Q1 2024 Proto Labs Inc Earnings Call

Participants

Jason Frankman; Vice President Corporate Controller; Proto Labs

Robert Bodor; President, Chief Executive Officer, Director; Proto Labs Inc

Daniel Schumacher; Chief Financial Officer, Chief Accounting Officer; Proto Labs Inc

Brian Drab; Analyst; William Blair

Greg Palm; Analyst; Craig-Hallum Capital Group

Jim Ricchiuti; Analyst; Needham & Company

Presentation

Operator

Greetings. Welcome to Proto Labs' quarter 2024 earnings call. (Operator Instructions)
Please note this conference is being recorded. I will now turn the conference over to Jason Friedman, Vice President and Corporate Controller, and thank you. You may begin.

Jason Frankman

Thank you, Sherry, and welcome, everyone, to Proto Labs First Quarter 2024 earnings conference call. I'm joined today by Robert Bodor, President and Chief Executive Officer, and Dan Schumacher, Chief Financial Officer.
This morning, Proto Labs issued a press release announcing its financial results for the first quarter ended March 31, 2024. 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, our discussion today 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 and 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 presentation at the Investor Relations section of our company website for a complete reconciliation of GAAP to non-GAAP results.
Now I will turn the call over to Robert. Rob?

Robert Bodor

Thanks, Jason. Good morning, everyone, and thank you for joining our first quarter 2024 earnings call. We demonstrated strong operational and financial execution in the quarter, delivering first quarter revenue at the top end of our guidance range and earnings above expectations. These results were driven by the continued execution of our two strategic priorities, increasing the number of customers using our comprehensive offer and driving higher revenue per customer through larger orders and all services. We delivered strong gross margins, earnings and cash flow.
I'll now expand on the progress being made across our key priorities, and then Dan will take us through the results momentarily.
First, we continued to increase the number of customers using our comprehensive offer fulfilled through both the factory and the network combined offer brings immense value to customers, enabling them to use Proto Labs as a single source manufacturer throughout the product lifecycle from prototype to production to end of life. We have seen that those customers that use Proto Labs across both the factory and the network spend approximately double what all other customer spend demonstrating the significant synergy and value that our customers derive from the combined offer.
Over the past few years, we've significantly expanded our offering and now serve more production needs than ever before yet we are in the early innings of customers fully utilizing our combined offer. In fact, last year less than 5% of the 53,000 total Proto Labs' customer contacts purchased parts fulfilled through both the factory and the network clearly presents a huge growth opportunity for Proto Labs, and I am very excited about this potential. We have been and continue to be very focused on accelerating the continued adoption of our combined offer in order to capitalize on the attractive growth opportunities to add new clients and increased share of wallet.
We also made progress on our second strategic priority, which is to drive higher revenue per customer through larger orders and all services. Of note, revenue per customer contact increased 5% year over year in the first quarter, we are benefiting from recent technological advancements to our offering, which allow us to win more in production in the factory. We're beginning to see early returns on investments in production, including robotics, our patented automated mold polishing process and machine perception in our quality verification process. We have also greatly supplemented our production offer with expanded capabilities and AI enabled pricing options through the network. We believe that Proto Labs has the strongest brand in the industry, known for our reliability and quality for the last 25 years.
Let me now bring these remarks to life with several examples of how we're helping our customers positively impact the world. These customer examples begin on page 6 of our slide presentation. The first two examples highlight our role in enabling the profound advancements taking place in medical devices. Specifically advanced prosthetic equipment. Bio adapt has used Proto Labs as their custom parts supplier since its founding in 2010 as we showcased on our website and our recent press release, bio that creates custom prosthetic equipment for Elite adaptive athletes via our world-class factory, CNC machining service.
Our ability to iterate and rapidly manufacture high-performance custom prosthetic equipment allows us to serve bio, adapt and provide bespoke highly engineered solutions for elite athletes such as Mike Schultz, Founder, of BIO adapt and former X Games and Paralympic Games, gold medalist as well as Noel Lambert, former Division one lacrosse athlete. It was training to complete the 2024 Paralympic Games circle egg, another manufacturer of advanced prosthetic equipment that enables entities in East Africa to live active lives, needed a way to mass produce a design that can be adjusted to each individual while being highly affordable.
Our Proto Labs network provided design input and affordably manufactured high-strength stainless steel CNC machine components for circulates prosthetic system in the high volumes that they require. I'm deeply proud of the fact that we can play a role in helping society through our work with pioneering medical device companies like bio depth and circling whether they need rapid prototyping for custom high requirement products or affordable manufacturing of Group Components and high production volumes. We can bring unique value to our customers throughout the lifecycle of their products through our combined offer.
The next example that I'd like to share comes from our work with NASA, where we delivered custom metal components within 48 hours of their design. Our unique highly automated digital factory enables us to serve NASA's needs faster than anyone else in the world. Over the years, our digital manufacturing offer has propelled NASA's design evolution and accelerated their innovations in February, NASA partnered with Proto Labs at the power source Global Summit, where they crowdsourced requirements and design constraints for a tool to capture gases on the moon surface conference attendees use generative design software to design metal components for lightweighting that could be manufactured using Proto Labs' 3D printing and CNC machining capabilities.
Once ordered, Proto Labs manufactured the parts in less than 24 hours less than 48 hours after they were designed. The physical parts were delivered to NASA at the conference, enabling these experts to innovate and move science forward, Proto Labs is uniquely positioned to achieve this speed for NASA as the only digital manufacturer in the world that combines the digital thread with speed, reliability and quality. This is a great example of the positive impact we can have for our customers by utilizing our unique capabilities to empower the world's most innovative organizations to bring new ideas and products to market. As I stated at the beginning of the call, we continue to execute well on our priorities during the first quarter, which drove strong financial and operational results. We are pleased with our progress to date and remain focused on executing on our strategic initiatives and generating strong financial results. I want to thank our entire team for their continued dedication to excellence and positioning Proto Labs for success and value creation.
Dan will now provide additional financial detail on our first quarter results as well as our outlook for the second quarter of 2024.

