Proto Labs, Inc. (PRLB) on Q2 2021 Results - Earnings Call Transcript
Operator: Greetings, welcome to the Protolabs Second Quarter 2021 Earnings Call. . I will now turn the call over to Dan Schumacher. You may begin.
Dan Schumacher: Thank you, Stacy, and good morning, everyone. With me today are Rob Bodor, Protolabs' President and Chief Executive Officer; and John Way, our Chief Financial Officer. This morning, Protolabs issued a press release announcing its financial results for the second quarter ended June 30th, 2021. The release is available on the company's website. 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 relating to future performance and expectations that are or may be considered forward-looking statements, and subject to many risks and uncertainties that could cause actual results to differ materially from expectations. Please refer to our earnings press release and recent SEC filings, including our annual report on Form 10-K for information on certain risks that could cause actual outcomes to differ materially and adversely from any forward-looking statements made today. The results and guidance we will discuss include non-GAAP financial measures consistent with our past practice. Please refer to our press release and the accompanying slide presentations at the Investor Relations section of the company website for our complete reconciliation of non-GAAP to GAAP results.
Robert Bodor: Thanks, Dan, and good morning, everyone. Thank you for joining us today for our Second Quarter 2021 Earnings Conference Call. I will begin with commentary on recent industry developments and an overview of our second quarter business performance. John will then provide details on our second quarter financial results and our outlook for the third quarter. During the first half of 2021, several emerging companies that offer online access to manufacturing have entered or announced plans to enter the public markets. This is not unexpected given the trends toward manufacturing 4.0 in recent years. These recent developments further highlight the very attractive digital contract manufacturing space and industry that Protolabs created in 1999. Protolabs remains unique. It's the only company to digitally manufacture parts across range of services, both additive and traditional. We remain the only company to have transformed these manufacturing processes, enabling us to be the fastest and most reliable manufacturer of custom parts in the world. We began to revolutionize manufacturing in 1999, and have over 20 years of experience and manufacturing data to drive continuous improvement in our systems and processes. With the acquisition of Hubs earlier this year, our ability to offer market-leading speed and consistency with a premium network of manufacturing partners will allow us to serve nearly all customer use cases, by combining our unique visual thread with the Hubs digital network. We believe the combination of Protolabs' internal manufacturing capabilities and Hubs' network of premium manufacturing partners is superior to competing offerings, provides the broadest set of capabilities and lead times in the world. We're focused on serving our customers in a sustainable manner that will in turn deliver long-term shareholder value. Protolabs has the best-in-class financial profile, driven by our software enabled manufacturing, and superior customer offerings. Through the continued integration of Hubs and further expansion of our internal capabilities, we will also have the broadest digital manufacturing offer in the market to serve our existing customers and to attract new customers. We invented the digital manufacturing space 2 decades ago. Our combination of the digital thread for manufacturing and our premium digital network is the winning model, and we will outperform other companies in the space, long-term. We are very excited about the future.
John Way: Thanks, Rob. Our detailed second quarter financial results begin on Page 11 of our presentation. With the Hubs acquisition occurring during the first quarter, this was our first full quarter reflecting the impact of the Hubs financials. Second quarter revenue of $123 million represents a 15.5% year-over-year increase or 5.3% organic growth in constant currencies. Hubs produced strong results, contributing $8.9 million of revenue in the second quarter, representing growth of 45% in this business. Changes in foreign currency had a $1.9 million favorable impact on the second quarter revenue, in line with our expectations. We served 23,250 unique product developers in the second quarter, up 6,200 or 36% year-over-year, and 650 or 3% sequentially. Year-over-year product developer growth was driven by approximately 4,000 developers served on the Hubs platform and with the remainder representing growth in our legacy business. Turning to Slide 12 and our detailed income statement. Our non-GAAP gross margin in the quarter of 46.8% compares to 48.5% in the first quarter of 2021, and our guidance range of 47.5% to 48.5%. Our second quarter gross margin was impacted by higher personnel costs in the form of medical costs and overtime and contractor spend in our manufacturing facilities due to the tight labor markets, as Rob referenced earlier in the call. In addition, Hubs second quarter gross margin was slightly lower than our projection for this business as global logistics costs, including freight and customs costs, remained at elevated levels. Overall, Hubs represented a 260 basis point headwind on second quarter gross margins due to the lower margin nature of the outsourced manufacturing model. Our total non-GAAP operating expenses were $42.8 million, slightly below our expectations and consistent with $42.4 million in the first quarter of 2021. Our non-GAAP operating expenses increased from $34.6 million in the second quarter of 2020. The Hubs acquisition added $3.2 million of operating expense in the quarter.
