PROTO LABS, INC. 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 an e-commerce driven digital manufacturer of quick-turn, on-demand injection-molded, CNC-machined, 3D-printed and sheet metal-fabricated custom parts for prototyping and short-run production. We provide custom parts to product developers and engineers worldwide, who are under increasing pressure to bring their finished products to market faster than their competition. We believe custom parts 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 product lines to the millions of product developers and engineers who use 3D CAD software to design products across a diverse range of end markets. Our primary manufacturing product lines currently include Injection Molding, CNC Machining, 3D Printing and Sheet Metal. We have experienced significant growth since our inception. Since we first introduced our Injection Molding product line 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 CNC Machining product line in 2007, we have expanded the range of part sizes, design geometries and materials we can support. In 2014, we acquiredFineLine Prototyping, Inc. (FineLine) to expand the number of process types we offer to include stereolithography (SL), selective laser sintering (SLS) and direct metal laser sintering (DMLS). In 2017, we acquired RAPID to expand the number of process types we offer to include sheet metal fabrication and expand our CNC machining capability. In 2019, we added Carbon DLS to our 3D printing processes, introduced precision color matching on Injection Molding parts and launched production capabilities for metal 3D printing. We also continually seek 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 to enhance our technology and manufacturing processes and expand the range of our existing capabilities with the aim of meeting the needs of a broader set of customers. As a result of the factors described above, many of our customers tend to return toProto Labs to meet their ongoing needs, with approximately 92%, 91% and 89% of our revenue in 2019, 2018 and 2017, respectively, derived from existing customers. We have established our operations inthe United States ,Europe andJapan , which we believe are three of the largest geographic markets where product developers and engineers are located. We entered the European market in 2005, launched operations inJapan in late 2009. Our operations were further expanded inEurope through our acquisition of Alphaform in 2015 andthe United States through our acquisition of RAPID inNovember 2017 . As ofDecember 31, 2019 , we had sold products into approximately 60 countries. Our revenue outside ofthe United States accounted for approximately 22%, 21% and 24% of our consolidated revenue in the years endedDecember 31, 2019 , 2018 and 2017, respectively. We intend to continue to expand our international sales efforts and believe opportunities exist to serve the needs of product developers and engineers in select new geographic regions. We have grown our total revenue from$264.1 million in 2015 to$458.7 million in 2019. During this period, our operating expenses increased from$87.3 million in 2015 to$155.4 million in 2019. We have grown our income from operations from$67.1 million in 2015 to$79.9 million in 2019. Our recent growth in revenue and income from operations has been accompanied by increased cost of revenues and operating expenses. We expect to increase investment 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 and engineer customers are facing three mega trends, which are disrupting long-term product growth models. We believe our customers are facing increased pressure to shorten product life-cycles, to embed products with connectivity driven by the internet of things technology, and to deliver products that are personalized and customized to unique customer specifications. 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 parts. 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 and engineer orders for custom parts in low volumes, including, among others, economic conditions, changes in product developer and engineer preferences or needs, developments in our industry and among our competitors, and developments in our customers' industries. For a more complete discussion of the risks facing our business, see Part I, Item 1A. "Risk Factors" of this Annual Report on Form 10-K. 32
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Table of Contents
Key Financial Measures and Trends
Revenue Our operations are comprised of three geographic operating segments inthe United States ,Europe andJapan . Revenue is derived from our Injection Molding, CNC Machining, 3D Printing and Sheet Metal product lines. Injection Molding revenue consists of sales of custom injection molds and injection-molded parts. CNC Machining revenue consists of sales of CNC-machined custom parts. 3D Printing revenue consists of sales of custom 3D-printed parts. Sheet Metal revenue consists of sales of fabricated sheet metal custom parts. Our revenue is generated from a diverse customer base, with no single customer company representing more than 2% of our total revenue in 2019. 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, including:
• the introduction of our 3D Printing product line through our acquisition of
FineLine in 2014;
• expanding 3D printing to
• the introduction of our Sheet Metal product line through our acquisition of
RAPID in 2017;
• continuously improving the usability of our product lines such as our
web-centric applications; and
• expanding the breadth and scope of our products by adding more sizes and
materials to our offerings.
During 2019, we served 47,774 unique product developers and engineers who purchased our products through our web-based customer interface, an increase of 3.9% over the same period in 2018.
During 2018, we served 45,968 unique product developers and engineers who purchased our products through our web-based customer interface, an increase of 22.5% over the same period in 2017.
During 2017, we served 37,538 unique product developers and engineers who purchased our products through our web-based customer interface, an increase of 19.3% over the same period in 2016.
