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PRLB > SEC Filings for PRLB > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for PROTO LABS INC

Form 10-K for PROTO LABS INC


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward- looking statements as a result of various factors, including those set forth under "Risk Factors" and elsewhere in this Annual Report on Form 10-K.

Overview

We are a leading online and technology-enabled manufacturer of quick-turn CNC-machined and injection-molded custom parts for prototyping and short-run production. We provide "Real Parts, Really Fast" to product developers worldwide, who are under increasing pressure to bring their finished products to market faster than their competition. We believe low-volume manufacturing has historically been an underserved market due to the inefficiencies inherent in the quotation, equipment set-up and non-recurring engineering processes required to produce custom parts. Our proprietary technology eliminates most of the time-consuming and expensive skilled labor conventionally required to quote and manufacture parts in low volumes, and our customers conduct nearly all of their business with us over the Internet. We target our services to the millions of product developers who use 3D CAD software to design products across a diverse range of end-markets. Our primary manufacturing services currently include Firstcut, which is our CNC machining service, and Protomold, which is our injection molding service. Through December 31, 2013, we have received over 1,400,000 uploaded part designs, sent over 1,200,000 part quotations and shipped over 300,000 unique parts to approximately 36,000 product developers representing over 16,000 customer companies across a wide range of industries.

We have experienced significant growth since our inception. Since we first introduced our Protomold injection molding service in 1999, we have steadily expanded the size and geometric complexity of the injection-molded parts we are able to manufacture, and we continue to extend the diversity of materials we are able to support. Similarly, since first introducing our Firstcut CNC machining service in 2007, we have expanded the range of part sizes, design geometries and materials we can support. We are also continually seeking to enhance other aspects of our technology and manufacturing processes, including our interactive web-based and automated user interface and quoting system. We intend to continue to invest significantly in enhancing our technology and manufacturing processes and expanding the range of our existing capabilities with the aim of meeting the needs of a broader set of product developers. As a result of the factors described above, many of our customers tend to return to Proto Labs to meet their ongoing needs, with approximately 86%, 84% and 81% of our revenue in 2013, 2012 and 2011, respectively, derived from existing customers who had placed orders with us in prior years.

We have established our operations in the United States, Europe and Japan, which we believe are three of the largest geographic markets where product developers are located. We entered the European market in 2005 and launched operations in Japan in late 2009. As of December 31, 2013, we had sold products into more than 50 countries. Our revenue outside of the United States accounted for approximately 27%, 25% and 26% of our consolidated revenue in the years ended December 31, 2013, 2012 and 2011, respectively. We intend to continue to expand our international sales efforts and believe opportunities exist to serve the needs of product developers in select new geographic regions.

We have grown our total revenue from $43.8 million in 2009 to $163.1 million in 2013. During this period, our operating expenses increased from $17.4 million in 2009 to $50.4 million in 2013. We have grown our income from operations from $7.9 million in 2009 to $51.3 million in 2013. Our recent growth in revenue and income from operations has been accompanied by increased operating expenses, with the two most significant components being marketing and sales and general and administrative expenses. We expect to increasingly invest in our operations to support anticipated future growth as discussed more fully below.

In addition, we believe that a number of trends affecting our industry have affected our results of operations and may continue to do so. For example, we believe that many of our target product developer customers have increasing e-commerce expectations, are facing increased pressure to accelerate the time to market for their products and continue to migrate from using 2D CAD to using 3D CAD for their design needs. We believe we continue to be well positioned to benefit from these trends, given our proprietary technology that enables us to automate and integrate the majority of activities involved in procuring custom low-volume parts, starting with our elegant web interface through which a product developer submits a 3D CAD part design. While our business may be positively affected by these trends, our results may also be favorably or unfavorably impacted by other trends that affect product developer orders for custom parts in low volumes, including, among others, changes in product developer preferences or needs, developments in our industry and among our competitors and factors impacting new product development volume such as economic conditions. For a more complete discussion of the risks facing our business, see "Risk Factors."