Daniel Schumacher

Thanks, Rob, and good morning, everyone. Our financial results begin on page 10 of the slide presentation. As Rob mentioned, we delivered first quarter revenue at the top end of our guidance range and earnings above expectations, driven by an uptick in order growth relative to the beginning of the year, as well as strong performance in higher-margin services.
First quarter revenue of $127.9 million was in our guidance range and grew 1% year over year in constant currency. Proto Labs network revenue was $23.9 million, a quarterly record, up 38% in constant currencies. First quarter US revenue grew 4% year over year, while Europe revenue was softer than expected, declining 9% year over year in constant currencies, primarily due to large orders in the first quarter of 2023 that did not recur this quarter. In addition, the Eurozone and UK manufacturing sectors continued to contract in the first quarter on the basis of weak demand.
Turning to slide 12 and revenue by service first, injection molding revenue grew approximately 1% year over year in constant currencies. Injection molding parts growth was particularly strong due to continued larger orders. Cnc machining grew 3% year over year in constant currencies, driven by continued growth through proto Protolabs network. First-quarter 3D printing revenue was flat year over year. Sheet Metal revenue declined 16% year over year in constant currencies.
As previously mentioned, our sheet metal services more exposed to the computer electronics verticals, which experienced continued industry-wide softness. We have right-sized the business and our month monitoring it carefully. First quarter non-GAAP gross margin increased 30 basis points sequentially to 45.6%, driven by improvements in factory gross margins.
Core Lab Network non-GAAP gross margin was 31.7%. First quarter non-GAAP diluted net income per share was $0.4 above the midpoint of our guidance range of $0.3. This outperformance was driven by revenue coming in near the top end of our guidance range and better than expected gross margins.
Gross margin exceeded our expectations due largely to stronger than anticipated factory revenues in injection molding in the Americas, one of our higher-margin services, we are pleased with the improvements we've seen in factory gross margins as we drive continued innovation and automation and efficiency as the world's most advanced digital manufacturer. Non-gaap EPS of $0.4 was down $0.06 sequentially, primarily due to higher operating expenses, including higher incentive compensation and other seasonal costs that increased sequentially in the first quarter. The increased SG&A costs were partially offset by higher volume and an improvement in factory gross margins.
Turning to cash flow and balance sheet highlights on Slide 13. Our industry-leading cash flow generation model produced 20 point $21.3 million in first quarter cash from operations. We repurchased $16 million of common stock in the quarter, equivalent to 85% of our free cash flow on March 31, 2024, we had 112.9 million of cash and investments on our balance sheet and zero debt.
Turning now to forward looking guidance, our guidance for the second quarter of 2024. As outlined on slide 15, we expect to generate second quarter revenue between $122 million and $130 million after strong orders from the end of January. Through the beginning of March, we saw some sub softening of larger orders as we approach the week of Easter that carried through the month of April, we do expect year-over-year revenue growth in the second quarter. We expect foreign currency to have a negligible impact on revenue compared to the second quarter of 2023.
Moving to earnings guidance. We anticipate non-GAAP add-backs in the second quarter to include stock-based compensation expense of approximately 4.5 million and amortization expense of $1 million we currently estimate a non-GAAP effective tax rate of 24% plus or minus 50 basis points in the second quarter.
In summary, we expect second quarter non-GAAP earnings per share between 30 and $0.38.
That concludes our prepared remarks. Operator, please open the line for questions.