Operator: . Our first question comes from Greg Palm with Craig-Hallam Capital Group.
Danny Eggerichs: This is Danny Eggerichs on for Greg today. I guess just digging into gross margin a little bit more. I appreciate the color on, I guess, the labor shortage, wage inflation, that kind of stuff. Obviously, compressed in Q2 looks to be more the same in Q3. I guess just looking out beyond that, if it's not going to be necessarily a revenue growth. What's -- I mean, what's going to be the drivers behind that starting to expand again towards that 50%?
John Way: Yes, Danny, I think as I stated before, mix is going to play a bigger role in our gross margin as we go forward. And the Hubs business and the outsourced manufacturing model carries a lower gross margin profile than our internal operations. So as you look at mix -- and that business is growing nicely, and we expect that to continue. So that growth in that business as you look at just pure percentages, is going to put pressure on that gross margin number. I think as we look at the internal operations, as we stated, we are experiencing some inflationary costs in both labor and some of the materials. And we're actively working with customers on pricing as well as our internal efficiencies and expect to continue to do so as we manage through this.
Danny Eggerichs: Okay. That's helpful. I guess just jumping into Hubs now and that integration, how should we think about that progressing, I guess, initial synergies you're realizing? Any initial feedback from the customer base?
Robert Bodor: Yes, sure. I can take that. So the Hubs integration has gone well. 2 teams are working together on the integration plan. As you think about this, we're going to be rolling out customer-facing capabilities incrementally. And our primary objective is to make sure that it's a really seamless and great customer experience. And so those are the things that we're working, right now together. At the same time, we're still running the companies pretty independently. Hubs has their own set of growth targets that they're working towards. They just grew 45% in the last quarter. And we're happy with that. So we're working the 2 in parallel as we work through the systems and backend to be able to present these capabilities to our customers on the front end, and we'll be doing that incrementally by service.
Dan Schumacher: Yes. Any change in the way you're thinking about that Hubs contribution for 2021?
John Way: No. I think the growth that we talked about, 45% growth this quarter, is kind of in line with our expectations, and it's trending. I think the gross margins are a little bit softer than we had originally anticipated, and we're working through solving that challenge.
Operator: . Your next question comes from Ben Rose, Battle Road Research.
Ben Rose: This is Jonathan Rowe filling in for Ben. I'm just wondering if you can highlight any trends in average order size at Protolabs during Q2?
John Way: I'm sorry, could you repeat that? We had some trouble hearing you.
Ben Rose: Yes. Yes. Can you hear me now?
John Way: Yes.
Robert Bodor: Yes.
Ben Rose: So I'm wondering if you can highlight any trends in average order size during Q2?
Robert Bodor: Trends in average order size.
Ben Rose: Yes, yes.
John Way: Yes. So I think the way I would look at it -- the average order size on our individual services remain pretty much in line with what they have been historically. I would say that in our Injection Molding service, we are experiencing strong orders, and those orders tend to be a little bit larger in quantities and size, given that we've kind of built up the backlog, and it's a little bit of a shift in the mix during this quarter. But as you look at the individual services and the underlying data, the average order sizes are remaining relatively consistent.
Ben Rose: Okay. Great. And then I'm just wondering if there's been any recent trends towards customers being willing to pay a premium for faster turnaround on different parts or prototypes?
Robert Bodor: Well, I mean, our historical model is to offer the fastest lead times in the world. And our standard pricing does have premiums as you increase the speed of that delivery. So whether that's in Injection Molding or CNC or 3D Printing or Sheet Metal, there's a premium. For example, in CNC, as you move from 3-day to 2-day to 1-day to same day, there are premiums at every level there. And -- so that's very standard for us.
Operator: Your next question comes from Brian Drab with William Blair.
Brian Drab: Okay. I had to dial back in. Some technical difficulties here. On Hubs, it seems, John, you haven't mentioned what the gross margin have you got, or can you tell us what gross margin was in the second quarter?
