Proto Labs, Inc. (NYSE:PRLB) Q3 2023 Earnings Call Transcript
Proto Labs, Inc. (NYSE:PRLB) Q3 2023 Earnings Call Transcript November 3, 2023
Proto Labs, Inc. beats earnings expectations. Reported EPS is $0.51, expectations were $0.3.
Operator: Greetings and welcome to Proto Labs Third Quarter Fiscal Year 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to Jason Frankman, Vice President and Corporate Controller. Thank you, you may begin.
Jason Frankman: Thank you, Jerry [ph] and welcome everyone, to Proto Labs’ third quarter 2023 earnings conference call. I’m joined today by Rob Bodor, Proto Lab’s President and Chief Executive Officer; and Dan Schumacher, Chief Financial Officer. This morning, Proto Labs issued a press release announcing its financial results for the third quarter ended September 30, 2023. The release is available on the company’s website. In addition, a prepared slide presentation is available online at the web address provided in our press release. Our discussion today will include statements relating to future performance and expectations that are or may be considered forward-looking statements and subject to many risks and uncertainties that could cause actual results to differ materially from expectations.
Please refer to our earnings press release and recent SEC filings, including our annual report on Form 10-K for information on certain risks that could cause actual outcomes to differ materially and adversely from any forward-looking statements made today. The results and guidance we will discuss include non-GAAP financial measures consistent with our past practice. Please refer to our press release and the accompanying slide presentation at the Investor Relations section of our company website for a complete reconciliation of GAAP to non-GAAP results. Now, I will turn the call over to Rob Bodor. Rob?
Rob Bodor: Thanks, Jason. Good morning, everyone, and thank you for joining our third quarter earnings call. Proto Labs had an excellent third quarter. From a financial perspective, I am very pleased with our results, which surpassed our expectations on the top and bottom line. In the third quarter, we generated record revenue, improved profitability, generated substantial cash flow and returned capital to shareholders. We reported revenue of $131 million, the highest quarterly revenue figure in Proto Labs' 24-year history. Revenue was up broadly both year-over-year and sequentially across injection molding, CNC machining and 3D printing. Along with record total revenue, network revenue in the third quarter was a record $23 million, growing over 80% year-over-year in constant currencies.
Our digital network powered by Hubs continues to take share in the market at an outstanding pace. Our digital factory business fulfilled through our internal factories, rebounded nicely from the second quarter with sequential growth. We continue to accelerate innovation for customers with the fastest and most reliable lead times in the industry. Our strategy is working. Record revenue in an uncertain macro climate demonstrates this. Proto Labs is becoming a one-stop-shop for custom prototypes and low volume production parts. As we integrate the factory and network offers, we continue to realize significant value from the Hubs acquisition. Our comprehensive offer through the Digital Factory and the Digital Network continues to resonate with customers who are increasingly adopting it.
This is clear to us as a significant portion of third quarter network growth was driven by Proto Labs customers. We serve the largest customer base in our industry. In the third quarter alone, over 23,000 unique design engineers and production buyers ordered parts from Proto Labs. While we have the scale, infrastructure and automation to serve all of these customers, a notable portion of our third quarter revenue growth was from larger strategic customers. These customers are taking advantage of our comprehensive offer fulfilled through the combined Digital Factory and Digital Network. This unique hybrid offer unlocks our ability to go deeper with customers and serve them more strategically, expanding our share of wallet. From prototype to production, from delivery overnight to overtime and from quantity 1 to quantity 1 million we can serve customers' needs better than any other company in our industry.
In addition to reporting record revenue, we also further improved our industry leading profitability. Third quarter earnings per share increased both year-over-year and quarter-over-quarter. We generated our highest quarterly non-GAAP EPS in three years. Earnings outperformance was largely driven by higher volume and improved gross margins in both the Digital Factory and the Digital Network, which resulted in Proto Labs' highest quarterly consolidated gross profit dollars since 2019. Third quarter network gross margin was also a record and we have now expanded consolidated gross margin and operating margin for three consecutive quarters. We are not just talking about profitable growth, but we've been executing on it. Expanding profits allows us to drive investments in innovation and improvements to our customer offer.
During the third quarter, we received external recognition for one such innovation, our instant design for additive manufacturability analysis tool. This proprietary software provides customers with rich design for manufacturability feedback to help them design the best 3D printed parts, and it does so instantly. For this innovation, Proto Labs won a 2023 IDEA Award. This is an award presented by several industry publications that recognizes the best new product innovations of 2023. This is another example of how our commitment to innovation helps us maintain our position as industry leader. While our offer continues to delight customers, the broader economic environment is still uncertain. Manufacturing conditions in the U.S. and Europe remained soft and have not consistently improved throughout 2023.
Yet we grew in the quarter, especially our digital manufacturing network business with year-over-year growth of over 80%. Proto Labs offers the most comprehensive digital manufacturing service in the world in terms of pricing, lead time options and part envelope. Our combined factory and network model is effective as you can see in our financial results and it resonates with our customers, which I'd like to highlight with a few tangible examples of how customers are driving value out of sourcing prototype and low volume production parts from Proto Labs through the factory and the network. In my first example, a Fortune 500 medical company's production vendor had a line down situation and could not deliver time sensitive components, leaving a large gap in delivery of end use equipment for surgical rooms.
