Proto Labs - Earnings Call - Q3 2020

Transcript

Speaker 0

Ladies and gentlemen, this is Dan Schumacher, Director of Investor Relations at Proto Labs. Thank you for your patience this morning. We experienced technical difficulties with our conference call service provider. As a result, we have recorded our call today. With me is Vicki Holt, our president and chief executive officer, and John Way, our chief financial officer.

This morning before the market opened, Proto Labs issued a press release announcing its financial results for the third quarter ended 09/30/2020. The release is available on the company's website at protolabs.com. In addition, a prepared slide presentation is available online at the web address provided in our press release. Before we begin, I would like to remind everyone that our discussion will include statements relating to future performance and expectations that are or may be considered forward looking statements and subject to risks and uncertainties that could cause actual results to materially from expectations. Please refer to our earnings press release and recent SEC filings, including our annual report on Form 10 ks for additional 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 within the Investor Relations section of our company website for a complete reconciliation of non GAAP to GAAP results. With that I will turn the recording over to Vicki Holt, President and Chief Executive Officer of Proto Labs. Vicki?

Speaker 1

Thanks Dan and good morning everyone. Thank you for joining us today for our third quarter earnings conference call. Our agenda includes a brief overview of our financial and business performance during the third quarter and how we continue to manage through the COVID-nineteen pandemic, as well as an update on our Proto Labs two point zero systems project. I will then turn the call over to John for additional insight into our financial results and our outlook for the fourth quarter. Before I touch on our financials and business performance, I'd like to express how proud I am with how our teams have worked together and continue to perform in a complex and challenging environment.

As has been the case throughout 2020, our top priority is to keep our employees, communities, and customers safe while continuing to delight our customers with our market leading digital manufacturing services. Our organization has continually adapted to near term changes guided by our core values of teamwork, trust, achievement. The uncertainty of 2020 has sparked rapid change and our colleagues have shown extreme dedication and resilience as we continue to focus on what we can control within our business during this global pandemic I want to thank each and every one of our employees for everything they do to make Proto Labs such a great company. Turning to our financial results for the third quarter, I'm pleased to share that we delivered third quarter revenue and earnings per share above expectations, driven by the compounding impacts of revenue at the high end of our guidance range, improved productivity, and lower costs. We reported third quarter revenue of $108,000,000 representing a year over year decline of 8% and a 1% increase over the second quarter of twenty twenty.

Our year over year revenue decline is a result of the continued global economic challenges and their impact on our customer base. COVID-nineteen related revenue in the third quarter $3,000,000 down from $12,000,000 in the second quarter. As a reminder, our orders related to COVID-nineteen include parts for ventilators and diagnostic equipment, as well as personal protective equipment for health care providers. We are grateful we have been able to contribute to the response to COVID-nineteen. During the third quarter, we saw a slight progressive improvement in revenue month to month.

This trend of sequential improvement aligns with macroeconomic data in the third quarter, which indicates a continued gradual global recovery. Yet global and US industrial and manufacturing activity remain below pre pandemic levels we served nearly 19,000 unique product developers in the most recent quarter representing companies of many different sizes from many different industries. Within our very broad customer base, some companies are back to normal operations, but many continue to recover from mandated closures and stay at home orders, which resulted in decreased demand for their products as well as the trickle down effect of project funding reductions and timing delays. Now I will transition to third quarter twenty twenty revenue by geography highlighted on slide five of our earnings presentation. America's 's revenue declined 1% compared to the second quarter of twenty twenty.

The vast majority of our COVID related orders were generated in The Americas and therefore this region saw the greatest impact from the $9,000,000 decline in COVID orders from Q2 to Q3. Excluding COVID orders, the underlying business trend in The Americas showed progressive improvement. The economic challenges are broad sweeping as all of our top US customer end markets were flat or down year over year in the third quarter. From a year over year growth perspective, aerospace has been our best performing customer industry in The Americas this year. Space exploration and satellite projects and funding continues at a rapid pace and our quick turn digital manufacturing services continue to be extremely valuable for customers in that industry.

Europe third quarter revenue declined 9% year over year or 13% in constant currency but improved 13% sequentially as the European markets begin to recover. Our European medical customer industry was flat while the remaining top customer industries declined compared to last year. In Japan, revenue declined 22% in constant currencies. Japan's economy continues to struggle, and the country's manufacturing purchasing managers index indicates the sector now has contracted for seventeen months in a row. Overall, our business declined 9% year over year in constant currencies during the third quarter of twenty twenty, but underlying business performance improved sequentially with the macroeconomic trends.

Revenue by service for the third quarter is presented on slide six of our earnings presentation. Injection molding revenue declined 3% compared to the same period in 2019. Our three d printing business performed very well in the quarter, growing 2% over the 2019 and fourteen percent sequentially. CNC and sheet metal both declined double digits year over year, consistent with second quarter performance. On the expense side, as the challenges and uncertainty of 2020 continue, we remain focused on what we can control.