John Way: Yes. gross margin was in the low teens. So in that 12% to 13% range, Brian, this quarter. A little lower.
Brian Drab: Okay. And why is that again? What are the main issues?
John Way: The main issues are the freight costs and customs and due to these things that we're incurring.
Brian Drab: Okay. And that doesn't include at this point any of the -- have you sorted out the movement of some of the costs between like COGS and SG&A? I mean, is that sorted out? These are...
John Way: Yes. That's consistent with how we report our gross margin.
Brian Drab: Got it. Okay. And the $8.9 million at Hubs is a solid revenue number. Can you just remind me or explain how that company -- how Hubs is or is not benefiting from being part of the Protolabs platform at this point? Is it still -- when I go to look for quotes, I mean, it still looks like an independent company, so does the Protolabs company, but I mean I need to go to their website to order something, right? So are they benefiting from being part of Protolabs do you think at all in the quarter?
Robert Bodor: Yes. So Brian, as we talked about it, we're still running the 2 independently as we're working through the platform to integrate them. So the plan is that we'll bring them on right and expose those capabilities to the Protolabs customers through the Protolabs website. We have not done that yet. That's not the stage that we're at. So, they're operating independently at this point.
Brian Drab: Are they able to offer any additional services, though, being -- and capabilities being part of the Protolabs family now?
John Way: At this stage, we're still working through the integration and how to plug those in effectively. There's a few orders that are being passed back and forth. But for the most part, I think that both businesses are relatively organic in Q2.
Brian Drab: Okay. Got it. And then just quickly on the Sheet Metal, I missed what the reasons were why that was down sequentially, but also, I'm just wondering if you could maybe elaborate on that? And also remind us when that should be tied in to Protolabs 2.0?
Robert Bodor: Yes. So on the first question, we consolidated our operations in Sheet Metal over the last quarter. We were operating out of 2 facilities. We consolidated into one, which I think is really the right long-term move for us so that we can improve operational efficiencies, and also believe that we'll be able to improve our lead times as a result of that. But that did cause some disruption in the quarter, which impacted revenue and lead times for a period. We're now fully back. And then the question on 2.0. Yes. So we're evaluating that. The plan is that we will integrate Sheet Metal into 2.0 and have a consolidated offer across, including Sheet Metal and integrating Hubs. Right now, with the integration planning, we're working through the prioritization of that. And so I'm not -- we're not announcing that timing as of now right.
Brian Drab: Right. And Rob, what's the biggest challenge in incorporating Sheet Metal in the Protolabs 2.0?
Robert Bodor: Well, it's simply a matter of prioritization. We've got a set of resources that are working on and building out the front end. And we want to add Hubs into it. We want to have the legacy business into it. Remember that when we launched 2.0, that was scoped to not include Sheet Metal at the time. So we've launched with our first -- our 3 services. Sheet Metal was always going to follow-on, and that's still in the plan.
Brian Drab: Got it. And then just a last question. You gave the guidance for the third quarter for gross margin. I mean how do you -- can you look a little bit farther on. In like fourth quarter, do you expect gross margin to kind of continue to improve? Or should we think about the Hubs growth and the lower gross margin they are, as weighing on gross margin somewhat through the balance of the year?
John Way: Yes. I think -- Brian, I think it's going to be mix dependent. And yes, I think it will continue to introduce variability into that gross margin as we look at projections. So depending on growth rates and things like that will impact those percentages. I think what I would say overall is, we would anticipate gross margins to be relatively stable through the remainder of the year as we work to mitigate some of the labor and inflationary costs that we're incurring in our internal businesses, and then there will be some headwinds from the strong growth that we're seeing in the Hubs business.
Operator: I will now turn the floor over to Rob Bodor for closing remarks.
Robert Bodor: Thank you for your time this morning. I'm pleased with our performance in the second quarter of 2021, and remain confident in our long-term strategic objectives. We're focused on creating long-term shareholder value through continued integration of Hubs and improvements to our customer offer. I'd like to thank our employees around the globe for their continued efforts as we move into the second half of 2021, a very important year for our business. I also want to thank our shareholders for their continued support to Protolabs. We look forward to updating you on our performance next quarter. Thank you very much. Have a great day.
Operator: This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.