Because this medical company is a regular customer of Proto Labs and injection molding and is familiar with our speed and reliability, they turned to Proto Labs to help solve this issue. The customer initially leveraged our Digital Factory and its world class lead times for CNC machine parts. Proto Labs has always been a great candidate for lying down situations due to the industry best lead times and on demand production that our Digital Factory affords. However, prior to the establishment of the digital network, production in these types of situations would often shift away from Proto Labs as volumes increased. That is no longer the case because of the Digital Network. Through the network, we were able to support production for the medical customer and delivered over $500,000 in production grade and use components over the course of a few months.
The combination of the factory and network capabilities provided immense value, enabling this Fortune 500 medical customer to avoid an extended production shutdown, saving them significant time and money. In addition to increasing number of customers using the combination of the factory and the network p Proto Labs also continues to accelerate innovation through our Digital Factory. As the industry leader, we are called upon by the most innovative companies in the world to help develop next generation products. Recently, a luxury high end automotive manufacturer selected Proto Labs to assist with its first foray into the electric vehicle market. Proto Labs worked with Hutchinson, a multinational design firm and manufacturer, to prototype the battery pack cooling system for the luxury automaker's first electric vehicle.
We rapidly manufactured injection molded parts which meant stringent project timelines and quality standards. Utilizing our speed, reliability and quality, we delivered parts to specification for testing and to be mounted on the electric supercar prototype reducing validation and testing times and accelerating their innovation. This is the power of Proto Labs and illustrates why we are often the partner of choice wherever innovation is happening. Now for a brief update on our 2023 priority areas as we approach the end of the year. As a reminder, our 2023 priorities are first to drive revenue growth, particularly in our largest services injection molding and CNC machining and second to increase shareholder value through expanding profitability in the factory and the network.
We are successfully delivering on both priorities, revenue growth and profitability. Starting with revenue, at the beginning of this year, we stated that our goal for injection molding was to grow 2023 revenue year-over-year. Year-to-date IM revenue is up organically and we believe we will achieve our goal for the full year. We continue to win more injection molding orders that leverage both factory and network fulfillment. Additionally, we are winning larger orders, demonstrating our expansion into more production use cases. CNC machining is also up year-to-date and like injection molding, we expect our CNC machining service to achieve revenue growth for the full year over 2022. Third quarter revenue through our Digital Factory grew sequentially as more customers took advantage of our world class reliability and the fastest lead times in our industry.
Meanwhile, third quarter CNC machining revenue via the Digital Network grew over 85% year-over-year, highlighting the effectiveness of the combined model and the value that Proto Labs customers get from the broad offerings fulfilled through the network. We have also delivered on our profitability priority. In the third quarter we exhibited the robust earnings power of our business model. Even in an uncertain macro climate, we expanded profitability. Margin expansion in both the Digital Factory and the Digital Network were the result of sound execution by controlling our cost structure and gaining efficiencies and leverage while fulfilling increasing demand. In addition, we continue to invest in our executive leadership team. I am excited to have Agnes Semington join our team as our new Chief Human Resources Officer.
Agnes has extensive experience in human resources leadership across manufacturing and digital companies and will guide our HR team and strategy as we continue to make Proto Labs a great place to work. I'd like to thank all Proto Labs employees for their contribution thus far in 2023. The efforts and commitment of our employees enable us to continue to succeed and grow profitably. In summary, Proto Labs' combination of factory and network offers has enabled us to outperform peers in the current environment and we believe we will outgrow the market over the long-term. Third quarter revenue growth was broad based including sequential and year-over-year growth in our three largest services from many different customers. We are well positioned to weather economic volatility due to our best-in-class profitability and strong cash flow generation.
We will continue to reinvest profits into the business as we seek to further expand our offer and capture additional share of wallet. In the third quarter, we generated record revenue, improved profitability, generated substantial cash flow and returned capital to investors. We are a great long-term strategic partner for our customers and believe we will deliver value for shareholders over the long-term. Dan will now provide additional financial detail on our third quarter results as well as our outlook for the fourth quarter of 2023. Dan?
Dan Schumacher: Thanks Rob and good morning everyone. Before I begin, I'd like to remind you all that we made a strategic decision to exit our Japanese operations last year and September 2022 was the last month in which we generated revenue in Japan. As such, this will be the last quarter of year-over-year comparisons including Japan. Our financial results begin on Page 11 of the slide presentation. Third quarter total revenue came in at $130.7 million, up 7.1% year-over-year in constant currencies and excluding Japan. Revenue exceeded our guidance range to a due to a pickup in order trends after the first few weeks of July that continued through the end of the quarter. Revenue fulfilled through our Digital Network of manufacturing partners was $22.6 million in the third quarter, a record for the network business and up 81.2% in constant currencies.
