
For us the challenge from the normal seasonality pattern, Greg was really.
Started in in August and late September which is why you saw from a Q3 perspective us coming to the lower end of our guidance range.
So what we're seeing is.
On the injection molding side, we talked about the softness there that softness has continued into the fourth quarter I think what we're seeing across the other product lines.
As things with the longer lead times at this point in time are holding up right. Those are those are actually doing well, it's the <unk>.
Short lead times say prototyping type business that we're seeing.
Additional softening in in October .
Given that what makes you confident that this is <unk>.
Macro related versus.
Additional competitive share loss.
I think what we did is we've reached out to customers and talk to customers about specifically what they were seeing.
And so.
We heard feedback from them.
The.
Projects that were being put on hold on.
Hey.
Already done with my budget for the year most of my budget is shorter for the year.
So.
Really.
I was talking with the customers about what they were seeing.
I'm hearing.
A lot of.
It put on slower demand on excess inventories with our customers.
And Greg I said recall that our Iam service is really designed for speed and high reliability and it's priced to win.
Low to mid volume so in times when Macroeconomically, we're seeing high demand.
That service does very well.
Outperforms the market.
When we see times of.
No big supply chain shocks, we do very well because of our ability to be responsive.
In times when.
There's slower demand in the market overall.
Customers aren't.
So much of a hurry, they're very price sensitive right. That's when we start to see headwinds in this and the service and so that's what we heard from our customers is that they.
Theyre seeing slowing demand they are sitting on excess inventories and so.
As I talked about in the call.
Our response to this is really to broaden our offer and injection molding just as we have.
Defined in our strategy and started to execute in our other services. When you look at our CMC business and our longer lead time portion of that business as we've expanded that offer right. That's growing over 40% I think that's the exact same strategy that we're now executing and injection molding and we will and we will start to see.
Traction in that here in the coming months.
Okay, and I guess, if I could just ask one more follow up.
Looking back I mean injection molding has been <unk>.
A lot less impacted by macro weakness.
Historical years, especially relative to GNC and Thats the business, you've always talked about as being very defensible in nature. So I guess, it's just surprising that you are seeing this magnitude.
Weakness now, especially relative to <unk>. So I guess I'm, just trying to dig into that a little bit further and I guess more importantly, what exactly are you doing internally to stem some of this weakness.
Sure.
So.
Well, so last year Q3, our injection molding parts business was up year over year at 25%. So in fact, we do see cyclicality in this business.
And.
We think that cyclicality is really driven by the area of the market that we've historically focused in which is in.
Yes.
That depends on innovation and.
Our ability to be highly responsive.
And so what we're doing is basically in two areas first on go to market.
Very aggressive sales actions, making sure. We're following up on every opportunity effort, calling on every quote.
<unk>.
And actively engaging with our with our customers.
And hunting for new customers.
And then of course, a broad range of digital marketing around that but.
But I really want to highlight the offer right. We are we're going to be just as we've done in CNC ware.
We've added longer lead times.
We're going to be expanding our offerings in both the factory.
To provide faster lead time options, so leaning in to where we are highly differentiated but then also offering a much broader capabilities and longer lead times, both within the digital factory and through cross selling through.
Our hubs MP network so.
That's all accelerating and.
We'll be seeing those capabilities rollout here.
In the coming months.
Okay understood alright, Thanks best of luck.
Thank you.
Thank you. The next question comes from Jim Ricchiuti with Needham and co.
Yes, good morning, again, I, just would like to understand a little better what you've seen.
Later in Q3 into Q4.
Perhaps in the Americans in the U S CNC machining and three D printing business I mean, it sounds like injection molding is just going to be a little bit more challenging in the near term, but I'm wondering if there has been a shift in demand that you are now seeing and CNC machining and three D printing.
So specifically.
As I've said before I think specifically in CNC machining and three D printing.
And across the services.
Things that are in that shorter lead time had been softening.
A bit in October .
And things that are in our longer lead times in those services have been holding up so both in P&C and in three D. We do offer longer lead times in those services.
And at a lower price point than our traditional quick turn.
Susan and both CNC and <unk> so.
We are seeing.
The evidence that.
It is different than what we saw in the third quarter and what we saw throughout.
2022 is is that there is some softening in that quick turn type business.
And when you say that you've seen some key customers express caution.
Presumably that's in those areas can you elaborate on that in terms of what sectors that youre seeing that and is that consistent with what you buy.
C N a S a slowing economic environment.
Yes, so a couple of the places that.
Typically I don't have the industry split maybe.
In terms of what I'm seeing in October , but just some color on the quarter.
So so auto for us was <unk>.
Down quite a bit.
And then medical actually was.
Was down more now medical some of that we really understand that to be that last year, we still were having some COVID-19 orders within medical so that's part of it but.
I would say.
