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The 3 Biggest Risks Facing Proto Labs Inc. Shouldn't Scare You

Because we live in an imperfect world, there's no such thing as the perfect investment. Last Tuesday, rapid manufacturing expert, Proto Labs (NYSE: PRLB  ) , reported an absolutely stellar quarter, thanks to a 21% increase in customers and a 9% increase in spending per customer, which sets it up nicely for long-term growth. However, even a great business like Proto Labs that's firing on all cylinders faces risks that could derail the long-term-investment thesis. As Fools, it's our duty to uncover these risks and understand how they could affect our investment.

Extreme sensitivity
At its core, Proto Labs provides rapid manufacturing services for customers that need up to 10,000 parts produced and delivered within 15 days. The company automates as much as the process as possible so that the customer gets the fastest turnaround time in the industry.

Easy as 1-2-3. Source: Proto Labs

As you can imagine, Proto Labs' operating model is very transactional in nature because it only receives orders when its customer have orders themselves. More often than not, this means the company carries little to no order backlog to process in the future. Without this added economic buffer, it makes Proto Labs extremely sensitive to all sorts of timing issues that could be brought on by events that may seem trivial to companies that operate with big backlogs. Extreme weather in a region where there is a high concentration of customers could negatively impact Proto Labs' operating results.

Thinking bigger picture, you have to question how well Proto Labs would stand up during an economic downturn. I think the answer depends on how fast the company has been growing going into a period of economic uncertainty. If Proto Labs was a mature company that was experiencing slow customer and revenue growth going into a recession, investors would likely experience significant downside because its business would be more dependent on periods of peak economic activity. On the flipside, if there was a recession tomorrow, it may not impact Proto Labs' operations too severely because it has achieved record revenues for the last seven quarters in a row, which could potentially help offset some economic uncertainty.

Lack of awareness
Proto Labs has been around since 1999 and hardly anyone has heard of this $2 billion company. Last quarter, fewer than 7,300 product developers were served, which is shockingly low when you think about all hundreds of thousands – if not millions – of product developers that exist throughout the world. Even Vicky Holt, the company's freshly appointed CEO agreed that increasing awareness was going to be a challenge. Sales and marketing expenses are expected to rise in the near term to help drive awareness of Proto Labs' services. Should expenses grow faster than revenues, it could negatively affect the company's profitability.

At the same time, a lack of brand awareness could also be considered an opportunity for Proto Labs because there remains such a large runway for customer growth in the future. It's also encouraging that Holt previously had led a successful turnaround as CEO of Spartech, resulting in a 73% increase in the company's operating income in two years time. She's certainly proven to have a skill for making a positive impact on a business.

Back to the backlog
During a period of economic uncertainty, a company like Boeing that has an insane $440 billion backlog helps it get through turbulent times. As I mentioned earlier, Proto Labs doesn't have the luxury of a backlog, which makes it difficult to predict future revenues with any real degree of certainty. Not only can this put investors at more risk due to a lack of visibility, it forces the company to keep more cash on hand to act as a buffer. At the close of 2013, Proto Labs had more than $143 million in cash on its balance sheet, but only recorded $50.4 million in operating expenses in 2013. Currently, Proto Labs appears to have more than enough cash on hand to minimize any wild revenue fluctuations.

The great balancing act
When you boil it down, investing is really a great balancing act between risk and reward, and whether or not you think an investment's reward is worth the risk. In the case of Proto Labs, management has done an excellent job minimizing the major risks it can control, and its most recent earnings report shows a company that's been firing on all cylinders. All things considered, there's currently a mountain of potential for Proto Labs to continue disrupting the manufacturing industry, and this reward seems to far outweigh the risks involved. If you haven't given Proto Labs a look, you probably should.

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Steve Heller

Covering 3-D printing at the intersection of business, investing, and what it means for the future of manufacturing. Follow me on Twitter to keep up with the ever-changing 3-D printing landscape by clicking the button below.

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9/2/2015 4:01 PM
PRLB $69.98 Down -0.37 -0.53%
Proto Labs CAPS Rating: *****