Our network offer with this broad range of manufacturing capabilities and lead times continues to gain share even in uncertain macroeconomic conditions. Changes in foreign currencies represented a $1.7 million favorable impact to revenue in the third quarter, in line with our expectations. Revenue by region is summarized on Slide 12. In the Americas revenue grew 5% year-over-year. In Europe, third quarter revenue grew 16.9% year-over-year in constant currencies. Looking at revenue by service, CNC machining grew 11% year-over-year in constant currencies and excluding Japan, driven by continued growth through our integrated CNC offer. Injection molding revenue grew approximately 6% year-over-year in constant currencies and excluding Japan. The increase was largely due to higher orders for follow on parts.
Expedites on part orders increased as customers still take advantage of our best-in-class lead times and reliability in uncertain economic conditions. Third quarter 3D printing revenue grew 7% year-over-year in constant currency. Sheet metal revenue declined 18% year-over-year in constant currencies in the third quarter. As you'll recall, our sheet metal service experienced revenue headwinds earlier in the year. In response, we furloughed 25% of our sheet metal workforce in the second quarter. We saw signs of improvement in the third quarter as revenue increased 9% sequentially. We served 23,080 unique product developers in the third quarter, a decrease of 3.1% year over year. As Rob mentioned, our unique hybrid offer allows us to go deeper with customers and serve them more strategically, expand share of wallet and grow our overall revenue.
Turning to Slide 18 and our detailed income statement, overall third quarter non-GAAP gross margin increased 190 basis points sequentially to 46%. This is the third consecutive quarter of sequential gross margin expansion. Both factory and network gross margins expanded over the second quarter. On the Digital Factory side, sequential gross margin improvement was driven mainly by higher volume, labor efficiencies and continued investments in increased automation. Our manufacturing facility teams managed costs to volume levels well in the third quarter including flexing overtime and contractors as needed while maintaining our industry best lead times. On the network side, third quarter gross margin increased to a record 33.7% from 31.2% in the second quarter of 2023.
Throughout 2023 we have continued to refine our network sourcing and pricing algorithms. Our long-term target for network gross margin is still between 25% and 30%. Turning to operating expenses, total non-GAAP selling, general and administrative expenses were $43.7 million in the quarter or 33.5% of revenue compared to $43.1 million or 35.2% of revenue in the second quarter of 2023. Improved operating expense leverage sequentially was driven by efficiencies on higher volume as well as continued focused cost containment efforts, partially offset by higher incentive compensation. Moving to taxes. Our non-GAAP effective tax rate in the third quarter was 20.5% compared to 25.2% in the second quarter. The sequential decrease in the non-GAAP effective tax rate was primarily due to an improvement in earnings in our tax jurisdictions that are fully reserved for net operating losses.
Third quarter non GAAP dilutive net income per share was $0.51 compared to $0.33 in the second quarter of 2023. The sequential earnings per share consisted of a few items. First, higher volume as revenue was up $8.4 million quarter-over-quarter. With our profit model, we get significant leverage on increased volume, especially in the Digital Factory. The remaining increase was driven by a number of items, including a lower effective tax rate and higher interest income. Moving to cash flow and balance sheet highlights on Slide 19. We generated $24.2 million in cash from operations in the quarter, up from $9.3 million in the prior quarter. Our business exhibits very strong cash flow generation in any economic climate, allowing us to invest in future growth and return capital to shareholders through share repurchases.
In the third quarter, we repurchased 9 million of common shares and will continue to purchase opportunistically going forward. Our balance sheet is still very strong. On September 30, 2023, we had $114.9 million of cash and investments on our balance sheet and zero debt. Turning now to our forward-looking guidance, which is outlined on Slide 21. We expect to generate fourth quarter revenue of between $118 million and $126 million. At the midpoint this implies 5% revenue growth year-over-year in constant currencies. The fourth quarter of any calendar year is difficult to forecast because of the impact of the holiday season. This revenue guidance takes into account quarter-to-date order trends as well as our best estimate of the impact of seasonality in the fourth quarter.
We expect foreign currency to have between a $0.5 and $1 million favorable impact on revenue compared to the fourth quarter of 2022. Moving to earnings guidance, we anticipate non-GAAP add backs in the fourth quarter to include stock based compensation of approximately $4.5 million and amortization expense of $1.5 million. We currently estimate our fourth quarter non-GAAP effective tax rate will be between 19% and 20%. Considering this, we expect fourth quarter non-GAAP earnings per share between $0.26 and $0.34. Now back to Rob for closing comments.
Rob Bodor: Thanks Dan. Our third quarter growth, including record total revenue and record network revenue is evidence that our unique combined offer is gaining significant traction in the market. In addition, gross and operating margins improved sequentially for the third consecutive quarter. Proto Labs is the most profitable and cash flow positive company in digital manufacturing. We are focused on executing successfully on our 2023 priorities and driving toward our long-term strategy which creates shareholder value. Thank you.
Operator: Are we ready for questions?
Rob Bodor: Yes we are.
Operator: Great.
See also 15 Most Undervalued Large Cap Stocks to Buy and 13 NASDAQ Stocks with Lowest PE Ratios.
To continue reading the Q&A session, please click here.