Cost of Revenue, Gross Profit and Gross Margin
Cost of revenue consists primarily of raw materials, equipment depreciation, employee compensation including benefits and stock-based compensation, facilities costs and overhead allocations associated with the manufacturing process for molds and custom parts. We expect our personnel-related costs to increase in order to retain and attract top talent and remain competitive in the market. Overall, 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 delivery of our products to our customers. Therefore, during each of 2019, 2018 and 2017 we made significant investments in additional factory space, equipment, and infrastructure inthe United States . We also made significant investments in infrastructure inEurope in 2017 and significant investments in additional factory space inJapan in 2019 and 2016. 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 by product line 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 mix of revenue by product line, pricing, sales volume, manufacturing costs, the costs associated with increasing production capacity, the mix between domestic and foreign revenue sources and foreign exchange rates. 33
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Table of Contents 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 in each of these 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, on-demand injection-molded, CNC-machined, CNC-turned, 3D-printed and sheet metal custom parts for prototyping and low-volume production. In order 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 electronic, print and pay-per-click advertising, trade shows 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 and grow revenue. Research and development. Research and development expense consists primarily of personnel and outside service costs related to the development of new processes and product lines, enhancement of existing product lines, software developed for internal use, maintenance of internally developed software, quality assurance and testing. Costs for internal use software are evaluated by project and capitalized where appropriate under Accounting Standards Codification (ASC) 350-40, Intangibles -Goodwill and Other,Internal-Use Software . We expect research and development expense to increase in the future as we seek to enhance our e-commerce interface technology, internal software and supporting business systems, and continue to expand our product lines. 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 in the future as we continue to grow and expand as a global organization. Other Income, Net Other income, net primarily consists of foreign currency-related gains and losses and interest income on cash balances and investments. 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. Provision for Income Taxes Provision for income taxes is comprised of federal, state, local and foreign taxes based on pre-tax income. OnDecember 22, 2017 , the Tax Cuts and Jobs Act was signed into law inthe United States . As a result, many provisions will affect our tax rate in future years. Some provisions, such as the reduction to theU.S. corporate tax rate from 35% to 21%, which began in 2018, reduced our effective tax rate in 2018 and subsequent years. Overall, our effective tax rate for 2018 and beyond will remain consistent based on the current tax laws. 34
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Table of Contents Results of Operations The following table summarizes 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) 2019 2018 $ % 2018 2017 $ %
Revenue $ 458,728 100.0 % $ 445,596 100.0 %
100.0 %$ 101,106 29.3 Cost of revenue 223,438 48.7 206,917
46.4 16,521 8.0 206,917 46.4 150,648
43.7 56,269 37.4
Gross profit 235,290 51.3 238,679 53.6 (3,389 ) (1.4 ) 238,679 53.6 193,842
56.3 44,837 23.1
Operating expenses:
Marketing and sales 72,976 15.9 68,533 15.4 4,443 6.5 68,533 15.4 56,856
16.5 11,677 20.5 Research and development 32,692 7.1 28,735 6.4 3,957 13.8 28,735 6.4 23,560
6.8 5,175 22.0 General and administrative 49,766 10.9 52,513 11.8 (2,747 ) (5.2 ) 52,513 11.8 41,200
12.0 11,313 27.5
Total operating expenses 155,434 33.9 149,781 33.6 5,653 3.8 149,781 33.6 121,616 35.3 28,165 23.2
Income from operations 79,856 17.4 88,898 20.0 (9,042 ) (10.2 ) 88,898 20.0 72,226 21.0 16,672 23.1
Other income, net 1,337 0.3 2,757 0.6 (1,420 ) (51.5 ) 2,757 0.6 2,209 0.6 548 24.8Income before income taxes 81,193 17.7 91,655 20.6 (10,462 ) (11.4 ) 91,655 20.6 74,435
21.6 17,220 23.1
Provision for income taxes 17,538 3.8 15,067 3.4 2,471 16.4 15,067 3.4 22,657 6.6 (7,590 ) (33.5 )
Net income $ 63,655 13.9 % $ 76,588 17.2 % $ (12,933 ) (16.9 %) $ 76,588 17.2 % $ 51,778 15.0 % $ 24,810 47.9 %
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Stock-based compensation expense included in the statements of comprehensive income data above is as follows:
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Year Ended December 31,
(dollars in thousands) 2019 2018 2017
Stock options and grants $ 9,591 $ 10,113 $ 7,954
Employee stock purchase plan 1,190 815 604
Total stock-based compensation expense
Cost of revenue$ 2,056 $ 1,543 $ 970 Operating expenses: Marketing and sales 2,632 1,942 1,429 Research and development 1,851 1,517 1,091 General and administrative 4,242 5,926 5,068
Total stock-based compensation expense
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Comparison of Years Ended
Revenue
Revenue by reportable segment and the related changes for 2019 and 2018 is summarized as follows:
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Year Ended December 31,
2019 2018 Change
% of Total % of Total
(dollars in thousands) $ Revenue $ Revenue $ %
Revenue
United States $ 360,205 78.5 % $ 350,535 78.7 % $ 9,670 2.8 %
Europe 82,805 18.1 80,889 18.2 1,916 2.4
Japan 15,718 3.4 14,172 3.1 1,546 10.9
Total revenue $ 458,728 100.0 % $ 445,596 100.0 % $ 13,132 2.9 %
-------------------------------------------------------------------------------- Our revenue increased$13.1 million , or 2.9%, for 2019 compared with 2018. By reportable segment, revenue inthe United States increased$9.7 million , or 2.8%, for 2019 compared with 2018. Revenue inEurope increased$1.9 million , or 2.4%, for 2019 compared with 2018. Revenue inJapan increased$1.5 million , or 10.9%, for 2019 compared with 2018. 35
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Our revenue growth in 2019 was primarily driven by an increased volume of the product developers and engineers we served. During 2019, we served 47,774 unique product developers and engineers, an increase of 3.9% over 2018. Our growth in product developers and engineers served increased at a greater rate than our revenue growth, resulting in a decrease of 1.0% in the average revenue per product developer and engineer during 2019 as compared to 2018. The decrease in average spend per product developer and engineer was driven by a change in the mix of products, with 3D Printing and CNC Machining generally producing lower average order revenue than our other products. 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 of existing customer accounts. Our marketing personnel focus on marketing activities that have proven to generate the greatest number of customer leads to support sales activity. International revenue was negatively impacted by$4.2 million in 2019 compared to 2018 as a result of foreign currency movements, primarily the weakening of the Euro relative tothe United States dollar.
