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UNITED STATES

 SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

(Mark One)

 

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

    For the quarterly period ended June 30, 2015

 

or

 

 

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

    For the transition period from                      to                     

 

Commission File Number: 001-35435

 

 

Proto Labs, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Minnesota

 

41-1939628

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

5540 Pioneer Creek Drive

 

 

Maple Plain, Minnesota

 

55359

(Address of principal executive offices)

 

(Zip Code)

 

(763) 479-3680

(Registrant’s telephone number, including area code)

 

                   Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 


 

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.               

 

☑   Yes     ☐   No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                    

 

☑   Yes     ☐   No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer    ☑

 

Accelerated filer   ☐

Non-accelerated filer    ☐

 

(Do not check if a smaller reporting company)

 

Smaller reporting company   ☐

   

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐   Yes   ☑   No

 

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 26,136,434 shares of Common Stock, par value $0.001 per share, were outstanding at July 30, 2015.

 



 
 

 

 

Proto Labs, Inc.

TABLE OF CONTENTS

 

         

Item

 

Description

 

Page

         

PART I

1.

 

Financial Statements

 

3

2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

14

3.

 

Quantitative and Qualitative Disclosures about Market Risk

 

22

4.

 

Controls and Procedures

 

23

PART II

1.

 

Legal Proceedings

 

24

1A.

 

Risk Factors

 

24

6.

 

Exhibits

 

24

 

 
2

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

 

Proto Labs, Inc.

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

 

   

June 30,

   

December 31,

 
   

2015

   

2014

 
   

(Unaudited)

         

Assets

               

Current assets

               

Cash and cash equivalents

  $ 56,324     $ 43,329  

Short-term marketable securities

    31,190       30,706  

Accounts receivable, net of allowance for doubtful accounts of $150 and $198 as of June 30, 2015 and December 31, 2014, respectively

    29,493       24,226  

Inventory

    6,828       6,194  

Prepaid expenses and other current assets

    3,935       3,406  

Income taxes receivable

    2,931       -  

Deferred tax assets

    464       483  

Total current assets

    131,165       108,344  

Property and equipment, net

    100,921       91,626  

Goodwill

    28,916       28,916  

Other intangible assets, net

    3,710       4,083  

Long-term marketable securities

    54,482       54,318  

Other long-term assets

    197       227  

Total assets

  $ 319,391     $ 287,514  
                 

Liabilities and shareholders' equity

               

Current liabilities

               

Accounts payable

  $ 11,334     $ 7,882  

Accrued compensation

    8,264       6,067  

Accrued liabilities and other

    1,779       2,718  

Income taxes payable

    -       1,953  

Current portion of long-term debt obligations

    71       139  

Total current liabilities

    21,448       18,759  

Long-term deferred tax liabilities

    2,423       1,846  

Long-term debt obligations

    -       10  

Other long-term liabilities

    1,533       1,360  

Total liabilities

    25,404       21,975  
                 

Shareholders' equity

               

Preferred stock, $0.001 par value, authorized 10,000,000 shares; issued and outstanding 0 shares as of each of June 30, 2015 and December 31, 2014

    -       -  

Common stock, $0.001 par value, authorized 150,000,000 shares; issued and outstanding 25,953,735 and 25,838,110 shares as of June 30, 2015 and December 31, 2014, respectively

    26       26  

Additional paid-in capital

    187,070       180,960  

Retained earnings

    109,621       87,482  

Accumulated other comprehensive loss

    (2,730 )     (2,929 )

Total shareholders' equity

    293,987       265,539  

Total liabilities and shareholders' equity

  $ 319,391     $ 287,514  
 
 

The accompanying notes are an integral part of these consolidated financial statements.

  

 
3

 

 

Proto Labs, Inc.

