Earnings Labs

Proto Labs, Inc. (PRLB)

Q3 2024 Earnings Call· Fri, Nov 1, 2024

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Transcript

Operator

Operator

Greetings. Welcome to Proto Labs Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce Jason Frankman, Corporate Controller. Thank you. You may begin.

Jason Frankman

Management

Thank you, Sherry, and welcome everyone, to Proto Labs' Third Quarter 2024 Earnings Conference Call. I'm joined today by Rob Bodor, 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, 2024. 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'll turn the call over to Rob Bodor. Rob?

Rob Bodor

Management

Thanks, Jason. Good morning everyone, and thank you for joining our third quarter 2024 earnings call. We had solid execution in the quarter with results coming in above expectations. Despite continued dynamic challenges in the manufacturing sector, our disciplined approach and resilient business model drove solid financial and operational results. Year-to-date, we've grown non-GAAP earnings per share over 10%. Additionally, in the third quarter, Proto Labs generated its highest quarterly operating cash flow since 2020 before the acquisition of 3D Hubs. This was driven in part by continued gross margin improvements in the Factory and the Network, and is a testament to the profitability of our business model against any macro backdrop, driven by our unique comprehensive fulfillment model. However, our revenue growth is flat year-to-date, and I believe we can accelerate our growth by continuing to invest in our priorities and execute our strategy under the realigned organizational structure. As a reminder last quarter, we announced the realignment separating regional go-to-market teams from a new global fulfillment organization in order to focus our regional teams on our customers to drive growth and to enable global efficiencies in fulfillment. Before expanding on the progress made across our realigned structure, I'd like to first cover our strategic priorities. We have made substantial progress on our 2024 priorities to-date. As previously mentioned, increasing the number of customers using our comprehensive services across Factory and Network is critical to our growth strategy. In the last 12 months, the number of customers using the combined offer grew 35% year-over-year. We are still in the early stages of exposing the full combined offer to customers, and is a huge growth opportunity for Proto Labs. Our other main priority for the year is to increase revenue per customer contact. We've made great strides here as well.…

Dan Schumacher

Management

Thanks, Rob. Our financial results begin on Page 8 of the slide presentation. Third quarter revenue was $125.6 million, representing a 4% decline from the record revenue we achieved in the third quarter of last year. Revenue was flat sequentially and slightly above our guidance range as order rates picked up more than anticipated through August and September. Turning to revenue by service on Slide 9. Third quarter Injection Molding revenue declined 10% year-over-year in constant currencies, as we saw weakness in the industrial and consumer electronics verticals. To drive growth in molding, we continue to invest in production capabilities and our new regional go-to-market teams are making production business a priority. CNC machining was flat year-over-year in constant currencies. We saw strong growth in our network CNC business. Third quarter 3D Printing revenue declined 1% year-over-year in constant currencies and sheet metal revenue declined 13% year-over-year. We served 22,511 customer contacts in the third quarter. Revenue per customer contact declined 1% year-over-year, largely due to the decline in Injection Molding revenue, our highest value per order service. As Rob discussed, growing revenue per customer is a long-term priority of ours, yet there may be bumpiness from quarter-to-quarter, as we shift to more production work. In that respect, year-to-date revenue per customer is up 5% over 2023. Third quarter consolidated non-GAAP gross margin increased 50 basis points sequentially to 46.2% with improvements in both the Factory and the Network. Factory gross margin was 49% in the third quarter, up sequentially from 48.8% driven by continued automation improvements and excellent work by our plant management teams to align staffing with volumes. Proto Labs Network gross margin was 35%, up from 32.8% in the second quarter driven by our AI-powered pricing and sourcing algorithms. Year-to-date, non-GAAP gross margin is 45.8%, up 130…

Operator

Operator

Thank you. [Operator Instructions] Our first question is from Brian Drab with William Blair. Please proceed.

Brian Drab

Analyst

Hi, good morning.

Rob Bodor

Management

Good morning.

Brian Drab

Analyst

Hi, Dan. Hi Rob. I just wanted to start on gross margins. The gross margin is pretty solid and higher than it's been in a while. Where do you expect to be able to sustain that? And how do you -- like how do you see the fourth quarter in terms of gross margin? And then I'm also asking this question, looking at the Network, which is of course, somewhat lower gross margin, and it looks like growth there decelerated some. So I'm just wondering if you're seeing maybe a convergence in the growth rate eventually here in the overall business between the Network and the Factory, and maybe you don't have this headwind in terms of gross margin from the faster growth on the Network side?