Revenue by product line and the related changes for 2019 and 2018 is summarized as follows:
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Year Ended December 31,
2019 2018 Change
% of Total % of Total
(dollars in thousands) $ Revenue $ Revenue $ %
Revenue
Injection Molding $ 217,415 47.4 % $ 210,523 47.2 % $ 6,892 3.3 %
CNC Machining 155,473 33.9 153,521 34.5 1,952 1.3
3D Printing 61,352 13.4 53,342 12.0 8,010 15.0
Sheet Metal 21,000 4.6 24,998 5.6 (3,998 ) (16.0 )
Other Revenue 3,488 0.7 3,212 0.7 276 8.6
Total revenue $ 458,728 100.0 % $ 445,596 100.0 % $ 13,132 2.9 %
-------------------------------------------------------------------------------- By product line, our revenue growth was driven by a 3.3% increase in Injection Molding revenue, a 1.3% increase in CNC Machining revenue, a 15.0% increase in 3D Printing revenue, as well as a$0.3 million increase in Other Revenue, which was partially offset by a 16.0% decrease in Sheet Metal revenue, in each case for 2019 compared with 2018. The decrease in Sheet Metal revenue was driven by a decision to move away from certain business which was not scalable and did not fit into the envelope of our revised Sheet Metal product offerings.
Cost of Revenue, Gross Profit and Gross Margin
Cost of Revenue. Cost of revenue increased$16.5 million , or 8.0%, for 2019 compared to 2018, which was faster than the rate of revenue increase of 2.9% for 2019 compared to 2018. The increase in cost of revenue resulted from the growth of the business and investments to support future growth. Specifically, the increases were driven by raw material and production cost increases of$2.6 million , an increase in direct labor headcount and wage inflation resulting in personnel and related cost increases of$7.8 million and equipment and facility-related cost increases of$6.1 million to support increased sales volumes and future growth of the business. Gross Profit and Gross Margin. Gross profit decreased from$238.7 million in 2018 to$235.3 million in 2019 primarily due to an increase in expenses associated with the cost of revenue. Gross margin decreased from 53.6% of revenue in 2018 to 51.3% of revenue in 2019 due to investments in facilities and personnel to support future growth and the timing and mix of revenue, with the lower volumes in Sheet Metal and certain CNC operations related to the RAPID acquisition being the primary driver of the mix related impact. Income from Operations Income from operations decreased$9.0 million , or 10.2%, for 2019 compared with 2018. By reportable segment, income from operations forthe United States andEurope decreased 6.1% and 10.0%, respectively, and Corporate Unallocated andJapan increased 0.6% for 2019 compared with 2018. Operating Expenses Marketing and Sales. Marketing and sales expense increased$4.4 million , or 6.5%, for 2019 compared to 2018 due to an increase in headcount resulting in personnel and related cost increases of$3.3 million and marketing program cost increases of$1.1 million . The increase in marketing program costs is the result of our focus on funding those programs that have proven to be the most effective in growing our business. Research and Development. Our research and development expense increased$4.0 million , or 13.8%, for 2019 compared to 2018 due to an increase in headcount resulting in personnel and related cost increases of$3.5 million , as well as an increase in administrative and depreciation cost increases of$0.5 million . 36
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General and Administrative. Our general and administrative expense decreased$2.7 million , or 5.2%, for 2019 compared to 2018 due to stock- based compensation cost decreases of$1.7 million driven by lower performance-related compensation, amortization cost decreases of$1.0 million driven by allocations to other expense categories to appropriately reflect the nature of our intangible assets and professional service decreases of$0.4 million , which were partially offset by administrative cost increases of$0.4 million .
Other Income, Net and Provision for Income Taxes
Other Income, Net. We recognized other income, net of$1.3 million in 2019, a decrease of$1.5 million compared to other income, net of$2.8 million for 2018. Other income, net for 2019 primarily consisted of$2.1 million in interest income on investments, which was partially offset by a$0.8 million loss on foreign currency. Other income, net for 2018 primarily consisted of$1.7 million in interest income on investments, a$0.7 million gain on our sale ofRAPID Wire & Cable, LLC and a$0.4 million gain on foreign currency. Provision for Income Taxes. Our income tax provision increased by$2.4 million for 2019 compared to 2018. The increase in the provision is primarily due to a decrease in tax benefits from the vesting of restricted stock and exercise of stock options. This increase was coupled with an increase in the state tax provision and an increase in valuation allowances. Our effective tax rate of 21.6% for 2019 increased 5.2% compared to 16.4% for the same period in 2018.
