Proto Labs Manufactures Solid Revenue Growth, but Shares Fall on Cautious Guidance

Image source: Proto Labs.

Proto Labs (PRLB 2.90%) reported its third-quarter 2016 earnings before the market opened on Thursday. In light of the slowdown in the manufacturing environment, the quick-turn manufacturing service provider posted decent numbers, with revenue coming in at the top end of the company's guidance range and adjusted earnings per share exceeding its projections.

Shares closed down 8.9% on Thursday, likely because Proto Labs provided very cautious forward guidance.

Proto Labs' Q3 headline numbers

Data source: Proto Labs. YOY = year over year. GAAP = generally accepted accounting principles. *Organic revenue = revenue generated from businesses owned for at least one year. 

Organic revenue excluded the $4 million contribution from Alphaform, the German service bureau that Proto Labs acquired last October. About half of Alphaform's revenue in the quarter came from 3D printing and half from injection molding. Proto Labs acquired this business to significantly expand its 3D printing capabilities in Europe by adding selective laser sintering, direct metal laser sintering, and additional stereolithography capabilities. Prior to this acquisition, its sole European location was in Telford, England. The acquisition also gave Proto Labs a major presence in Germany, which is the largest single market for the company's services in Europe. 

Analysts expected Proto Labs to deliver adjusted EPS of $0.44 on revenue of $75.27 million, so the company comfortably beat both estimates. Of course, investors shouldn't give too much credence to analysts' estimates, as Wall Street is focused on the short term. However, they can be helpful to keep in mind because together with forward guidance they often help explain market reactions.

Revenue in the quarter grew, while operating income and net income contracted, indicating that both operating and profit margins contracted year over year.

Revenue results by service provided 

Data source: Proto Labs. YOY = year over year. *Excludes Alphaform's $2.0 million in 3D printing revenue.

The fact that 3D printing is growing much faster than the other businesses is both a positive and a negative. For one thing, the company's revenue growth wouldn't be nearly as good without this business. However, 3D printing has a lower gross margin than the other services, which flows through to some degree to operating and profit margins.  

What happened with Proto Labs in the quarter?

• The number of unique product developers and engineers served increased 14% year over year to 14,271.
• The average revenue generated per developer/engineer declined 3.9%.
• Gross margin was 57.2%, a decline from 59.4% in the third quarter of 2015, but up from 56.4% in the second quarter of 2016. The 80-basis-point sequential improvement is attributable to improved margins at Alphaform and improved execution in the injection molding and CNC machining businesses. The sequential improvement was particularly notable because it occurred while the company was completing its moves into new facilities in North Carolina and Japan. The year-over-year decline is largely due to the acquisition of Alphaform/product mix -- 3D printing has a lower gross margin than the company's other services.
• GAAP operating margin was 21.7% compared to 25.7% for the third quarter of 2015. Adjusted operating margin was 25%.
• Cash generated from operations was $19.6 million.
• The company accelerated the geographic launch of its overmolding process (which bonds two different materials together), which initially launched in September, and also launched 5-axis machining, a CNC offering.
• Worth noting, but occurring just after the quarter ended, the company opened its new 3D printing facility in Cary, North Carolina, on Oct. 7. The 77,000-square-foot facility triples space devoted to 3D printing, and consolidates all 3D printing operations in one facility. Proto Labs expanded into 3D printing and beyond its Minnesota base in the U.S. via its 2014 acquisition of North Carolina-based FineLine Prototyping.

What management had to say

CEO Vicki Holt acknowledged the current challenging macroeconomic environment, but expressed optimism about the long-term outlook for the business:

There is uncertainty in the market right now due to the election in the United States and Brexit in Europe and that uncertainty is impacting the economy. Our business is not immune to that impact. While the current economic environment is challenging, we are focused on our internal processes, in both sales and operations, to position ourselves as economic conditions improve. We remain very optimistic about the outlook for Proto Labs. We are fortunate to serve a large, underpenetrated market with a unique value proposition, unsurpassed service and quality for customers, and the commitment and employee talent to successfully execute our strategy for profitable growth.

Looking ahead

CFO John Way provided Proto Labs' fourth-quarter guidance on the analyst conference call as follows:

Data source: Proto Labs. YOY = year over year.

Going into the earnings report, analysts expected Proto Labs to earn $0.49 per share on an adjusted basis on revenue of $79.88 million in the fourth quarter. Both expectations are beyond the upper range of Proto Labs' guidance, which is surely why the market sent shares tumbling on Thursday.

Holt and Way acknowledged on the call that the company was being "cautious" on guidance. There are three basic reasons for this: the lack of good visibility into market conditions, softer-than-anticipated orders thus far in October, and the fact that the fourth quarter has historically been hard to project.