We are managing costs to the level of demand that we experience on a daily basis. Our plant managers and operations teams have done an excellent job of staffing our manufacturing facilities to predicted demand, then quickly responding to actual customer ordering levels. This increased focus and execution on controlling our costs resulted in significant gross margin improvement to 51.7% from 50.1% in the second quarter on a non GAAP basis. Turning to earnings, we reported third quarter non GAAP EPS of $0.67 per share, up $07 from the second quarter of twenty twenty. Our earnings in the third quarter were up sequentially due to diligent cost management throughout the business.

Our teams are carefully evaluating all spending in order to drive efficiency considering the new working environments at Proto Labs and among our customers. John will provide further insights into our third quarter financial performance a little later in the call. Our top priority entering 2020 was Proto Labs two point zero, an evolution of our e commerce quoting platform and our back end systems that was initiated by a desire to better serve our customers. The emergence of a global pandemic in the first quarter meant that our priorities shifted. While our top priority became the health and safety of our employees, communities, and customers, our dynamic teams have continued to work on Proto Labs two point zero at an energetic pace despite having to adapt to remote working environments.

We've continued investing in and executing on this significant strategic project forging ahead with development, documentation, validation, training, and testing. Thanks to the hard work of dedicated of the dedicated Proto Labs organization we are on track to go live in Europe in November followed by a US debut in Q1 We are extremely excited to introduce our new e commerce digital manufacturing quoting experience to our customers, and our employees are anxious to begin working with the improved functionality and interconnectivity of our back end systems that support our operations. Proto Labs two point zero will offer a much improved customer experience. The new online quoting platform is more intuitive than our legacy platform with fewer clicks required to place an order and an overall better buying experience. In addition to a modern user friendly interface, the new e commerce platform provides the ability for users to better manage their project requirements, collaborate easier with colleagues, and experience new levels of transparency into their orders.

In addition, our signature interactive design for manufacturability or DFM analysis is more intuitive than ever before. As the economy continues its gradual recovery and we serve up a new and improved customer experience, we expect higher customer satisfaction and retention moving forward. We revolutionized manufacturing two decades ago. By automating the traditional manufacturing process, this new platform continues to revolutionize the buying experience for our customers. RotoLabs two point zero will allow us to maintain and extend our position as the leader in digital manufacturing.

In summary, our business model continues to produce strong cash flows and our solid financial foundation and healthy balance sheet have enabled us to continue to invest in our future in this uncertain environment. We will continue to flex costs where we can match demands. We have demonstrated through our Proto Labs two point zero efforts that we will continue to invest in the long term growth of the company. With our new and improved customer experience, we help our customers succeed and capture additional demand as individuals and companies reaccelerate development projects as momentum builds in recovery. Now I'll turn the call over to John for an in-depth look at our financial performance in the third quarter as well as our outlook for the final quarter of twenty twenty.

John?

Speaker 2

Thank you, Vicki. Our third quarter financial results begin on page eight of our presentation. We reported third quarter revenue of $107,500,000 a decrease of $10,000,000 or 8.5 percent over the same quarter in 2019. Our revenue declined 9.2% year over year in constant currencies as foreign currency represented an $860,000 benefit in the quarter. We served 18,800 unique product developers in the third quarter, a sequential increase of 10% but down 12% year over year.

As Vicki mentioned, though some customers have returned to normal levels of demand and production, many are still seeing continued impacts to their businesses. Turning to slide 10 and our detailed income statement our non GAAP cost of revenue decreased $1,300,000 compared to the second quarter while our revenue increased $900,000 sequentially. This improvement reflects the focused efforts of our operations teams to align staffing to daily variability in demand across our manufacturing services. Our non GAAP gross margin in the quarter was 51.7% compared to 50.1% in the second quarter and 51.5% in the third quarter of twenty nineteen. I'm very proud of the work our plant managers and operations teams have done to control costs while continuing to delight our customers maintaining quality and on time delivery on par with Proto Labs standards.

Turning to operating expenses. Our total non GAAP operating expenses totaled $33,300,000 in the quarter, down 1,400,000.0 sequentially. As we described in our first and second quarter calls, we have eliminated essentially all of our discretionary spend and are prudently managing costs given the uncertain nature of the current industrial demand environment. Non GAAP operating expense as a percent of revenue in the quarter was 30.9% down from 32.5% last quarter. In sales and marketing we continue to focus on the marketing activities that are most effective while pulling back on spend that is inefficient in the current environment.

The remaining sequential reductions in operating expenses were predominantly driven by timing of vacation usage, lower medical expenses, and lower incentive compensation accruals. GAAP operating income was $17,700,000 or 16.4% of revenue in the third quarter. This compares to $14,400,000 in the second quarter. Adjusted non GAAP operating income was $22,400,000 or 20.8 percent of revenue, up significantly from $18,700,000 in the prior quarter. This strong financial performance was driven by prudent cost management while continuing to invest in our future through Proto Labs two point zero.