Comparison of Years Ended
Revenue
Revenue by reportable segment and the related changes for 2018 and 2017 is summarized as follows:
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Year Ended December 31,
2018 2017 Change
% of Total % of Total
(dollars in thousands) $ Revenue $ Revenue $ %
Revenue
United States $ 350,535 78.7 % $ 263,086 76.4 % $ 87,449 33.2 %
Europe 80,889 18.2 70,154 20.4 10,735 15.3
Japan 14,172 3.1 11,250 3.2 2,922 26.0
Total revenue $ 445,596 100.0 % $ 344,490 100.0 % $ 101,106 29.3 %
-------------------------------------------------------------------------------- Our revenue increased$101.1 million , or 29.3%, for 2018 compared with 2017. By reportable segment, revenue inthe United States increased$87.4 million , or 33.2%, for 2018 compared with 2017. Revenue growth inthe United States was partially attributable to the acquisition of RAPID inNovember 2017 . Revenue inEurope increased$10.7 million , or 15.3%, for 2018 compared with 2017. Revenue inJapan increased$2.9 million , or 26.0%, for 2018 compared with 2017. Our revenue growth in 2018 was primarily driven by an increased volume of the product developers and engineers we served. During 2018, we served 45,968 unique product developers and engineers, an increase of 22.5% over 2017. Average revenue per product developer or engineer increased 6% during 2018 as compared to 2017 due to changes in the mix of products purchased by our customers. 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 of existing customer accounts. Our marketing personnel focus on marketing activities that have proven to generate the greatest number of customer leads to support sales activity. International revenue increased by$3.5 million in 2018 compared to 2017 as a result of foreign currency movements, primarily the strengthening of the Euro relative tothe United States dollar. 37
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Revenue by product line and the related changes for 2018 and 2017 is summarized as follows:
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Year Ended December 31,
2018 2017 Change
% of Total % of Total
(dollars in thousands) $ Revenue $ Revenue $ %
Revenue
Injection Molding $ 210,523 47.2 % $ 194,432 56.4 % $ 16,091 8.3 %
CNC Machining 153,521 34.5 103,739 30.1 49,782 48.0
3D Printing 53,342 12.0 43,329 12.6 10,013 23.1
Sheet Metal 24,998 5.6 1,767 0.5 23,231 *
Other Revenue 3,212 0.7 1,223 0.4 1,989 *
Total revenue $ 445,596 100.0 % $ 344,490 100.0 % $ 101,106 29.3 %
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* Percentage change not meaningful
By product line, our revenue growth was driven by an 8.3% increase in Injection Molding revenue, a 48.0% increase in CNC Machining revenue and a 23.1% increase in 3D Printing revenue, as well as a$23.2 million increase in Sheet Metal revenue and a$2.0 million increase in Other Revenue, in each case for 2018 compared with 2017. OurNovember 2017 acquisition of RAPID added the Sheet Metal product line, expanded our CNC Machining product line and contributed to Other Revenue.
Cost of Revenue, Gross Profit and Gross Margin
Cost of Revenue. Cost of revenue increased$56.3 million , or 37.4%, for 2018 compared to 2017, which was faster than the rate of revenue increase of 29.3% for 2018 compared to 2017. The increase in cost of revenue resulted from the growth of the business, including via the RAPID acquisition, and was due to raw material and production cost increases of$16.6 million to support increased sales volumes, an increase in direct labor headcount resulting in personnel and related cost increases of$30.8 million and equipment and facility-related cost increases of$8.9 million . Gross Profit and Gross Margin. Gross profit increased from$193.8 million in 2017 to$238.7 million in 2018 primarily due to an increase in revenue. Gross margin decreased from 56.3% of revenue in 2017 to 53.6% of revenue in 2018 primarily due to the timing and mix of revenue, with the RAPID acquisition and CNC facility relocation inthe United States being the primary drivers of the reduction in gross margin. Income from Operations Income from operations increased$16.7 million , or 23.1%, for 2018 compared with 2017. By reportable segment, income from operations forthe United States ,Europe and Corporate Unallocated andJapan increased 17.0%, 30.8% and 10.9%, respectively, as a percentage of revenue for 2018 compared with 2017. Operating Expenses Marketing and Sales. Marketing and sales expense increased$11.7 million , or 20.5%, for 2018 compared to 2017 due to an increase in headcount resulting in personnel and related cost increases of$10.0 million and marketing program cost increases of$1.7 million . The increase in marketing program costs is the result of our focus on funding those programs that have proven to be the most effective in growing our business. Research and Development. Our research and development expense increased$5.2 million , or 22.0%, for 2018 compared to 2017 due to an increase in headcount resulting in personnel and related cost increases of$4.9 million and professional services cost increases of$0.6 million , which were partially offset by a decrease in operating cost of$0.3 million . General and Administrative. Our general and administrative expense increased$11.3 million , or 27.5%, for 2018 compared to 2017 due to an increase in headcount resulting in personnel and related cost increases of$2.4 million , stock- based compensation cost increases of$0.9 million , administrative cost increases of$5.3 million and amortization cost increases of$2.7 million .
Other Income, Net and Provision for Income Taxes
Other Income, Net. We recognized other income, net of$2.8 million in 2018, an increase of$0.6 million compared to other income, net of$2.2 million for 2017. Other income, net for 2018 primarily consisted of$1.7 million in interest income on investments, a$0.7 million gain on our sale ofRAPID Wire & Cable, LLC and a$0.4 million gain on foreign currency. Other income, net for 2017 primarily consisted of$1.5 million in interest income on investments, a$0.4 million favorable legal settlement and a$0.3 million gain on foreign currency. 38
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Provision for Income Taxes. Our income tax provision decreased by$7.6 million for 2018 compared to 2017. The decrease in the provision is primarily due to the Tax Cuts and Jobs Act that went into effect in 2018 and benefits from the vesting of restricted stock and the exercise of stock options. Our effective tax rate of 16.4% for 2018 decreased 14.0% compared to 30.4% for the same period in 2017.
