Proto Labs' Earnings Slip on Continued Weakness in Acquired Business

Proto Labs (PRLB +1.77%) released weak second-quarter 2019 results before the market open on Thursday. 

Shares of the quick-turn contract manufacturer dropped 9.8% on Thursday, but then jumped 9% on Friday. So they closed out the week just 1.7% lower than the level they were at before earnings were released. Such a whiplash-inducing market reaction following a company announcing quarterly results isn't that uncommon. It likely indicates that some market participants thought the initial sell-off was overdone.

We can attribute the market's initial reaction to both second-quarter revenue and earnings falling short of what many investors were likely expecting, along with third-quarter guidance for both the top and bottom lines coming in lighter than widely anticipated.

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.

On the earnings call, CEO Vicki Holt said that "revenue growth in our legacy services was approximately 9% in constant currencies with our acquired Rapid Manufacturing business declining 8.6% compared to the prior year." Proto Labs acquired Rapid in December 2017. This business, which provided the company with sheet metal services and expanded its CNC offerings, has been underperforming, negatively affecting both revenue and earnings.

CFO John Way added that the year-over-year decrease in EPS was "mainly due to lower volume in the Rapid services and investments in sales and marketing and R&D." 

The Minneapolis area-based company generated $36.9 million in cash from operations during the quarter, and ended the period with cash and cash equivalents of $150.7 million.

Proto Labs had guided for adjusted EPS in the range of $0.66 to $0.74 on revenue of $114 million to $120 million. So, its earnings came in just above the midpoint of its expectation range, and its revenue landed just below the middle of its outlook range. On the earnings call, management said that the softer-than-anticipated revenue was largely due to foreign currency headwinds that were a little greater than expected.

For additional context (though long-term investors shouldn't give too much importance to Wall Street's near-term estimates), analysts were looking for adjusted EPS of $0.70 on revenue of $116.5 million. So, the company slightly missed both expectations.

In the first quarter, Proto Labs' results were very similar with revenue growing 5.3% and adjusted EPS contracting 2.8%.

Revenue results by service provided

Data source: Proto Labs. 

Category results were very similar to last quarter. In the first quarter, year-over-year revenue in injection molding, CNC machining, and 3D printing was up 7.7%, 3.1%, and 18%, respectively, and down 20% in sheet metal.

What happened with Proto Labs in the quarter?

• Revenue grew 5.6% year over year to $91.1 million in the U.S., rose 3.6% (10% in constant currency) to $20.9 million in Europe, and jumped 33% (26% in constant currency) to $3.8 million in Japan. As with last quarter, the U.S. performance was dragged down by weakness in the company's acquired Rapid business. In the U.S. legacy business, revenue grew 8% year over year, CEO Holt said on the earnings call.
• The number of unique product developers and engineers served increased 4.7% year over year to 20,840. This growth rate is down significantly sequentially, as it was 9.3% in the first quarter. 
• Gross margin declined to 52%, from 54% in the year-ago period. However, it edged up slightly sequentially, as it was 51.9% in the previous quarter. 
• The company began offering two new services: custom color matching for injection molding and metal 3D printing production services. 

What management had to say

Here's what Holt had to say about the quarter in the earnings release:

[We continue] to be a leader in digital manufacturing and achieved record revenue of $115.9 million in the second quarter. We continue to focus on serving our customers by expanding our differentiated offering as we launched a metal 3D printing production offer and custom color matching for injection molding.

On the earnings call, she spoke to the challenges in the quarter: 

As we stated in our first quarter conference call, we're focused on improving the performance of the acquired sheet metal and expanded CNC services and realized a sequential increase in revenue of $2.1 million.

Turning to customer end market performance in the Americas, the medical industry showed strong growth, while automotive and industrial machinery and equipment end markets declined year over year. ... We saw similar trends in Europe as in the Americas, with strong performance in medical and year-over-year declines in automotive and computer electronics.

Looking ahead

Proto Labs' quarterly results were somewhat disappointing, though, as I said last quarter, "it's still early in the process of integrating the Rapid services into the fold." 

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

Data source: Proto Labs.

Way said that "current economic growth has moderated and with limited visibility in our business, we are taking a cautious approach" to guidance.

Going into earnings, Wall Street had been modeling for adjusted EPS of $0.81 on revenue of $123.8 million in the third quarter. So the company's guidance on both the top and bottom lines fell short of these expectations.