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(Unaudited)

 

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2015

   

2014

   

2015

   

2014

 
                                 

Statements of Operations:

                               

Revenue

  $ 63,969     $ 52,866     $ 122,505     $ 98,940  

Cost of revenue

    26,419       20,183       49,701       37,233  

Gross profit

    37,550       32,683       72,804       61,707  

Operating expenses

                               

Marketing and sales

    9,502       7,261       18,356       13,678  

Research and development

    4,397       3,914       8,711       7,370  

General and administrative

    6,304       5,534       12,549       10,237  

Total operating expenses

    20,203       16,709       39,616       31,285  

Income from operations

    17,347       15,974       33,188       30,422  

Other income (expense), net

    (36 )     (66 )     (493 )     37  

Income before income taxes

    17,311       15,908       32,695       30,459  

Provision for income taxes

    5,625       4,952       10,556       9,401  

Net income

  $ 11,686     $ 10,956     $ 22,139     $ 21,058  
                                 

Net income per share:

                               

Basic

  $ 0.45     $ 0.43     $ 0.86     $ 0.82  

Diluted

  $ 0.44     $ 0.42     $ 0.84     $ 0.81  
                                 

Shares used to compute net income per share:

                               

Basic

    25,921,111       25,620,005       25,885,888       25,597,055  

Diluted

    26,277,503       26,146,848       26,245,135       26,132,265  
                                 

Comprehensive Income (net of tax)

                               

Comprehensive income

  $ 12,960     $ 11,488     $ 22,338     $ 21,762  
 
 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
4

 

 

Proto Labs, Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

   

Six Months Ended

 
   

June 30,

 
   

2015

   

2014

 
                 

Operating activities

               

Net income

  $ 22,139     $ 21,058  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    6,940       4,683  

Stock-based compensation expense

    2,909       2,248  

Deferred taxes

    620       107  

Excess tax benefit from stock-based compensation

    (989 )     (1,623 )

Amortization of held-to-maturity securities

    632       854  

Changes in operating assets and liabilities:

               

Accounts receivable

    (5,219 )     (5,742 )

Inventories

    (663 )     (306 )

Prepaid expenses and other

    (469 )     (372 )

Income taxes

    (3,687 )     2,431  

Accounts payable

    3,377       5,143  

Accrued liabilities and other

    2,243       (2,464 )

Net cash provided by operating activities

    27,833       26,017  
                 

Investing activities

               

Purchases of property and equipment

    (15,717 )     (31,625 )

Acquisitions, net of cash acquired

    -       (33,864 )

Purchases of marketable securities

    (25,389 )     (38,463 )

Proceeds from sales and maturities of marketable securities

    24,109       55,441  

Net cash used in investing activities

    (16,997 )     (48,511 )
                 

Financing activities

               

Payments on debt

    (77 )     (954 )

Acquisition-related contingent consideration

    (1,000 )     (400 )

Proceeds from exercises of stock options and other

    2,207       1,806  

Excess tax benefit from stock-based compensation

    989       1,623  

Net cash provided by financing activities

    2,119       2,075  

Effect of exchange rate changes on cash and cash equivalents

    40       234  

Net increase (decrease) in cash and cash equivalents

    12,995       (20,185 )

Cash and cash equivalents, beginning of period

    43,329       43,039  

Cash and cash equivalents, end of period

  $ 56,324     $ 22,854  
 
 

The accompanying notes are an integral part of these consolidated financial statements.

 

 
5

 

 

Note 1 – Basis of Presentation

 

The unaudited interim Consolidated Financial Statements of Proto Labs, Inc. (Proto Labs, the Company, we, us or our) have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These statements are unaudited but, in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s statement of financial position, results of operations and cash flows for the periods presented. Except as otherwise disclosed herein, these adjustments consist of normal, recurring items. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.

 

On April 23, 2014, the Company completed the acquisition of FineLine Prototyping, Inc. (FineLine). The operations of FineLine have been integrated into the operations of the Company and operating results beginning April 23, 2014 are included in the consolidated results under the Fineline product line.

 

The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. For further information, refer to the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 as filed with the Securities and Exchange Commission (SEC) on February 27, 2015.

 

The accompanying Consolidated Balance Sheet as of December 31, 2014 was derived from the audited Consolidated Financial Statements but does not include all disclosures required by U.S. GAAP for a full set of financial statements. This Form 10-Q should be read in conjunction with the Company’s Consolidated Financial Statements and Notes included in the Annual Report on Form 10-K filed on February 27, 2015 as referenced above.

 

Note 2 – Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. 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. The Company is required to adopt the new pronouncement using one of two retrospective application methods.

 

On July 9, 2015, the FASB voted to approve a one-year deferral of the effective date of ASU 2014-09 by one year to December 15, 2017 for annual reporting periods beginning after that date. The Company is evaluating the application method and the impact of this new standard on our financial statements, but does not expect the impact to be material.