Selected Quarterly Results of Operations Data
The following tables set forth selected unaudited quarterly results of
operations data for 2019 and 2018. This unaudited quarterly information has been
prepared on the same basis as our annual audited consolidated financial
statements appearing elsewhere in this Annual Report on Form 10-K and includes
all adjustments, consisting only of normal recurring adjustments, that we
consider necessary to present fairly the financial information for the fiscal
quarters presented. The quarterly data should be read in conjunction with our
selected financial data and consolidated financial statements and the related
notes appearing elsewhere in this Annual Report on Form 10-K. Operating results
for any quarter are not necessarily indicative of results for a full-year
period, and the historical results presented below are not necessarily
indicative of the results to be expected in any future period.
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Three Months Ended
(in thousands, except share and per share
amounts) Dec. 31, 2019 Sep. 30, 2019 Jun. 30, 2019 Mar. 31, 2019 Dec. 31, 2018 Sep. 30, 2018 Jun. 30, 2018 Mar. 31, 2018
(unaudited)
Consolidated Statements of Comprehensive
Income Data:
Revenue $ 111,889 $ 117,455 $ 115,932 $ 113,452 $ 112,769 $ 115,430 $ 109,652 $ 107,745
Cost of revenue 55,311 57,839 55,696 54,592 53,614 53,027 50,439 49,837
Gross profit 56,578 59,616 60,236 58,860 59,155 62,403 59,213 57,908
Operating expenses:
Marketing and sales 17,510 17,604 19,285 18,577 17,586 16,818 17,557 16,572
Research and development 8,151 8,359 8,169 8,013 7,580 7,458 7,032 6,665
General and administrative 11,355 12,380 13,209 12,822 13,834 13,096 12,640 12,943
Total operating expenses 37,016 38,343 40,663 39,412 39,000 37,372 37,229 36,180
Income from operations 19,562 21,273 19,573 19,448 20,155 25,031 21,984 21,728
Other income (expense), net (229 ) 228 1,125 213 1,381 390 808 178
Income before income taxes 19,333 21,501 20,698 19,661 21,536 25,421 22,792 21,906
Provision for income taxes 4,147 4,709 4,532 4,150 2,250 4,484 4,478 3,855
Net income $ 15,186 $ 16,792 $ 16,166 $ 15,511 $ 19,286 $ 20,937 $ 18,314 $ 18,051
Net income per share:
Basic $ 0.57 $ 0.63 $ 0.60 $ 0.58 $ 0.71 $ 0.77 $ 0.68 $ 0.67
Diluted $ 0.56 $ 0.62 $ 0.60 $ 0.57 $ 0.71 $ 0.77 $ 0.67 $ 0.66
Shares used to compute net income per
share:
Basic 26,777,536 26,846,030 26,875,153 26,963,366 27,040,207 27,038,585 26,972,990 26,879,388
Diluted 26,945,927 27,005,341 27,041,422 27,177,039 27,311,988 27,337,886 27,274,882 27,197,099
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Liquidity and Capital Resources
Cash Flows
The following table summarizes our cash flows for the years ended
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Year Ended December 31,
(dollars in thousands) 2019 2018 2017
Net cash provided by operating
activities $ 116,052 $ 122,929 $ 81,748
Net cash used in investing activities (44,303 ) (63,281 ) (123,975 )
Net cash (used in) provided by
financing activities (31,617 ) (10,438 ) 9,192
Effect of exchange rates on cash and cash equivalents 47 (871 ) 947 Net increase (decrease) in cash and cash equivalents$ 40,179 $ 48,339 $ (32,088 )
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Sources of Liquidity We finance our operations and capital expenditures through cash flow from operations. We had cash and cash equivalents of$125.2 million as ofDecember 31, 2019 , an increase of$40.2 million fromDecember 31, 2018 . The increase in our cash was due primarily to cash generated through operations, partially offset by investing activity and repurchases of common stock. We had cash and cash equivalents of$85.0 million as ofDecember 31, 2018 , an increase of$48.3 million fromDecember 31, 2017 . The increase in our cash was due primarily to cash generated through operations. We had cash and cash equivalents of$36.7 million as ofDecember 31, 2017 , a decrease of$32.1 million fromDecember 31, 2016 . The decrease in our cash was due primarily to the acquisition of RAPID inNovember 2017 . As ofDecember 31, 2019 , the amount of cash and cash equivalents held by foreign subsidiaries was$21.6 million . Our intent is to continue to permanently reinvest these funds outside theU.S. and our current plans do not demonstrate a need to repatriate them to fund our domestic operations. We believe that our existing cash and cash equivalents together with cash generated from operations will be sufficient to meet our working capital expenditure requirements for at least the next 12 months.
