Proto Labs Inc.'s Expenses Trumped Revenue Growth in Q2

By Markets Fool.com

Image source: Proto Labs.

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Before the market opened on Thursday, quick-turn manufacturing service provider Proto Labs (NYSE: PRLB) reported that its second-quarter revenue increased 17% year over year, to a record $75 million. This translated to earnings of $10.7 million, or $0.40 per diluted share -- flat compared to last year.

Excluding the benefit of Alphaform AG, a German-based 3D printing service provider that Proto Labs acquired in October, the company's legacy revenue grew by a slower 10% year over year, to $70.2 million. Previously, management expected Proto Labs to generate between $75 million and $80 million in second-quarter revenue.

Manufacturing Service

Revenue (Thousands)

YOY Change

Injecting molding

$44,762

12.1%

CNC machining

$19,854

6.8%

3D printing

$9,099

66.7%

YOY = year over year. Data source: Proto Labs.

Although Proto Labs reported strong headline and customer growth, the company's rising expenses caused its profitability to stagnate. At the market's open, Proto Labs' stock traded down over 15%.

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Popularity on the rise

During the second quarter, Proto Labs served a record number of product developers -- 13,519. This was 14% more than it served last year and 2% more than the first quarter. Both measures continue to suggest that Proto Labs' rapid manufacturing services are faring well and becoming more widely accepted in the marketplace. What's more, revenue per product developer increased by about 2.5% year over year, to $5,545, which suggests that product developers became slightly more loyal to Proto Labs' services.

Rising numbers of product developers and increased spending per product developer are good signs that Proto Labs' core business is engaging customers in a positive way.

Ballooning expenses

Proto Labs' gross margin declined by 230 basis points year over year, to 56.4%. This was largely due to the fact that Proto Labs' 3D printing business is a lower-margin business and is growing faster than the rest of its other services. The inclusion of Alphaform had a 310-basis-point negative impact on Proto Labs' gross margin.

While it's reasonable for Proto Labs' gross margin to decline as its 3D printing business becomes a bigger part of the company, its falling operating margin may give investors a reason to take pause. That's because Proto Labs' GAAP operating margin fell from 27.1% last year to 19.8% this year, as total operating expenses grew by a blistering 35.6% year over year -- more than twice as fast as its revenue growth rate.

Operating Expense

Amount (Thousands)

YOY Change

Marketing and sales

$11,453

20.5%

Research and development

$5,816

32.3%

General and administrative

$10,126

60.6%

YOY = year over year. Data source: Proto Labs.

Ultimately, the benefit of revenue growth will not flow to the bottom line as improved earnings if operating expenses continue to outpace revenue growth. In other words, this scenario could cause Proto Labs' earnings potential to stagnate.

An international growth story

Thanks to the inclusion of Alphaform and improved performance in Japan, Proto Labs' international revenue growth was robust. Even without Alphaform, Proto Labs' revenue in Europe increased by 24% year over year. Overall, Proto Labs' second-quarter international revenue represented 30.8% of its total sales, versus 22.9% last year.

Region

Revenue (Thousands)

YOY Change

Europe

$17,277

71.3%

Japan

$2,361

46.1%

U.S. (shipped internationally)

$3,471

16.8%

YOY = year over year. Data source: Proto Labs.

Management's two cents

Last quarter, Proto Labs CEO Vicki Holt noted that the global slowdown affecting the majority of industrial-facing companies started to weigh on Proto Labs' as well. This quarter, Holt said that "in theAmericas, we experienced slower-than-expected growth in injection molding and CNC machining. This was primarily due to a slowdown in the U.S. industrial economy as well as attrition in sales leadership."

Looking ahead, Holt said that Proto Labs "will be focused on driving actions to improve our sales performance and efficiency through our operations, and we expect to see improvement in sales growth, especially in theAmericas, over time." In other words, it sounds like Proto Labs is going to start focusing on reining in its operating expenses to improve its bottom-line profitability.

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Steve Heller owns shares of Proto Labs. The Motley Fool owns shares of and recommends Proto Labs. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.