 

Note 3 – Net Income per Common Share

 

Basic net income per share is computed based on the weighted-average number of common shares outstanding. Diluted net income per share is computed based on the weighted-average number of common shares outstanding, increased by the number of additional shares that would have been outstanding had potentially dilutive common shares been issued and reduced by the number of shares the Company could have repurchased from the proceeds from issuance of the potentially dilutive shares. Potentially dilutive shares of common stock include stock options, restricted stock units and restricted stock awards granted under stock-based compensation plans and shares committed to be purchased under the employee stock purchase plan.

 

 
6

 

 

The table below sets forth the computation of basic and diluted net income per share:

             
             
   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 

(in thousands, except share and per share amounts)

 

2015

   

2014

   

2015

   

2014

 

Net income

  $ 11,686     $ 10,956     $ 22,139     $ 21,058  
                                 

Basic - weighted-average shares outstanding:

    25,921,111       25,620,005       25,885,888       25,597,055  

Effect of dilutive securities:

                               

Employee stock options and other

    356,392       526,843       359,247       535,210  

Diluted - weighted-average shares outstanding:

    26,277,503       26,146,848       26,245,135       26,132,265  

Net income per share:

                               

Basic

  $ 0.45     $ 0.43     $ 0.86     $ 0.82  

Diluted

  $ 0.44     $ 0.42     $ 0.84     $ 0.81  
                                 

 

Note 4 – Goodwill and Other Intangible Assets

 

The changes in the carrying amount of Goodwill during the six months ended June 30, 2015 were as follows:

 

       

(in thousands)

 

Six Months Ended June 30, 2015

 

Balance as of the beginning of the period

  $ 28,916  

Goodwill acquired during the period

    -  

Balance as of the end of the period

  $ 28,916  
         

 

Intangible assets other than Goodwill at June 30, 2015 and December 31, 2014 were as follows:

 

                         
   

June 30, 2015

   

December 31, 2014

   

Useful

   

Weighted Average

 
          Accumulated                 Accumulated           Life     Useful Life  

(in thousands)

 

Gross

   

Amortization

   

Net

   

Gross

   

Amortization

   

Net

   

(in years)

    Remaining (in years)  

Intangible Assets with finite lives:

                                                               

Marketing assets

  $ 930     $ (109 )   $ 821     $ 930     $ (62 )   $ 868       10.0       8.8  

Non-compete agreement

    190       (111 )     79       190       (63 )     127       2.0       0.8  

Trade secrets

    250       (58 )     192       250       (33 )     217       5.0       3.8  

Internally developed software

    680       (264 )     416       680       (151 )     529       3.0       1.8  

Customer relationships

    2,530       (328 )     2,202       2,530       (188 )     2,342       9.0       7.8  

Total intangible assets

  $ 4,580     $ (870 )   $ 3,710     $ 4,580     $ (497 )   $ 4,083                  
                                                                 

 

Amortization expense for intangible assets for the three and six months ended June 30, 2015 was $0.2 million and $0.4 million, respectively. Amortization expense for intangible assets, which were acquired in the purchase of FineLine in April 2014, was $0.1 million for each of the three and six months ended June 30, 2014.

 

 
7

 

 

Estimated aggregated amortization expense based on the current carrying value of the amortizable intangible assets is as follows:

 

       

(in thousands)

 

Estimated

Amortization Expense

 

Remaining 2015

  $ 373  

2016

    682  

2017

    500  

2018

    424  

2019

    391  

Thereafter

    1,340  

Total estimated amortization expense

  $ 3,710  
         

 

Note 5 – Fair Value Measurements

 

ASC 820, Fair Value Measurement (ASC 820), defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires classification based on observable and unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:

 

Level 1—Quoted prices in active markets for identical assets or liabilities.

 

Level 2—Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

The Company’s cash consists of bank deposits. The Company’s cash equivalents measured at fair value consist of money market mutual funds. The Company determines the fair value of these investments using Level 1 inputs.