Key Financial Measures and Trends

Revenue

Our operations are comprised of three geographic business units in the United States, Europe and Japan. Revenue within each of our subsidiaries is derived from our Firstcut and Protomold services. Firstcut revenue consists of sales of CNC-machined custom parts. Protomold revenue consists of sales of custom injection molds and injection-molded parts. Our revenue is generated from a diverse customer base, with no single customer company representing more than 2% of our total revenue in 2013. Our historical and current efforts to increase revenue have been directed at gaining new customers and selling to our existing customer base by increasing marketing and selling activities, offering additional services such as the introduction of our Firstcut service in 2007, expanding internationally such as the opening of our Japanese office in 2009, improving the usability of our services such as our web-centric applications, and expanding the breadth and scope of our products such as by adding more sizes and materials to our offerings.

During 2013, we sold our services to approximately 5,730 customer companies from our existing customer base, an increase of 20% over the comparable period in 2012, and to approximately 3,020 new customer companies, an increase of 1% over the comparable period in 2012. During 2012, we sold our services to approximately 4,760 customer companies from our existing customer base, an increase of 39% over the comparable period in 2011, and to approximately 2,990 new customer companies, an increase of 15% over the comparable period in 2011. During 2011, we sold our services to approximately 3,430 customer companies from our existing customer base, an increase of 38% over the comparable period in 2010, and to approximately 2,600 new customer companies, an increase of 36% over the comparable period in 2010.

During 2013, we served approximately 7,820 existing product developers, an increase of 30% over the comparable period in 2012, and approximately 8,300 new product developers, an increase of 12% over the comparable period in 2012. During 2012, we served approximately 6,020 existing product developers, an increase of 38% over the comparable period in 2011, and approximately 7,430 new product developers, an increase of 23% over the comparable period in 2011. During 2011, we served approximately 4,360 existing product developers, an increase of 44% over the comparable period in 2010, and approximately 6,060 new product developers, an increase of 48% over the comparable period in 2010.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of raw materials, equipment depreciation, employee compensation, benefits, stock-based compensation and overhead allocations associated with the manufacturing process for molds and custom parts. We expect cost of revenue to increase in absolute dollars, but remain relatively constant as a percentage of total revenue.

Our business model requires that we invest in our capacity well in advance of demand to ensure we can fulfill the expectations for quick service from our customers. Therefore, during each of 2013 and 2012 we made significant investments in additional factory space and infrastructure in the United States and Japan. We expect to continue to grow in future periods, which will result in the need for additional investments in factory space and equipment. We expect that these additional costs for factory and equipment expansion can be absorbed by revenue growth, and allow gross margins to remain relatively consistent over time.

We define gross profit as our revenue less our cost of revenue, and we define gross margin as gross profit expressed as a percentage of revenue. Our gross profit and gross margin are affected by many factors, including our pricing, sales volume and manufacturing costs, the costs associated with increasing production capacity, the mix between domestic and foreign revenue sources and foreign exchange rates.

Our gross margins vary between geographic markets due primarily to the costs associated with starting new factories and our operating maturity in these markets. We believe that over time and with growth and maturity of our international business, gross margins will be generally consistent through all our markets.


Operating Expenses

Operating expenses consist of marketing and sales, research and development and general and administrative expenses. Personnel-related costs are the most significant component of the marketing and sales, research and development and general and administrative expense categories.

Our recent growth in operating expenses is mainly due to higher headcounts to support our growth and expansion, and we expect that trend to continue. Our business strategy is to continue to be a leading online and technology-enabled manufacturer of quick-turn CNC-machined and injection-molded custom parts for prototyping and short-run production. For us to achieve our goals, we anticipate continued substantial investments in technology and personnel, resulting in increased operating expenses.

Marketing and sales. Marketing and sales expense consists primarily of employee compensation, benefits, commissions, stock-based compensation, marketing programs such as print and pay-per-click advertising, trade shows, direct mail and other related overhead. We expect sales and marketing expense to increase in the future as we increase the number of marketing and sales professionals and marketing programs targeted to increase our customer base.

