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Protolabs (PRLB -0.76%)
Q3 2020 Earnings Call
Oct 29, 2020, 3:30 p.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Dan Schumacher -- Director of Investor Relations and Financial Planning and Analysis

Ladies and gentlemen, this is Dan Schumacher Director of Investor Relations at Protolabs. 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 and Chief Executive Officer and John Way our Chief Financial Officer. This morning, before the market open Protolabs issued a press release announcing its financial results for the third quarter ended September 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 related to future performance and expectation that are or may be considered forward looking statements and subject to risks and uncertainties that could cause actual results to material differently from expectations. Please refer to our earnings press release and recent SEC filings, including our annual report on form 10 K. For additional certain risks that could cause actual outcomes to differ materially and adversely from any forward looking statements made today. results and guidance, we will discuss include non-GAAP financial measures, consistent with our past practice. Please refer to our press release, and the company 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?

Victoria M. Holt -- President and Chief Executive Officer

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-19 pandemic, as well as an update on our Protolabs 2.0 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, and 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 protein 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 impact of revenue at the high end of our guidance range, improved productivity and lower costs.

We reported third quarter revenue of $108 million representing a year over year decline of 8% and a 1% increase over the second quarter of 2020, our year-over-year revenue decline is a result of the continued global economic challenges, and their impact on our customer base. COVID-19 related revenue in the third quarter was $3 million down from $12 million in the second quarter. As a reminder, our orders related to COVID-19 include parts for ventilators and diagnostic equipment, as well as personal protective equipment for healthcare providers. We are grateful, we have been able to contribute to the response to COVID-19. During the third quarter. We saw slight progressive improvement in revenue month to month. This trend of sequential improvement aligns with macro economic data in the third quarter, which indicates a continued gradual global recovery that global and us industrial and manufacturing activity remained below pre pandemic level. We served nearly 19,000 unique product developers in the most recent quarter, representing companies from many different sizes, from many different industries. Within our very broad customer base. Some companies are back to normal operations. Many continued 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, our electricity grid transition to third quarter 2020 revenue by geography highlighted on slide five of our earnings presentation. America's revenue declined 1% compared to the second quarter of 2020.

The vast majority of our COVID related orders were generated in the Americas. And therefore, this region saw the greatest impact from the $9 million decline in COVID orders from Q2 to Q3, excluding COVID orders, the underlying business trend in the Americas showed progressive improvement, the economics challenges are broad sweeping, and all of our top us customer and 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 customers 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 a year or 13% in customer currency, but improved 13% sequentially as your European markets, begin to recover, or European medical customer industry was slapped, 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 17 months in a row. Overall, our business declined 9% year over year in constant currencies during the third quarter of 2020, but underlying business performance improved sequentially, with the macro economic 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 third printing business performed very well in the quarter growing 2% over the third quarter of 2019 and 14% 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 demands 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 gap basis. Turning to earnings. We reported third quarter non gap ups of 67 cents per share of seven cents from the second quarter of 2020, 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. Ours our top priority entering 2020 was Protolabs, 2.0, 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 health and safety of our employees communities and customers, our dynamic teams have continued to work up for the last 2.0 at an energetic pace.

Despite having to adapt to remote working environments. We continue to 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 U.S. 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 backend systems that support our operations. For the last 2.0 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. Revolutionize manufacturing two decades ago by automating the traditional manufacturing process [Indecipherable] platform revolutionize the buying experience. Our customer Protolabs 2.0 allows us to maintain and extend our position as the leader, digital manufacturing summary, my business model continues to produce strong cash. And our solid financial foundation and healthy balance sheet enabled us [Indecipherable] Future uncertain environment. We will continue to possible can match demand demonstrated through a portal web 2.0 efforts that we will continue to invest in our long term growth as a company with our new and improved customer experience to help our customers succeed. Digital demand individuals and companies. Celebrate development projects and recovering.

Now I'll turn the call over to john for an in depth look at our financial performance to the third quarter outlook for the final quarter of 2020, John?

