Proto Labs' Earnings Slip on Challenges in Acquired Business

Proto Labs (PRLB 0.32%) released weak first-quarter 2019 results before the market opened on Thursday. 

Shares of the quick-turn, contract manufacturer declined 5.5% on Thursday. We can attribute the market's reaction to both first-quarter revenue and earnings falling short of Wall Street's expectations, along with second-quarter guidance for both the top and bottom lines also coming in lighter than what many investors were likely anticipating.

Here's how the quarter worked out for Proto Labs and its investors.

Image source: Proto Labs.

Proto Labs results: The key numbers

Data source: Proto Labs. GAAP = generally accepted accounting principles. EPS = earnings per share.

Revenue growth in the company's legacy business (which excludes the services provided by Rapid Manufacturing, which Proto Labs acquired in Dec. 2017) was approximately 11% in constant currency, CEO Vicki Holt said on the earnings call. 

The company generated $18 million in cash from operations during the quarter, compared with $26.1 million in the year-ago period, and ended the quarter with cash and cash equivalents of $85.4 million.

Proto Labs had guided for adjusted EPS in the range of $0.65 to $0.73 on revenue of $113 million to $119 million. So, its earnings came in at the midpoint of its expectation range, and its revenue landed at the low end of its outlook range. For additional context (though long-term investors shouldn't assign too much importance to Wall Street's near-term estimates), the Street was looking for adjusted EPS of $0.70 on revenue of $115.6 million. So, the company slightly missed on the bottom line and fell short on revenue. 

For further context, in the previous quarter, Proto Labs grew revenue and adjusted EPS 19.7% and 27.6%, respectively. 

Revenue results by service provided

Data source: Proto Labs. *New category stemming from the acquisition of Rapid Manufacturing in Dec. 2017. 

Proto Labs' "legacy CNC [computer numerical control] operations grew 8% in the first quarter of 2019 after experiencing tremendous growth of over 40% in the first quarter of 2018, creating a difficult year-over-year comparable," Holt said on the earnings call. 

See below for Holt's in-depth comments about the subpar performance of the acquired Rapid business, which includes the entire sheet-metal business and part of the CNC metal-working business. 

What happened with Proto Labs in the quarter?

• Revenue grew 4.3% year over year to $87.8 million in the U.S., rose 6.6% (14.8% in constant currency) to $21.3 million in Europe, and surged 20.8% (23.2% in constant currency) to $4.4 million in Japan. The tepid U.S. performance was largely due to weakness in the company's Rapid sheet-metal service and expanded CNC offering. In the U.S. legacy business, revenue grew 9.3% year over year, Holt said on the earnings call.
• The number of unique product developers and engineers served increased 9.3% year over year to 20,573. 
• Gross margin declined to 51.9%, from 53.7% in the year-ago period. It also declined sequentially, as it was 52.5% in the fourth quarter of last year.

What management had to say

On the earnings call, Holt reiterated Proto Labs' four main priorities for 2019, the first and last of which are focused on improving the performance of the Rapid services: "continue to evolve our go-to market model, enhance our customer experience, improve our overall efficiency as a company, and improve the performance of the acquired Rapid operation." 

She went on to outline the four primary actions the company is taking to improve its performance, based on its experiences in the first quarter:

First, in the first quarter we restructured the Rapid sales organization, including changes in sales leadership. Our New Hampshire sellers are getting comfortable with the new books of business and selling all of Proto Labs' services. In Q2, we will continue to train and share best practices to improve our go-to-market success. Second, we will continue to invest in marketing to highlight the availability of our expanded service offerings to drive increased demand. Third, we will reduce the published lead time of the sheet metal business. We are able to do this based on automation and capacity investments we've made in the business. This promise of unprecedented speed is something our customers have learned to expect from us and allows us to take share from the market. And finally, we continue to analyze our data and see opportunities to implement value-based pricing and better leverage our quoting engine to improve close rates.

Looking ahead

Proto Labs' quarterly results were disappointing, though it's still early in the process of integrating the Rapid services into the fold. The company's legacy business performed pretty solidly, with revenue rising about 11% in constant currency.

On the earnings call, CFO John Way outlined the company's second-quarter 2019 outlook: 

Data source: Proto Labs.

The revenue outlook reflects that the "services of the Rapid Manufacturing business will improve sequentially, but will likely be down year over year," and there will be an anticipated $1 million negative impact from foreign exchange, Way said. 

Going into earnings, Wall Street had been projecting adjusted EPS of $0.76 on revenue of $120.4 million in the second quarter. Proto Labs' top- and bottom-line guidance fell slightly short of these expectations, likely contributing to the market sending shares tumbling 5.5% on Thursday.