Cash Flows from Operating Activities
Cash flow from operating activities of$116.1 million during 2019 primarily consisted of net income of$63.7 million , adjusted for certain non-cash items, including depreciation and amortization of$30.9 million , stock-based compensation expense of$10.8 million and deferred taxes of$6.1 million and changes in operating assets and liabilities and other items totaling$4.3 million . The cash flow from operating activities during 2019 compared to 2018 decreased$6.8 million due to decreases in net income of$12.9 million and deferred taxes of$5.8 million , which were partially offset by increases in depreciation and amortization of$4.1 million driven by an increase in capital investments and changes in operating assets and liabilities and other items of$7.8 million . Cash flow from operating activities of$122.9 million during 2018 primarily consisted of net income of$76.6 million , adjusted for certain non-cash items, including depreciation and amortization of$26.8 million , stock-based compensation expense of$10.9 million and deferred taxes of$11.9 million , which were partially offset by changes in operating assets and liabilities and other items totaling$3.3 million . The cash flow from operating activities during 2018 compared to 2017 increased$41.2 million due to increases in net income of$24.8 million , increases in stock-based compensation expense of$2.4 million driven by an increased level of equity grants to employees, increases in depreciation and amortization of$8.3 million driven by an increase in capital investments and increases in deferred taxes of$10.8 million . These increases were partially offset by changes in operating assets and liabilities and other items of$5.1 million . Cash flow from operating activities of$81.8 million during 2017 primarily consisted of net income of$51.8 million , adjusted for certain non-cash items, including depreciation and amortization of$18.5 million , stock-based compensation expense of$8.6 million and changes in operating assets and liabilities and other items totaling$2.9 million . The cash flow from operating activities during 2017 compared to 2016 increased$4.2 million due to increases in net income of$9.0 million , increases in stock-based compensation expense of$1.8 million driven by an increased level of equity grants to employees and increases in depreciation and amortization of$1.0 million driven by an increase in capital investments. These increases were partially offset by decreases to deferred taxes of$1.6 million , amortization of held-to-maturity securities of$0.1 million and changes in operating assets and liabilities of$5.9 million . 40
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Cash Flows from Investing Activities
Cash used in investing activities was$44.3 million for the year endedDecember 31, 2019 , consisting of$62.2 million for the purchase of property, equipment and other capital assets,$46.4 million for the purchase of marketable securities and$4.0 in other investing activities, which were partially offset by$68.3 million in proceeds from maturities of marketable securities. Cash used in investing activities was$63.3 million for the year endedDecember 31, 2018 , consisting of$87.1 million for the purchase of property, equipment and other capital assets primarily to expand our production capacity and$41.4 million for the purchase of marketable securities, which were partially offset by$65.1 million in proceeds from maturities of marketable securities and$0.1 million in other investing activities. Cash used in investing activities was$123.9 million for the year endedDecember 31, 2017 , consisting of$110.5 million for the purchase of RAPID,$32.6 million for the purchase of property, equipment and other capital assets primarily to expand our production capacity,$20.0 million for the purchase of marketable securities and$8.8 million for the purchases of other assets and investments, which were partially offset by$48.0 million in proceeds from maturities and call redemption of marketable securities.
Cash Flows from Financing Activities
Cash used in financing activities was$31.6 million for the year endedDecember 31, 2019 , consisting of$33.5 million in repurchases of common stock, and$2.5 million in purchases of shares withheld for tax obligations associated with equity transactions, partially offset by$4.4 million in proceeds from exercises of stock options. Cash used in financing activities was$10.4 million for the year endedDecember 31, 2018 , consisting of$12.2 million in repurchases of common stock, payments on short-term debt obligations of$5.0 million , and$2.1 million in purchases of shares withheld for tax obligations associated with equity transactions, partially offset by$8.9 million in proceeds from exercises of stock options. Cash provided by financing activities was$9.2 million for the year endedDecember 31, 2017 , consisting of$5.0 million in short-term debt obligations and$8.6 million in proceeds from the exercise of stock options, partially offset by$4.4 million for repurchases of common stock.
Operating and Capital Expenditure Requirements
We believe, based on our current operating plan, that our cash balances and cash generated through operations and interest income will be sufficient to meet our anticipated cash requirements through at least the next 12 months. From time to time we may seek to sell equity or convertible debt securities or enter into credit facilities. The sale of equity and convertible debt securities may result in dilution to our shareholders. If we raise additional funds through the issuance of convertible debt securities or enter into credit facilities, these securities and debt holders could have rights senior to those of our common stock, and this debt could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on terms acceptable to us, or at all.
Our future capital requirements will depend on many factors, including the following:
• the revenue growth in Injection Molding, CNC Machining, 3D Printing and Sheet
Metal product lines;
• costs of operations, including costs relating to expansion and growth;
• the emergence of competing or complementary technological developments;
• the costs of filing, prosecuting, defending and enforcing any patent claims
and other intellectual product rights, or participating in litigation-related
activities; and
• the acquisition of businesses, products and technologies, although we
currently have no commitments or agreements relating to any of these types of
transactions.
Our recent annual capital expenditures have varied between 10% and 20% of annual
revenue. We believe future growth capital expenditures, excluding any
expenditures for buildings and maintenance capital we might purchase for our
operations, are likely to vary between approximately 8% and 12% of annual
revenue.
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Table of Contents Contractual Obligations
As of
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Payment Due by Period
Less than 1
(in thousands) Total Year 1-3 Years 3-5 Years More than 5 Years
Operating leases$ 12,678 $ 4,034 $ 6,533 $ 1,406 $ 705 Total$ 12,678 $ 4,034 $ 6,533 $ 1,406 $ 705
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The table above reflects only payment obligations that are fixed and
determinable. Our commitments for operating leases relate to three of our
Financing Arrangements
We had no financing arrangements as of
Inflation We experience normal inflation and changing prices, primarily on our production materials and labor. In 2019 and 2018, wage inflation contributed to our lower gross margin. In 2017, we do not believe inflation and changing prices had a material effect on our financial condition.
Off-Balance Sheet Arrangements
Since our inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.
Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States . The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amount of assets, liabilities, revenue, expenses and related disclosures. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, goodwill, other intangible assets, stock-based compensation, and income taxes. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Management has discussed the development, selection and disclosure of these estimates with the audit committee of our board of directors. Our actual results may differ significantly from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments used in the preparation of our consolidated financial statements. See the Notes to Consolidated Financial Statements included in Item 8. "Financial Statements and Supplementary Data" in this Annual Report on Form 10-K for additional information about these critical accounting policies, as well as a description of our other accounting policies. 42
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Table of Contents Revenue Recognition OnJanuary 1, 2018 , we adopted ASC 606, Revenue from Contracts with Customers, using the modified retrospective approach. We manufacture custom parts to specific customer orders that have no alternative use to us, and we believe there is a legally enforceable right to payment for performance completed to date on these manufactured parts. For manufactured parts that meet these two criteria, we will recognize revenue over time. Prior to 2018, we recognized revenue in accordance with ASC 605, Revenue Recognition, which states that revenue is realized or realizable and earned when all of the following criteria are met: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the price to the buyer is fixed or determinable, and (4) collectability is reasonably assured. Revenue was recognized upon transfer of title and risk of loss, which was generally upon the shipment of parts in our Injection Molding, CNC Machining, 3D Printing, Sheet Metal and Other product lines.Goodwill We recognize goodwill in accordance with ASC 350, Intangibles-Goodwill and Other.Goodwill is the excess of cost of an acquired entity over the amounts assigned to assets acquired and liabilities assumed in a business combination.Goodwill is not amortized.Goodwill is tested for impairment annually in the fourth quarter of each year, and is tested for impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired. An impairment charge for goodwill is recognized only when the estimated fair value of a reporting unit, including goodwill, is less than its carrying amount. As ofDecember 31, 2019 no impairment charges for goodwill have been recognized. Other Intangible Assets We recognize other intangibles assets in accordance with ASC 350, Intangibles-Goodwill and Other. Other intangible assets include software technology, customer relationships and other intangible assets acquired from independent parties. Other intangible assets with a definite life are amortized over a period ranging from two to 10 years on a straight line basis, and are tested for impairment whenever events or circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable. An impairment loss is recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows generated by the asset. As ofDecember 31, 2019 no impairment charges for intangible assets have been recognized. Stock-Based Compensation We determine our stock-based compensation in accordance with ASC 718, Compensation-Stock Compensation (ASC 718), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and non-employee directors based on the grant date fair value of the award. Determining the appropriate fair value model and calculating the fair value of stock option grants requires the input of subjective assumptions. We use the Black-Scholes option pricing model to value our stock option awards. Stock-based compensation expense is significant to our consolidated financial statements and is calculated using our best estimates, which involve inherent uncertainties and the application of management's judgment. Significant estimates include our expected term and stock price volatility. If different estimates and assumptions had been used, our common stock valuations could be significantly different and related stock-based compensation expense may be materially impacted. The Black-Scholes option pricing model requires inputs such as the risk-free interest rate, expected term, expected volatility and expected dividend yield. We base the risk-free interest rate that we use in the Black-Scholes option pricing model on zero couponU.S. Treasury instruments with maturities similar to the expected term of the award being valued. The expected term of stock options is estimated from the vesting period of the award and represents the weighted average period that our stock options are expected to be outstanding. We estimated the volatility of our stock price based on the historic volatility of our common stock. We have never paid and do not anticipate paying any cash dividends in the foreseeable future and, therefore, we use an expected dividend yield of zero in the option pricing model. We account for forfeitures as they occur. 43
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The fair value of each new employee option awarded was estimated on the date of grant for the periods below using the Black-Scholes option pricing model with the following assumptions:
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Year Ended December 31,
2019 2018 2017
Risk-free interest rate 2.35 - 2.58% 2.52 - 3.07% 2.24 - 2.36%
Expected life (years) 6.25 6.25 6.50
Expected volatility 42.52 - 42.74% 41.68 - 42.22% 42.68 - 44.68%
Expected dividend yield 0% 0% 0%
Weighted average grant date fair value $47.84 $50.08 $32.26 -------------------------------------------------------------------------------- Our 2012 Employee Stock Purchase Plan (ESPP) allows eligible employees to purchase a variable number of shares of our common stock during each offering period at a discount through payroll deductions of up to 15% of their eligible compensation, subject to plan limitations. The ESPP provides for six-month offering periods with a single purchase period. At the end of each offering period, employees are able to purchase shares at 85% of the lower of the fair market value of our common stock on the first trading day of the offering period or on the last trading day of the offering period. We determine the fair value stock-based compensation related to our ESPP in accordance with ASC 718 using the component measurement approach and the Black-Scholes standard option pricing model.