Dan Schumacher

Management

Yes. Let me -- Brian, I think there's two questions in there. I think one's related to gross margin and one's about the growth from the Network. I'll take the gross margin one first. Yes, what I would tell you is the gross margin percent improved, as I said both in the Factory and the Network. And so in terms of the Network gross margins, as we've talked about before, we're experiencing gross margins that are above the range that we've given. And we're really happy with our sourcing algorithms and how we're able to use that model to drive more profitability through that area. Now we've been in a state in which manufacturing continues to contract. We're keeping our range at that 25% to 30% even though it is at 35%, but I don't expect conditions to change much quarter-over-quarter. I would expect that we're going to be above the range on Network gross margins in the fourth quarter. As it relates to the Factory improvements, we continue to add automation to the Factory side of our business and we're doing a better job in terms of managing labor costs as that goes through. So there's improvement there as well. So I know you kind of alluded to, is there a mix in which the Network may be not growing as high as it was last year, there may be some aspect to that. But if you look at the core, both the Network gross margins and the Factory gross margins are improving. Now Rob, did you want to take the question on Network growth?

Rob Bodor

Management

Yes, certainly. Thank you, Brian, for the question. So yes. Yes, I think look, so in Q3 of last year, we saw absolutely stupendous growth in the Network, right, north of 80%. On the year-over-year comparison, we grew the Network 11% in the third quarter of this year, building upon that. And we did that in the context of a difficult macro. I think I read the report, we're now at 22 consecutive months of contraction in manufacturing. And so I'm pleased with it. I'm very confident that we can grow the Network even higher in the future and fully expected, the Network is going to continue to be a strong growth engine for our business. And we're seeing customers adopting it, right? I mean we had 35% growth year-over-year in customers adopting our comprehensive offer, buying more the Network. So I'm pleased with that and do expect it would continue to be a strong growth engine for us.

Dan Schumacher

Management

One more thing, Brian, that was in your question that did not cover on gross margin. We do expect gross margin to come down quarter-over-quarter. As we go into the holiday season, we're a little more inefficient with our labor as we're using contractors and such and the volume ends up being a little more uneven as you go through that holiday period. So we would expect the gross margin to come down just Q3 to Q4.

Brian Drab

Analyst

Right. Okay. And that's what I see. I mean, obviously, that's typical in the fourth quarter for you.

Dan Schumacher

Management

Yes, it's typical.

Brian Drab

Analyst

Right. Rob, on the blend of the idea that you're getting more people using the blend of the services, where -- what can you tell me about where that stands now in terms of like is still very early in that opportunity, right? Is it a low single-digit percentage of the customer contacts that are using both services?

Rob Bodor

Management

Yes. We are still in early innings with this absolutely. So I see it as a really big continued growth opportunity for our business. But I'm quite pleased to see the rate of adoption that we're getting in terms of customers buying the comprehensive offer and also more and more customers using us for production and bringing value to them, like in the examples that I shared in the prepared remarks. But yes, overall, we are still in the early innings. I would consider less than 5% of customers. So there's a lot of opportunity for us to continue to penetrate and that's what our go-to-market teams are focused on.

Brian Drab

Analyst

Okay. Great. And then maybe I'll just ask one more and then pass it on. You touched on it in the prepared remarks. I think that the increased inspection capabilities that I've talked to you guys a lot about and seeing the capabilities in the facility, and it's impressive, it seems like that's a key strategic initiative that you have, and it's making a difference. Can you just talk a little bit more about the traction that you are getting from the high-volume work? Because -- I mean, obviously, the -- you've got a challenging environment that you are operating in. Revenue is down, but still the revenue per customer is up. And so this is like a key lever that you're pulling in. Can you just talk about the traction you're getting in higher volume orders through that?

Rob Bodor

Management

Yes. So we've been going through this transformation, right, to really drive production and to serve our customers end to end across their entire product life cycle. And of course, given that we started with prototyping that means doing more and more production work for them. And so adding capabilities around comprehensive offerings, the ability to produce a much broader range of their parts needs and also being able to do the inspection and other documentation, process control documentation and the like that they expect in production have been important additions. And as we've brought that forward, our customers have been adopting it, and we're seeing nice growth there. That drives our average revenue per customer to be, I think, the highest in our industry, and we're seeing continued growth in that number as more and more customers are adopting production. And we're seeing that grow kind of 35% in terms of the customers buying the comprehensive offer year-over-year last quarter. So I'm pleased with it. I think it's -- again, we're in the early stages. We're really driving to grow it. and we're seeing strong and positive customer response. So I think we're on the right track and we're going to keep focused.

Brian Drab

Analyst

All right. Great. Thank you very much.

Operator

Operator

Our next question is from Jim Ricchiuti with Needham & Company. Please proceed.