 

A summary of financial assets as of June 30, 2015 and December 31, 2014 measured at fair value on a recurring basis follows:

 

             
   

June 30, 2015

   

December 31, 2014

 

(in thousands)

 

Level 1

   

Level 2

   

Level 3

   

Level 1

   

Level 2

   

Level 3

 

Financial Assets:

                                               

Cash and cash equivalents

                                               

Money market mutual fund

  $ 15,761     $ -     $ -     $ 6,129     $ -     $ -  

Total

  $ 15,761     $ -     $ -     $ 6,129     $ -     $ -  
                                                 

 

 
8

 

 

Note 6 – Marketable Securities

 

The Company invests in short-term and long-term agency, municipal, corporate, commercial paper and other debt securities. The securities are categorized as held-to-maturity and are recorded at amortized cost. Categorization as held-to-maturity is based on the Company’s ability and intent to hold these securities to maturity. Information regarding the Company’s short-term and long-term marketable securities as of June 30, 2015 and December 31, 2014 is as follows:

 

       
    June 30, 2015  

(in thousands)

 

Amortized

Cost

   

Unrealized

Gains

   

Unrealized

Losses

   

Fair Value

 

U.S. municipal securities

  $ 32,661     $ 20     $ (49 )   $ 32,632  

Corporate debt securities

    25,932       5       (31 )     25,906  

U.S. government agency securities

    19,857       9       (23 )     19,843  

Certificates of deposit/time deposits

    5,656       12       -       5,668  

Commercial paper

    1,566       -       (1 )     1,565  

Total marketable securities

  $ 85,672     $ 46     $ (104 )   $ 85,614  
                                 

 

 

                                 
    December 31, 2014  

(in thousands)

 

Amortized

Cost

   

Unrealized

Gains

   

Unrealized

Losses

   

Fair Value

 

U.S. municipal securities

  $ 30,004     $ 32     $ (18 )   $ 30,018  

Corporate debt securities

    29,316       7       (79 )     29,244  

U.S. government agency securities

    20,048       -       (71 )     19,977  

Certificates of deposit/time deposits

    5,656       5       (15 )     5,646  

Total marketable securities

  $ 85,024     $ 44     $ (183 )   $ 84,885  
                                 

 

Fair values for the corporate debt securities are primarily determined based on quoted market prices (Level 1). Fair values for the U.S. municipal securities, U.S. government agency securities, certificates of deposit and commercial paper are primarily determined using dealer quotes or quoted market prices for similar securities (Level 2).

 

The Company tests for other-than-temporary losses on a quarterly basis and has considered the unrealized losses indicated above, which are the result of changes in interest rates, to be temporary in nature. In reaching this conclusion, the Company considered the credit quality of the issuers of the debt securities as well as the Company's intent to hold the investments to maturity and recover the full principal.

 

Classification of marketable securities as current or non-current is based upon the security’s maturity date as of the date of these financial statements.

 

The June 30, 2015 balance of held-to-maturity debt securities by contractual maturity is shown in the following table at amortized cost. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

 

       
   

June 30,

 

(in thousands)

 

2015

 

Due in one year or less

  $ 31,190  

Due after one year through five years

    54,482  

Total marketable securities

  $ 85,672  
         

 

Note 7 – Inventory

 

Inventory consists primarily of raw materials, which are recorded at the lower of cost or market using the average-cost method, which approximates first-in, first-out (FIFO) cost. The Company periodically reviews its inventory for slow-moving, damaged and discontinued items and provides allowances to reduce such items identified to their recoverable amounts.

 

 
9

 

 

The Company’s inventory consists of the following:

 

                 
   

June 30,

   

December 31,

 

(in thousands)

 

2015

   

2014

 

Raw materials

  $ 6,108     $ 5,728  

Work in process

    922       653  

Total inventory

    7,030       6,381  

Allowance for obsolescence

    (202 )     (187 )

Inventory, net of allowance

  $ 6,828     $ 6,194  
                 

 

Note 8 – Stock-Based Compensation

 

Under the 2012 Long-Term Incentive Plan (2012 Plan), the Company has the ability to grant stock options, stock appreciation rights (SARs), restricted stock, stock units, other stock-based awards and cash incentive awards. Awards under the 2012 Plan will have a maximum term of ten years from the date of grant. The compensation committee may provide that the vesting or payment of any award will be subject to the attainment of specified performance measures in addition to the satisfaction of any continued service requirements and the compensation committee will determine whether such measures have been achieved. The per share exercise price of stock options and SARs granted under the 2012 Plan generally may not be less than the fair market value of a share of our common stock on the date of the grant. 