Research and development. Research and development expense consists primarily of employee compensation, benefits, stock-based compensation, depreciation on equipment, outside services and other related overhead. All of our research and development costs have been expensed as incurred. We expect research and development expense to increase in the future as we seek to enhance and expand our service offerings.

General and administrative. General and administrative expense consists primarily of employee compensation, benefits, stock-based compensation, professional service fees related to accounting, tax and legal and other related overhead. We expect general and administrative expense to increase on an absolute basis and as a percentage of revenue as we continue to grow and expand our operations and develop the infrastructure necessary to operate as a public company. These expenses will include increased audit and legal fees, costs of compliance with securities and other regulations and implementation costs for compliance with the provisions of the Sarbanes-Oxley Act.

Other Income (Expense), Net

Other income (expense), net primarily consists of foreign currency-related gains and losses, interest income on cash balances and investments, and interest expense on borrowings. Our foreign currency-related gains and losses will vary depending upon movements in underlying exchange rates. Our interest income will vary each reporting period depending on our average cash balances during the period, composition of our marketable security portfolio and the current level of interest rates. Our interest expense will vary based on borrowings and interest rates.

Provision for Income Taxes

Provision for income taxes is comprised of federal, state, local and foreign taxes based on pre-tax income. We expect income taxes to increase as our taxable income increases and our effective tax rate to remain relatively constant.


Results of Operations

The following table sets forth a summary of our results of operations and the related changes for the periods indicated. The results below are not necessarily indicative of the results for future periods.

                                       Year Ended                                                                  Year Ended
                                      December 31,                              Change                            December 31,                            Change
(dollars in
thousands)                    2013                      2012                $            %                2012                      2011               $           %

Revenue              $ 163,112       100.0 %   $ 125,991       100.0 %   $ 37,121       29.5 %   $ 125,991       100.0 %   $ 98,939       100.0 %   $ 27,052       27.3 %
Cost of revenue         61,410        37.6        49,853        39.6       11,557       23.2        49,853        39.6       39,324        39.7       10,529       26.8
Gross profit           101,702        62.4        76,138        60.4       25,564       33.6        76,138        60.4       59,615        60.3       16,523       27.7
Operating
expenses:
Marketing and
sales                   22,386        13.7        18,098        14.4        4,288       23.7        18,098        14.4       15,752        15.9        2,346       14.9
Research and
development             11,863         7.3         9,137         7.2        2,726       29.8         9,137         7.2        5,222         5.3        3,915       75.0
General and
administrative          16,154         9.9        13,957        11.1        2,197       15.7        13,957        11.1       11,772        11.9        2,185       18.6
Total operating
expenses                50,403        30.9        41,192        32.7        9,211       22.4        41,192        32.7       32,746        33.1        8,446       25.8
Income from
operations              51,299        31.5        34,946        27.7       16,353       46.8        34,946        27.7       26,869        27.2        8,077       30.1
Other income
(expense), net             279         0.1            23         0.1          256          *            23         0.1         (114 )      (0.2 )        137          *
Income before
income taxes            51,578        31.6        34,969        27.8       16,609       47.5        34,969        27.8       26,755        27.0        8,214       30.7
Provision for
income taxes            16,301        10.0        10,944         8.7        5,357       48.9        10,944         8.7        8,783         8.8        2,161       24.6
Net income           $  35,277        21.6 %   $  24,025        19.1 %   $ 11,252       46.8 %   $  24,025        19.1 %   $ 17,972        18.2 %   $  6,053       33.7 %

* Percentage change not meaningful

Stock-based compensation expense included in the statements of comprehensive income data above is as follows:

                                             Year Ended December 31,
(dollars in thousands)                     2013        2012        2011

Stock options and grants                 $  3,084     $ 2,539     $ 1,130
Employee stock purchase plan                  377         500           -
Total stock-based compensation expense   $  3,461     $ 3,039     $ 1,130

Cost of revenue                          $    316     $   335     $    78
Operating expenses:
Marketing and sales                           610         418         215
Research and development                      754         486         274
General and administrative                  1,781       1,800         563
Total stock-based compensation expense   $  3,461     $ 3,039     $ 1,130