How much we were down if it goes above and beyond that the COVID-19 piece right.
Yeah.
So those are those are some of the industries at least we are seeing.
Sorry.
And then last question for me.
With respect to.
The growth at least in constant currency that youre seeing in Europe .
It sounds like.
A good portion of that is as hubs.
Hubs related but also it sounds like the rest of the business is doing a little bit better. There. How concerned are you that or are you seeing any signs of weakness.
And that part of it.
In Europe , albeit it's a smaller part of your business, but just wondering what youre seeing there.
Yes, I mean, specifically for Europe .
Again, it wasn't an injection molded story, but outside of that we saw.
Really good growth in both CNC and <unk> specifically in Europe .
CNC growing.
Mid 30% and <unk> growing 20% ish so.
In constant currencies.
Those businesses within.
Within Europe with hubs.
Well.
Yes.
In Europe .
I think we're seeing less of.
Although the softening trend from Q3 to Q4 than what we're seeing in the U S.
Okay. Thank you.
Yes.
Thank you. The next question comes from Ben Rose Battle Road Research.
Yes, Hi, I'm good good morning.
Rob just to drill down a little bit in terms of the.
Plans for.
Rekindling the growth in injection molding.
I understand kind of at a high level, what you want to do is try to compete for some of that.
Is this which which has longer lead times from a kind of a mechanic standpoint due to <unk>.
Question of.
Reconfiguring the factory space that you have with Proto labs in order to.
To respond to.
To that kind of business is it a question of.
Sales coverage or not or maybe some of your customers or prospects not knowing that you can.
Kind of that you can fulfill a longer lead time orders, maybe just some color on that would be helpful.
Sure absolutely. So I think the first step is to.
Make the software and e-commerce changes right to make those additional capabilities available to order online.
And then.
Okay. The factories right. The factory is able to manufacture in that way so that doesn't require reconfiguration in any material way.
So the first would be the e-commerce changes and then of course.
Yes, having the sales teams.
Immuno Kate.
Message to our customers and start to engage them on those orders frankly, we're seeing that.
Those opportunities come through in the flow and so that'll be that.
Looking to the next step we will also expose.
Now as we reached this point in our integration with hubs.
The network to those opportunities as well.
We'll be continuing to accelerate our cross selling into the network.
Those are the steps.
Right that makes sense.
Another question that I have is.
Is there.
Is there any sense that you have that perhaps some of your customers are.
In terms of their own material.
In terms of the prototypes.
The low volume production.
Is there any.
Evidence to indicate that.
Their use might be shift their use cases might be shifting more to CNC machining and <unk>.
<unk> printing.
As opposed to an injection molding.
Well so.
We're seeing continued growth in CNC and <unk> printing if you are asking if.
If those are.
Are taking share from injection molding no. We don't believe so the applications and the use cases, where you are.
Where it makes sense to do three D printing, our CNC are are different than that injection molding.
And our injection molding.
Service, our molds are very inexpensive we started like around $500 a mold so the.
The crossover point, even from a volume standpoint is quite low so that's not what we see is this is the dynamic.
Okay, and then one final question.
Outset of your remarks you.
You talked about some of the exciting developments in the industry.
And obviously, there's quite a bit of prototyping going on.
In the U S.
Maybe some in Europe as well, but.
Maybe a little bit surprised to hear that that.
The automotive sector was down year over year.
Do you see in your pipeline.
Some growing opportunities for EV.
Product development and if so when do you think those might materialize.
So.
First thing Ben.
Auto being down year over year.
Auto is one place in our injection molding parts business that we have a fairly large part quarters last year as customers were facing supply chain impacts and came to us because we can give them their parts quickly.
So auto.
Auto on the production side I would say is what drove the decrease year over year specifically in.
I am.
In <unk>, we are seeing opportunities.
To help companies.
Prototype and in.
To advance those technologies for them so.
We see that as a great place of opportunity for us on the prototype as we.
Go through the fourth quarter and next year.
Okay.
Alright, thank you.
Okay.
Thank you there are no further questions at this time I would like to turn the floor back over to <unk> for closing comments.
Thank you for joining us for our third quarter earnings call. The global manufacturing market is undergoing substantial transformation and enduring macroeconomic headwinds that will create volatility in the near term we are confident that our profitable business model and strong balance sheet position.
Well for profitable growth in the long term we.
We've sharpened our focus on a clear set of priorities, including improved performance in our injection molding business and continued progress on our integrated offerings.
Our offerings in CMC has driven significant growth in that service and we're confident this strategy will.
Had a positive impact in injection molding as well.
I want to thank our employees around the world for their continued efforts as we close out 2020, we look forward to updating you on our performance in early 2023.
Good day.
Okay.
This does conclude our teleconference for today you may disconnect. Your lines at this time. Thank you for your participation.
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Okay.
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