Question and Answer Session

Operator

(Operator Instructions) Brian Drab, William Blair.

Brian Drab

Good morning. Thanks for taking my questions.

Robert Bodor

Morning, Brian.

Brian Drab

I'd like to just start up on the orders. I think I have the picture, but can you just put maybe put a finer point on it? So when we talked to you on February 9, the year had been getting off to a pretty slow start. And it sounds like it picked up on it, I guess in terms of the whole business or just large orders, but they seem to up in the later part of February and March, but then slowed in April. Can you just elaborate on that?

Robert Bodor

Yes. So at the beginning of the year at end of last year and beginning of this year, really a softer order period for us than we've had historically. And we saw an order pickup in January, and that continued to be strong. And through February and the beginning of March but as we started approaching the Easter period, it was a bit softer and that continued through April on our guidance is based as we as we always do. We've looked at the order trends and the guidance is indicative of that.
In terms of you asked about specific areas or geographies, I mean, we talked about in the script, we had really strong larger injection molding orders through that timeframe. And those were primarily in the Americas, which you can see in our results in terms of our strength by region.

Brian Drab

Got it. Thanks. And then can I ask about gross margin? Because gross margin again above 45% on system, it's been moving in the right direction. Is that sustainable? And can you remind me I don't know if you said, but within that within the network, where are we with gross margin in the first quarter?

Daniel Schumacher

Yes, so on, I would say a couple of things Brian first, you know, we started we saw improvements last year in gross margin in two areas. One is in the network, and that has to do with continue to improve our algorithm for both pricing and sourcing through the network as well as expanding, um, you know, RMP.s into different geographies so that as we go into the first quarter of this year, we we had historically had a stronger impact from Chinese New Year, which causes the capacity in our MP network to be a bit lighter and for us to be more challenged from a gross margin perspective, our algorithms and expanding our sourcing helped us to maintain margins over 31% in the network in the first quarter.
The second thing, and Rob talked about it, and I talked about it as well. We've increased automation in our facilities around full robotics, our patented automated mold polishing, our quality labs and those things add efficiency, especially when we get larger orders. And we started seeing that last year and an improvement in our margins last year and that continued into the first quarter.
I would say, absolutely. As you know, as as we continue to make larger orders, maintain larger orders, we should be able to continue that type of margins in the factory from the network side. We've been in this very uneven environment from a macro perspective, and we're very pleased with where our network gross margins are, which are at the high end of our range. I wouldn't want to extend the range right now until we maybe get into a different macro time.

Brian Drab

And if we're able to still maintain that high margin through that period Yes, definitely within the network, the gross margin has been at the high end of expectations. And you know, I've seen obviously, the automation in the factory is very impressive. And last question for me. Can I just push a little harder? Do you think that consolidated gross margin can say about 45 throughout 2024?

Robert Bodor

Yes. I mean, with the limited visibility that we have on, you know, if I'm not going to say for Q3 and Q4, because I'm kind of trying to right now forecast what that volume will be, but I would say the guidance, our earnings guidance for the next quarter assumes, you know, the flat to slightly down gross margin percentage is based on the mid point being a lower volume number than in the first quarter, but that's maintaining kind of healthy efficiency and healthy margins.
Yes.

Brian Drab

Thanks very much.

Operator

Greg Palm, Craig-Hallum Capital Group.

Greg Palm

Yes, good morning, everybody. Thanks for taking the questions on. I wanted to dig into the guidance just a little bit and kind of what you said about April specifically, can you just maybe give us some sense on how you approach the the guidance? Is it essentially based on what you've seen in April and the assumption that maybe it improves from there? Or is it based on things stabilizing at these levels? Just a little bit more more color because, John, I think normally Q2 is seasonally stronger than Q1. So just wanted to get some sense on how you're approaching the guide.