Comparison of Years Ended December 31, 2013 and 2012



Revenue



Revenue and the related changes for 2013 and 2012 were as follows:




                                          Year Ended December 31,
                                    2013                          2012                       Change
                                        % of Total                    % of Total
(dollars in thousands)       $            Revenue          $            Revenue          $             %


Revenue
Protomold                $ 115,069            70.5 %   $  90,371            71.7 %   $  24,698          27.3 %
First Cut                   48,043            29.5        35,620            28.3        12,423          34.9

Total revenue            $ 163,112           100.0 %   $ 125,991           100.0 %   $  37,121          29.5 %


Revenue by geographic region, based on the billing location of the end customer, is summarized as follows:

                                           Year Ended December 31,
                                    2013                            2012                       Change
                                        % of Total                     % of Total
(dollars in thousands)       $           Revenue             $          Revenue             $            %

Revenue
United States            $ 119,870             73.5 %   $  94,866             75.3 %   $  25,004          26.4 %
International               43,242             26.5        31,125             24.7        12,117          38.9

Total revenue            $ 163,112            100.0 %   $ 125,991            100.0 %   $  37,121          29.5 %

Our revenue increased $37.1 million, or 29.5%, for 2013 compared with 2012. This revenue growth was driven by a 26.4% increase in United States revenue, a 38.9% increase in international revenue, a 27.3% increase in Protomold revenue and a 34.9% increase in Firstcut revenue, in each case for 2013 compared with 2012.

Our revenue growth in 2013 was the result of increased volume and spending of the product developers we served. During 2013, we served approximately 16,120 unique product developers, an increase of 20% over 2012. Average revenue per product developer also increased 8% during 2013 as compared to 2012.

Our revenue increases were primarily driven by increases in sales personnel and marketing activities. Our sales personnel focus on gaining new customer accounts and expanding the depth and breadth into existing customer accounts. Our marketing personnel focus on marketing activities that have proven to result in the greatest number of customer leads to support sales activity. International revenue was negatively impacted by $1.7 million in 2013 compared to 2012 due to strengthening of the United States dollar relative to certain foreign currencies. The effect of pricing changes on revenue was immaterial for 2013 compared to 2012.

Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue increased $11.6 million, or 23.2%, for 2013 compared to 2012, which was slower than the rate of revenue increase of 29.5% for 2013 compared to 2012. The increase in cost of revenue was due to raw material and production cost increases of $4.8 million to support increased sales volumes, equipment and facility-related cost increases of $1.9 million and an increase in direct labor headcount resulting in personnel and related cost increases of $4.9 million.

Gross Profit and Gross Margin. Gross profit increased from $76.1 million, or 60.4% of revenues, in 2012 to $101.7 million, or 62.4% of revenues, in 2013 primarily due to revenue increasing faster than cost of revenue as discussed above. Gross margin increased primarily as a result of increased productivity as we leveraged production equipment and resources and additional capacity added in prior years.

Operating Expenses, Other Expense, Net and Provision for Income Taxes

Marketing and Sales. Marketing and sales expense increased $4.3 million, or 23.7%, for 2013 compared to 2012 due to an increase in headcount resulting in personnel and related cost increases of $3.6 million and marketing program cost increases of $0.7 million. The increase in marketing program costs is the result of our focus and concentration on funding those programs which have proven to be the most effective in growing our business. Marketing and sales expense as a percentage of revenue decreased to 13.7% for 2013 from 14.4% in 2012, primarily due to the fixed nature of certain marketing and sales costs as well as focus on effective marketing spending as previously discussed.

Research and Development. Our research and development expense increased $2.7 million, or 29.8%, for 2013 compared to 2012 due to an increase in headcount resulting in personnel and related cost increases of $2.2 million and operating cost increases of $0.6 million, which were partially offset by a decrease in professional services of $0.1 million.

General and Administrative. Our general and administrative expense increased $2.2 million, or 15.7%, for 2013 compared to 2012 due to an increase in headcount resulting in personnel and related cost increases of $0.8 million, facility and administrative cost increases of $0.6 million and professional service cost increases of $0.8 million for outside legal and accounting services.