Jim Ricchiuti

Analyst

Hi, good morning. Thanks. Congrats on the quarter, by the way. If we go back to August, you talked about slowing activity, and it sounds like the pace picked up a little bit relative to your expectations. Any sense as to what drove that, that are showing in August, September? Was it just the overall market, some of the things that you've done? And I'm just wondering if you've seen some of that traditional pickup in the daily rates, how has that been trending thus far in October?

Dan Schumacher

Management

Yes. Jim, the market that we are playing in is very uneven is what I would tell you. As I talked about in the prepared remarks, we saw in really June and into July, a lower order rate. And what we did see, to your point is we did see a higher pickup than normal seasonality on our order rate perspective in August and September. But that was starting from a data point of July that was really lower than historical, obviously because we reported that revenue was down. So we were -- it was nice to see the pickup in August to September. I would say, there wasn't anything in particular that I would point out. I would just say the general business responded better than what seasonality would say from a really low June and July. And as I'm creating the guide, again I'm looking at four-weeks of data that I have around shipments and orders and the guide is showing kind of a normal decline quarter-over-quarter, Q3 to Q4 that we normally see.

Rob Bodor

Management

I would just say I'm pleased that the go-to-market teams were able to get better than expected traction, right, as we kind of ended the quarter.

Jim Ricchiuti

Analyst

Got it. And a nice sequential stop up in operating margins in the quarter. And yes, I'm wondering if there's a way for you to help us with the global operations, organization alignment. How much of that would you attribute to it? Or is this just mainly a function, the revenues came in at the upper end of the range? You saw some nice solid improvement in gross margins as well.

Dan Schumacher

Management

Yes. What I would say is, again, kind of to repeat the two aspects to that gross margin, one being our Network gross margin, which is really about how we continue to improve our sourcing algorithms and improve the pricing within that model. And the second is really on a plant-by-plant perspective in terms of the automation that we're putting in and the tools that we're using to manage our costs in those areas in an environment in which the volume can be volatile. We just continue to improve in those respects, and that's what drove it. In terms of the new organization I'll let Rob talk to that.

Rob Bodor

Management

Yes. So I think as we look at that longer-term again the strategy there was a few things. One, we want to be able to bring our global full capabilities, right? So wherever we've got manufacturing capabilities around the world, we want to be able to bring those full capabilities to every customer regardless of what region that they're in to be able to serve them fully and to the best of our ability. Secondly, that structure now allows us to also reduce areas of redundancy or parts of the operation where maybe we are not operating at healthy margins, right? We can -- we have some more degrees of freedom to really optimize that. And so you are seeing these recent announcements is one example of that. And I think, over time, you'll see more and more opportunity for us to kind of optimize our operations from that standpoint to both drive healthy profitability for the business, but also make sure that we're serving our customers as fully as possible.

Jim Ricchiuti

Analyst

Thank you.

Operator

Operator

Thank you. Our next question is from Troy Jensen with Cantor Fitzgerald. Please proceed.

Troy Jensen

Analyst

Congrats on the great margins and cost controls here.

Dan Schumacher

Management

Thanks, Troy.

Troy Jensen

Analyst

Hi, gentlemen, congrats on the great margins and cost controls here.

Rob Bodor

Management

Thanks Troy, good morning.

Troy Jensen

Analyst

So maybe I'll first start off with the German facility update. Was this deal -- was it the Alphacam acquisition, mainly additives out in Germany?

Rob Bodor

Management

Yes, that's right. So these were a couple of the components of the business that we acquired from Alphacam years ago.

Troy Jensen

Analyst

Alphacam, okay. All right. Did you do much DMLS in Europe? Or is it all mostly polymers and you did metals in Raleigh?

Rob Bodor

Management

Yes. So we have both polymers and metal additive manufacturing in Europe in Putzbrunn. And this announcement was specific to the metal -- the DMLS. And so we'll be phasing that out of fulfillment from Germany and fulfilling it instead through a combination of our capabilities in North Carolina and our network partners.

Dan Schumacher

Management

But what I would tell you, Troy, similar to our Raleigh operation, DMLS is a good chunk of the business, but it is not the majority of the business in either location.

Troy Jensen

Analyst

Okay. All right. I guess, well, two questions come to that then. Can you help me out with the OpEx savings? I know we probably won't see it in Q4, but how much will this reduce OpEx in like the March or June quarters of next year?

Dan Schumacher

Management

Listen, Troy. So this is more of a savings from a gross margin perspective than it is from an OpEx perspective. For instance, in Putzbrunn we're still maintaining the facility. We are just fulfilling the DMLS differently, both through our manufacturing partners and also through Raleigh.

Troy Jensen

Analyst

Yes. Understood. That's shuttering the facility, but it's just kind of relying --. I get it.

Dan Schumacher

Management

So the action lower facility -- so we do have another facility that is the precision injection molding facility and so that one we are closing.