Third quarter adjusted EBITDA was $30,000,000 or 27.9 percent of revenue, up from 27.5% of revenue in the same period in the prior year and up from 24.5% in the second quarter. Our third quarter non GAAP tax rate was 22%, consistent with our expectations and up slightly from 21.5% in the third quarter of twenty nineteen. On a GAAP reporting basis net income totaled $14,700,000 resulting in diluted earnings per share of $0.55 Adjusting for the after tax costs of stock compensation, amortization of intangibles, and unrealized foreign currency gains, our non GAAP diluted earnings per share in the quarter were $0.67 representing a $09 per share decrease from the prior year and a sequential increase of $07 per share. Breaking down the sequential increase in earnings per share further improvements in gross margin represented a benefit of $06 per share and lower operating expenses delivered a benefit of $04 per share. These increases were partially offset by a $03 per share related to a higher effective tax rate than Q2.

Now turning to cash flow on slide 11. We generated $29,000,000 in cash from operations during the quarter. Capital spend in the third quarter was $7,200,000 including continued investments in Proto Labs two point zero. Our business produces very strong free cash flows even when the revenue growth is not at historical levels due to the digital nature of our manufacturing operations and less investment required for additional equipment. Our cash and marketable securities balance now exceeds $200,000,000 up from $175,000,000 at the end of the second quarter.

Consistent with previous quarters our balance sheet remains free of debt. Now turning to fourth quarter guidance. Consistent with our second quarter earnings call in July we'll provide formal revenue guidance along with qualitative summary of our expectations for costs in the fourth quarter of twenty twenty. Our fourth quarter guidance is summarized on slide 16. We currently expect fourth quarter revenue to be in the range of $96,000,000 to $106,000,000 compared to $107,500,000 in the third quarter.

The third quarter included $3,000,000 of COVID related orders and we expect less COVID related revenue in the fourth quarter. Additionally our fourth quarter revenue tends to be lower than the third quarter due to our normal seasonality pattern caused in part by the holiday season. In 2019 we experienced a $5,500,000 sequential decline revenue from Q3 to Q4. As Vicki mentioned, we saw a slight progressive month to month improvement through the third quarter. October revenue trends have remained fairly consistent with September.

With the ongoing uncertainty related to the global pandemic and its impact on our customer base combined with the U. S. Presidential election, Brexit, and the quick turn nature of our business, we continue to forecast a broad range for the remainder of the year. Now turning to expenses. As we did in the third quarter, we will continue to manage our cost structure in response to the revenue levels in each of our services.

We expect our non GAAP fourth quarter gross margin to be approximately 51% plus or minus 50 basis points. Our gross margin forecast is slightly lower than Q3 as we factor in seasonally lower revenue, holiday pay, and the potential inefficiencies in our operations in Europe as the teams begin working with our new systems. Turning to operating expenses, we expect our non GAAP selling, general, and administrative expenses to be between $36,000,000 and 37,000,000 These projected expenses include approximately $3,000,000 in the fourth quarter related to the launch of Proto Labs two point zero consisting of 7 and $50,000 of depreciation in the quarter as the system is placed into service and approximately $2,000,000 related to the costs of employees and contractors working on the project. The spend associated with the individuals working on the project is capitalized prior to the system launch, but will convert to expense when the system is placed in service. The remaining amount consists of overtime and training of employees that ease the transition to working in the new systems.

Outside of the Proto Labs two point zero costs, we expect to manage our non GAAP operating costs generally in line with third quarter levels. Our non GAAP pre tax add backs in the fourth quarter will include stock compensation costs of approximately $4,000,000 and amortization of approximately $750,000 We currently estimate our non GAAP tax rate to be between 1920% in the fourth quarter. In addition to the expense in Q4, I also want to outline the impact of Proto Labs two point zero on our operating expenses in 2021. We anticipate the quarterly depreciation will be approximately $1,500,000 of expense beginning in the first quarter of twenty twenty one. In addition, we currently estimate the employee and contractor expenses will increase from $2,000,000 to approximately $3,000,000 in the first quarter with these resources expensed for the full quarter.

As we progress through the year, our Proto Labs employees will shift to other R and D projects while many of the contractors will roll off. I will now turn the call over to Vicki for some final comments.

Speaker 1

Thank you, John. 2020 has been a difficult year for many of us. For Proto Labs, all of our employees have adapted to new methods of working while continuing to provide customers with the world class digital services they have come to expect from Proto Labs. We have done a wonderful job adapting to the volatility created in 2020. As future demand remains uncertain, we will continue to adjust our cost structure and prudently manage the business performance in the short term.

However, we will continue to drive the business ahead and invest to ensure our position as the digital manufacturing leader. Proto Labs two point zero will build on our twenty year history as the digital manufacturing leader as we revolutionize the industry we created. Along with a new and improved customer facing e commerce platform, we are the only prototype and low volume manufacturer using truly differentiated digital manufacturing processes, allowing us to separate from the competition with a strong resilient business model. I want to thank everyone for your time this morning and I want to thank the Proto Labs employees for their extraordinary efforts through the 2020 and during these uncertain times. I also want to thank our customers for their continued support.

We will continue our efforts to improve our offering to customers and our financial performance. Over the long term, we are committed to serving our customers and driving shareholder value. We look forward to reporting to you on our progress during our next call. Thank you very much.