Other Income (Expense), Net. Other income (expense), net increased $0.3 million for 2013 compared with 2012 due to an increase in interest income of $0.4 million partially offset by $0.1 million due to unfavorable changes in foreign currency rates.

Provision for Income Taxes. Our income tax provision increased $5.4 million for 2013 compared to 2012 due an increase of taxable income. Our effective tax rate increased marginally to 31.6% in 2013 from 31.3% in 2012 due primarily to the mix of revenue earned in domestic and foreign tax jurisdictions and deductions for which we qualify in the current year.

Comparison of Years Ended December 31, 2012 and 2011



Revenue



Revenue and the related changes for 2012 and 2011 were as follows:




                                          Year Ended December 31,
                                    2012                          2011                       Change
                                        % of Total                    % of Total
(dollars in thousands)        $           Revenue          $            Revenue          $             %

Revenue
Protomold                $  90,371            71.7 %   $  74,090            74.9 %   $  16,281          22.0 %
First Cut                   35,620            28.3        24,849            25.1        10,771          43.3

Total revenue            $ 125,991           100.0 %   $  98,939           100.0 %   $  27,052          27.3 %

Revenue by geographic region, based on the billing location of the end customer, is summarized as follows:

                                          Year Ended December 31,
                                    2012                          2011                       Change
                                        % of Total                    % of Total
(dollars in thousands)       $            Revenue          $            Revenue          $             %

Revenue
United States            $  94,866            75.3 %   $  73,010            73.8 %   $  21,856          29.9 %
International               31,125            24.7        25,929            26.2         5,196          20.0

Total revenue            $ 125,991           100.0 %   $  98,939           100.0 %   $  27,052          27.3 %

Our revenue increased $27.1 million, or 27.3%, for 2012 compared with 2011. This revenue growth was driven by a 29.9% increase in United States revenue, a 20.0% increase in international revenue, a 22.0% increase in Protomold revenue and a 43.3% increase in Firstcut revenue, in each case for 2012 compared with 2011.

Our revenue growth in 2012 was the result of increased volume of the product developers we served. During 2012, we served approximately 13,450 unique product developers, an increase of 29% over 2012. Average revenue per product developer declined by 1% during 2012 as compared to 2011.

Our revenue increases were primarily driven by increases in sales personnel and marketing activities. Our sales personnel focus on gaining new customer accounts and expanding the depth and breadth into existing customer accounts. Our marketing personnel focus on marketing activities that have proven to result in the greatest number of customer leads to support sales activity. International revenue was negatively impacted by $0.3 million in 2012 compared to 2011 due to strengthening of the United States dollar relative to certain foreign currencies. The effect of pricing changes on revenue was immaterial for 2012 compared to 2011.


Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue increased $10.5 million, or 26.8%, for 2012 compared to 2011, which was slightly slower than the rate of revenue increase of 27.3 % for 2012 compared to 2011. The increase in cost of revenue was due to raw material and production cost increases of $2.9 million to support increased sales volumes, equipment and facility-related cost increases of $2.4 million and an increase in direct labor headcount resulting in personnel and related cost increases of $5.2 million.

Gross Profit and Gross Margin. Gross profit increased from $59.6 million, or 60.3% of revenues, in 2011 to $76.1 million, or 60.4% of revenues, in 2012 primarily due to revenue increasing faster than cost of revenue as discussed above. Gross margin remained consistent primarily as a result of increased productivity offset by the cost of additional capacity added during the year, primarily additional manufacturing space and facilities.

Operating Expenses, Other Expense, Net and Provision for Income Taxes

Marketing and Sales. Marketing and sales expense increased $2.3 million, or 14.9%, for 2012 compared to 2011 due to an increase in headcount resulting in personnel and related cost increases of $2.1 million and marketing program cost increases of $0.2 million. The marginal increase in marketing program costs is the result of our focus and concentration on funding those programs which have proven to be the most effective in growing our business. Marketing and sales expense as a percentage of revenue decreased to 14.4% for 2012 from 15.9% in . . .

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