Troy Jensen

Analyst

Okay. Cool. And I get it, you are doing this because you can get better margins running through the network. Curious if there is other products kind of in your portfolio that makes sense. I guess I'm wondering primarily about Sheet Metal. I see that to me, that's like a lower gross margin product segment that hasn't grown for you guys and would it make sense to kind of run that through the Network business also.

Rob Bodor

Management

Yes. So yes last quarter, I think we definitely saw headwinds in Sheet Metal. I'll remind you that's our smallest service and it's got a lot of exposure to kind of the computer electronics segment, which did see slowing last quarter, and actually, we've seen headwinds for several quarters now. I will remind you that we've taken action there. We've rightsized that business. We're monitoring it and operating it very closely. So I would say that the new global structure enables us to I think, have some degrees of freedom around this that we haven't had before. And we're considering all these things as we go forward.

Troy Jensen

Analyst

Got it. Okay. Keep up the good work.

Rob Bodor

Management

Thanks Troy.

Operator

Operator

Our next question is from Greg Palm with Craig-Hallum Capital Group. Please proceed.

Greg Palm

Analyst

Hi, thanks for taking the question here. Maybe just kind of starting with the outperformance. I'm curious if you can attribute any of the outperformance to the sort of the realignment? Rob, it sounded like maybe hint to that, maybe that was a little bit of that. And then just to be clear, as it relates to the order trends, you said pick up August, September. Have those picked up in October? Have they stayed at similar rates? I'm just trying to gauge kind of the guide of where order rates are for the first four weeks versus kind of what normal seasonality is in the quarter.

Rob Bodor

Management

Sure. Thanks for the question, Greg. Yes, I'm pleased with how we were able to end the quarter and beat our expectations. The work that our go-to-market team did in terms of driving demand in the second half of the quarter was great to see. I do believe that as we focused our teams through this reorganization, focusing our go-to-market teams on the customers within their region, allowing them to specialize and focus on that, I do believe helped and expect to see that continue to help provide benefits for growth as we continue to go forward with this model.

Dan Schumacher

Management

On the order rate question no, they have not picked up. I would say it's more that June and July were soft, and then we got to a more normal kind of seasonality in August and September. So there hasn't been a pickup in October, and that's reflected in the guide.

Greg Palm

Analyst

Okay. And the margin performance was impressive. I'm curious on the Network side, have you changed the algorithm all the way you are sourcing stuff? Or do you attribute some of the outperformance, not just this quarter, but year-to-date, is that more of a byproduct of the environment we are in, the fact that a lot of suppliers just have more open capacity right now?

Rob Bodor

Management

Yes. I think you are right. So I attribute it to two things. One is we launched this -- our pricing algorithm about 1.5 years ago, which was a significant improvement, and then we continue to make incremental improvements in it over that period. And I think you are seeing that play out in terms of the margin. As we look at it externally, we believe that we are very competitive in terms of our pricing but we are able to get -- and we've got very strong close rates, right? So we are seeing that be very competitive yet, we’re able to continue to increase the gross margin because of the way the algorithm is working. So quite pleased with that. At the same time, I would agree with you that we're clearly seeing excess capacity in manufacturing and that is factoring in right, to the margins that we're able to get right now in this macro environment.

Greg Palm

Analyst

Yes. Okay. Makes sense. And I guess, just lastly, as it relates -- I just want to make sure I'm clear on the P&L impact of sort of the recent news around the European facility. What is the expected P&L impact I guess? So it doesn't sound like much of an OpEx, but it sounds like potentially some COGS savings. Are you able to quantify anything at all?

Dan Schumacher

Management

Yes. Nothing that we are going to specifically come out with in terms of specific numbers, but there's a precision molding part of the business that some of that business will be able to be fulfilled through the Network, and some of it will not. So there is some of that business that we looked at as wasn't strategic for our prototype to production strategy. And so there is some revenue that won't be there. But we should see some gross margin improvement overall. I would say, it's not a huge amount because of the relative size of what those businesses are.

Greg Palm

Analyst

And I assume the revenue impact, I mean, it's more like in the hundreds of thousands of maybe business that got lost versus millions? Or --.

Dan Schumacher

Management

Yes. Yes. It's not a huge amount. And what I would say is what that business was doing much more complex molds, but it was very difficult the way they were doing that to take it to production. And so what we're shifting is doing more of those complex molds through the network using steel tools and other type so that we can then take that customer from prototype to production as a part of our strategy. So what we feel is although there might be a short-term impact from that, from the longer term, it's much better aligns with our strategy to move more to production over the long term.

Greg Palm

Analyst

Okay, that make sense. All right, I will leave it there. Thanks.

Dan Schumacher

Management

Thank you.

Operator

Operator

With no further questions, this will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.