Robert Bodor

It's interesting in this environment, Greg, if you take a look at us last year, Q2 was not seasonally stronger than Q1. And so we're we are looking at them the order input, as you just said, and we're looking at what our businesses are seeing from a from a quotation trend and based on that, we are developing a range that you know that we think is where the revenue is going to end up being it's a challenging environment, right? Because a forecast because as I talked about last call, we had soft refers to come into the quarter as well.
We went through a period where the orders are fairly strong and now they're softening again. And so we used our same information that we have going in in terms of what our orders at or did April come in to help protect the quarter I will say something else, though. On top of that, you know, we've shown last year in this uneven type of macro environment that we can grow and that's what we're focused on right now and the middle of the guide and our first quarter both indicate us growing, and that's what we're focused on.

Greg Palm

Yes, makes sense. Okay. Appreciate that. And then, thanks for providing a little bit more color on sort of the customers and the cross-sell opportunity. And I think you mentioned that 5% of customers are currently using both services. Did I hear that right?

Robert Bodor

Yes, Austin, less than five. Yes.

Greg Palm

Less than five. What was that number a year ago? Where do you want it to be whether it's a year from now or a couple of years from now? And I guess more importantly, what are you doing internally to increase that number?

Robert Bodor

Yes. I appreciate the question. Thank you. So you're asking, what's what's driving the cross selling that we're seeing? The answer is we are mark. This is very fundamental to our strategy or this is what our sales and marketing teams are focused on. We've over the last several years, expanded our offering dramatically both through the network and through the factory in terms of being able to take larger quantity orders into production more efficiently and more. And we're starting to see that traction right now. We've got over 53,000 customers that we serve who are used to relying on us for prototyping and have been asking us for it more and more opportunities to work together in different use cases and needs that they have.
And we're now able to bring that to them and able to support them through the lifecycle of their products. And so we are working very aggressively to and to bring that to our customers right at the beginning of the year. We changed the brand united around Proto Labs with the network, and we've been communicating this to our customers. And our salespeople have been approaching our customers with these broader offerings to capture some of these opportunities.
And so we're seeing that have traction, right? And as you point out, we are absolutely in the early innings with this right. We are just scratching the surface. I'm pleased with how quickly the number grew from zero to what it is today. And I and I'm just really excited about attacking the remaining 95% of our customers, right and bringing this opportunity sooner because I think that this is clearly a huge growth potential for our business.

Greg Palm

Yes, makes sense. Okay. I will leave it there.

Robert Bodor

Thanks.

Operator

(Operator Instructions) Jim Ricchiuti, Needham & Company.

Jim Ricchiuti

Hi, good morning. It just given the variability that you're seeing in the business on the softening we've seen more recently, is that in any is there much of a difference Europe versus the U.S. or are you seeing any change in any particular vertical?

Robert Bodor

Yes, I would say the general softness is more on just to do with larger orders.

Jim Ricchiuti

And I think more of that softness is in U.S. than it is in Europe from a quarter-over-quarter perspective in EM, remind me of you, you were impacted at least by the comparison in Europe by some larger orders you had in the year ago period, a q. one, what did that look like in Q2 of last year? I'm just trying to think about how we might see that portion of the business bounce back in Q2?

Robert Bodor

Yes. So when we're talking specifically about Europe on our factory side of the business, in Q1 of last year in Europe had some really large orders that didn't repeat into Q2. So on last year's Q2, your number for the factory was lower than what it's on Q1, the number was. And so that part of the reason why you saw the decline that you did in Europe was a really tough comps with Q1 of last year. From the timing of larger orders within Europe.

Jim Ricchiuti

Got it. How should we be thinking about OpEx as we think is a reasonable step up in OpEx from Q4 to Q1 as you look out over the balance of the year? And any thoughts on how we should be modeling OpEx?

Robert Bodor

Yes, I think OpEx will be slightly higher in Q2 versus Q1. We have some, you know, additional investments we're making in the business. There's some more expense from a tradeshow perspective and so on. We expect a slight uptick in OpEx from Q1 to Q2.

Jim Ricchiuti

Okay. Thank you.

Daniel Schumacher

Thanks, Jim.

Operator

There are no further questions at this time. We will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.