The fair value of each offering period was estimated using the Black-Scholes option pricing model with the following assumptions:
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Year Ended December 31,
2019 2018 2017
Risk-free interest rate 1.59 - 2.35% 2.06 - 2.33% 0.97 - 1.48%
Expected life (months) 6.00 6.00 6.00
Expected volatility 42.63 - 53.57% 31.50 - 37.36% 24.49 - 34.51%
Expected dividend yield 0% 0% 0%
-------------------------------------------------------------------------------- There are significant differences among option valuation models, and this may result in a lack of comparability with other companies that use different models, methods and assumptions. If factors change and we employ different assumptions in the application of ASC 718 in future periods, or if we decide to use a different valuation model, such as a lattice model, the stock-based compensation expense that we record in the future under ASC 718 may differ significantly from what we have recorded using the Black-Scholes option pricing model and could materially affect our operating results. We recognize stock-based compensation expense on a straight-line basis over the requisite service period. We recorded stock-based compensation expense relating to stock options, restricted stock awards, performance stock units and our ESPP of$10.8 million ,$10.9 million and$8.6 million during the years endedDecember 31, 2019 , 2018 and 2017, respectively. As ofDecember 31, 2019 , we had$3.6 million of unrecognized stock-based compensation costs related to unvested stock options that are expected to be recognized over a weighted average period of 2.6 years. We issued options to purchase 53,708, 36,600 and 60,100 shares of our common stock in 2019, 2018 and 2017, respectively. As ofDecember 31, 2019 , we had$21.1 million of unrecognized stock-based compensation costs related to non-vested restricted stock, which is expected to be recognized over a weighted average period of 2.6 years. We issued restricted stock awards of 115,471, 106,855 and 210,744 shares of our common stock in 2019, 2018 and 2017, respectively. As ofDecember 31, 2019 , we had$0.1 million of unrecognized stock-based compensation costs related to non-vested performance stock, which is expected to be recognized over a weighted average period of 0.1 years. The decrease in unrecognized stock-based compensation costs related to non-vested performance stock in 2019 when compared to 2018 is driven by a decrease in the number of shares expected to vest at the end of future performance periods. We issued performance stock awards of 21,434, 20,006 and 25,707 shares of our common stock in 2019, 2018 and 2017, respectively. In future periods, our stock-based compensation expense is expected to increase due to our existing unrecognized stock-based compensation and the issuance of additional stock-based awards to continue to attract and retain employees and non-employee directors. Income Taxes We account for income taxes in accordance with ASC 740, Income Taxes (ASC 740). Under this method, we determine tax assets and liabilities based upon the differences between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of most events recognized in the current year's financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities and equity, revenues, expenses, gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax basis of assets or liabilities and their reported amounts in the financial statements. Because we assume that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or liability and its reported amount in the balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or the reported amounts of the assets are recovered, giving rise to a deferred tax asset or liability. We establish a valuation allowance for any portion of our deferred tax assets that we believe will not be recognized. 44
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ASC 740 also clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise's financial statements. Additionally, ASC 740 provides guidance on measurement, de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Including interest and penalties, we have established a liability for uncertain tax positions of$5.4 million as ofDecember 31, 2019 . The effective tax rate increased by 5.2% for the year endedDecember 31, 2019 when compared to 2018 primarily due to a decrease in tax benefits from the vesting of restricted stock and exercise of stock options, an increase in the state tax provision, and an increase to valuation allowances for unrealizable deferred tax assets. The Tax Cuts and Jobs Act (the "Act") was enacted onDecember 22, 2017 . The Act reduced theU.S. federal corporate tax rate from 35% to 21%, required companies to pay a transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign sourced earnings. No additional income taxes have been provided for any remaining undistributed foreign earnings not subject to the transition tax or any additional outside basis difference inherent in these entities as these amounts continue to be indefinitely reinvested in foreign operations.
Recently adopted accounting pronouncements
During the fourth quarter of 2019, we early adopted theFinancial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2017-04, Intangibles -Goodwill and Other, which is intended to simplify the subsequent measurement of goodwill. The adoption of this guidance had no material impact on our consolidated financial statements. During the first quarter of 2019, we adopted the FASB ASU 2016-02, Leases (ASC 842), which introduces the balance sheet recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. We have adopted the new lease standard using the new transition option issued under the amendments in ASU 2018-11, Leases, which allowed us to continue to apply the legacy guidance in Accounting Standards Codification (ASC) 840, Leases, in the comparative periods presented in the year of adoption. We elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed us to carry forward the historical lease classification. We made an accounting policy election to keep leases with an initial term of 12 months or less off of the balance sheet. We will recognize those lease payments in the Consolidated Statements of Comprehensive Income on a straight-line basis over the lease term. The impact of the adoption was an increase to our operating lease assets and liabilities onJanuary 1, 2019 of$13.1 million . During the first quarter of 2018, we adopted the FASB ASU 2014-09, Revenue from Contracts with Customers (ASC 606). This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue from the transfer of goods or services to customers in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. We adopted the new revenue standard using the modified retrospective approach. We manufacture custom parts to specific customer orders that have no alternative use to us, and we believe there is a legally enforceable right to payment for performance completed to date on these manufactured parts. For manufactured parts that meet these two criteria, we will recognize revenue over time. The transition adjustment recorded was an increase of$1.5 million to our retained earnings balance as ofJanuary 1, 2018 . During the first quarter of 2018, we adopted ASU 2017-09, Compensation - Stock Compensation, which is intended to provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance to a change to the terms or conditions of a share-based payment award. The adoption of this guidance did not have a material impact on our consolidated financial statements.
Recently issued accounting pronouncements
InDecember 2019 , the FASB issued ASU 2019-12, Income Taxes, which is intended to simplify the accounting for income taxes. This guidance will be effective for fiscal years beginning afterDecember 15, 2020 and interim periods within those fiscal years with early adoption permitted. We are evaluating the impact of future adoption of this guidance on our consolidated financial statements, but we do not expect the impact to be material. InJune 2016 , the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments held by a reporting entity at each reporting date. This guidance will be effective for fiscal years beginning afterDecember 15, 2019 and interim periods within those fiscal years with early adoption permitted. The impact of this guidance will not have a material impact on our consolidated financial statements. 45
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