John A. Way -- Chief Financial Officer

Thank you, Vicki. Our third quarter financial results, begin on page eight of our presentation, we report in third quarter revenue of $107.5 million, a decrease of $10 million or 8.5% 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. Earnings slide 10, and our detailed income statement. Our non-GAAP cost of revenue decreased $1.3 million 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 2019. 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 protolith standards. Turning to operating expenses. Our total non-GAAP operating expenses totaled $33.3 million in the quarter down 1.4 million sequentially. As we as 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 Estrin 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 vacation usage lower medical expenses and lower incentive compensation accruals operating income was $17.7 million or 16.4% of revenue in the third quarter. This compares to $14.4 million in the second quarter adjusted non gap operating income was $22.4 million dollars or 20.8% of revenue up significantly from $18.7 million in the prior quarter. This strong financial performance was driven by prudent cost management, while continuing to invest in our future through the web 2.0. Third quarter adjusted EBIT da was $30 million or 27.9% 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 gap tax rate was 22% consistent with our expectations and up slightly from 21.5% in the third quarter of 2019, and a gap reporting basis, net income totaled $14.7 million, resulting in diluted earnings per share of 55 seconds, adjusting for the after tax costs of stock compensation amortization of intangibles and unrealized foreign currency gains or non gap diluted earnings per share in the quarter, were 67 cents, representing a nine cent per share decrease from the prior year, and the sequential increase of seven cents per share, breaking down the sequential increase in earnings per share further improvements in gross margin, Representative benefit of six cents per share, and lower operating expenses delivered a benefit of four cents per share. These increases were partially offset by a three cent per three cents per share related to the higher effective tax rate then Q2. Now turn into cash flow on slide 11, we generated $29 million in cash from operations during the quarter. Capital spend in the third quarter was $7.2 million, including continued investments in Protolabs 2.0.

Our business produces very strong free cash flows, even when their 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 million up from $175 million. 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 2020. Our fourth quarter guidance is summarized on slide 16. We currently expect fourth quarter revenue to be in the range of 96. million to $106 million compared to $107.5 million in the third quarter. The third quarter included $3 million 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 crossed in part by the holiday season. In 2019, we experienced a $5.5 million sequential decline in revenue from Q3 to Q4 as Vicki mentioned, we saw slight progressive month to month improvement through the third quarter. October, when the 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 US 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 gap 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 season seasonally lower revenue holiday pay and potential inefficiencies and operations in europe has 15s begin workin with our new systems.

The operating expenses we expect non-GAAP selling general administrative expenses to be between $36 between $37 million. These projected expenses include approximately $3 million in the fourth quarter related to the launch of Protolabs 2.0, consisting of $750,000 of depreciation in the quarter, as the system is placed into service and approximately $2 million related to the cost of employees and contractors working on the project. The spend associated with the individuals working in 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. They ease the transition to working in the new system. Outside of the prolapse to point out costs, we expect to manage our non gap operating costs, generally in line with third quarter level or non gap pre tax setbacks in the fourth quarter will include stock compensation cost of approximately $4 million, and amortization of approximately $750,000. We currently estimate, our non-GAAP tax rate to be between 19 and 20% in the fourth quarter. In addition to the expense in Q4. I also want to outline the impact of product credit labs 2.0 on our operating expenses in 2021. We anticipate the quarterly depreciation will be approximately $1.5 million of expense, beginning in the first quarter of 2021. In addition, we currently estimate the employee and contractor expenses will increase from $2 million to approximately $3 million in the first quarter, with these resources expensed for the full quarter. As we progress through the year, our prototypes employees will shift to other R&D projects. While many of the contractors will roll off.

I will now turn the call over to Vicki for some final comments.

Victoria M. Holt -- President and Chief Executive Officer

Thank you John. 2020 has been a difficult year for many of us for Protolabs, all of our employees have adapted to new methods of working while continuing to provide customers with the world class digital manufacturing services they have come to expect from the left, we have done a wonderful job, adapting to volatile, 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 Protolabs, 2.0 will build on our 20 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 manufacturing 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 for you. And I want to thank the proto labs employees for their extraordinary efforts through the first three quarters of 2020 and during these uncertain times. I also want to thank our customers for their continued to support 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.

Questions and Answers:

Duration: 24 minutes

Call participants:

Dan Schumacher -- Director of Investor Relations and Financial Planning and Analysis

Victoria M. Holt -- President and Chief Executive Officer

John A. Way -- Chief Financial Officer

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