 

Employee Stock Purchase Plan

 

The Company’s 2012 Employee Stock Purchase Plan (ESPP) allows eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions of up to 15 percent of their eligible compensation, subject to plan limitations. The ESPP provides for six-month offering periods ending May 15 and November 15, respectively. At the end of each offering period, employees are able to purchase shares at 85 percent of the lower of the fair market value of the Company’s common stock on the first trading day of the offering period or on the last trading day of the offering period.

 

Stock-Based Compensation Expense

 

Stock-based compensation expense was $1.6 million and $1.2 million for the three months ended June 30, 2015 and 2014, respectively, and $2.9 million and $2.2 million for the six months ended June 30, 2015 and 2014, respectively.

 

Stock Options

 

A summary of stock option activity during the six months ended June 30, 2015 is as follows:

 

                 
           

Weighted-

 
           

Average

 
   

Stock Options

   

Exercise Price

 

Options outstanding at December 31, 2014

    998,987     $ 26.49  

Granted

    110,335       67.36  

Exercised

    (86,656 )     15.72  

Forfeited

    (25,713 )     52.39  

Options outstanding at June 30, 2015

    996,953     $ 31.28  
                 

Exercisable at June 30, 2015

    515,568     $ 19.12  
                 

 

The outstanding options generally have a term of ten years. For employees, options granted become exercisable ratably over the vesting period, which is generally a five-year period beginning on the first anniversary of the grant date, subject to the employee’s continuing service to the Company. For directors, options generally become exercisable in full on the first anniversary of the grant date.

 

The weighted-average grant date fair value of options that were granted during the six months ended June 30, 2015 was $32.42.

 

 
10

 

 

The following table provides the assumptions used in the Black-Scholes pricing model valuation of options during the six months ended June 30, 2015 and 2014, respectively:

 

                     
   

Six Months Ended June 30,

 
   

2015

   

2014

 

Risk-free interest rate

  1.69 - 1.77%     0.43 - 2.14%  

Expected life (years)

  5.50 - 6.50     2.00 - 6.50  

Expected volatility

  46.80 - 47.23%     48.87 - 49.30%  

Expected dividend yield

    0%         0%    
                     

 

As of June 30, 2015, there was $8.8 million of unrecognized compensation expense related to unvested stock options, which is expected to be recognized over a weighted-average period of 3.3 years.

 

Restricted Stock

 

The 2012 Plan provides for the award of restricted stock or restricted stock units. Restricted stock awards are share settled awards and restrictions lapse ratably over the vesting period, which is generally a five-year period, beginning on the first anniversary of the grant date, subject to the employee's continuing service to the Company. For directors, restricted stock awards generally vest in full on the first anniversary of the grant date.

 

A summary of restricted stock activity during the six months ended June 30, 2015 is as follows:

 

               
           

Weighted-

 
           

Average

 
           

Grant Date

 
   

Restricted

   

Fair Value

 
   

Stock

   

Per Share

 

Nonvested restricted stock at December 31, 2014

    76,574     $ 69.27  

Granted

    68,580       68.89  

Vested

    (16,161 )     69.47  

Forfeited

    (1,858 )     78.59  

Nonvested restricted stock at June 30, 2015

    127,135     $ 68.90  
                 

 

As of June 30, 2015, there was $7.9 million of unrecognized compensation expense related to non-vested restricted stock, which is expected to be recognized over a weighted-average period of 4.1 years.

 

Employee Stock Purchase Plan

 

The following table presents the assumptions used to estimate the fair value of the ESPP during the six months ended June 30, 2015 and 2014, respectively:

 

                     
   

Six Months Ended June 30,

 
   

2015

   

2014

 
Risk-free interest rate   0.08 - 0.10%     0.01 - 0.11%  
Expected life (months)     6.00         6.00    
Expected volatility   33.68 - 37.64%     39.16 - 39.80%  
Expected dividend yield     0%         0%    
                     

  

 
11

 

 

Note 9 – Accumulated Other Comprehensive Income (Loss)

 

Other comprehensive income (loss) is comprised entirely of foreign currency translation adjustments. The following table presents the changes in accumulated other comprehensive income (loss) balances during the three and six months ended June 30, 2015 and 2014, respectively:

 

             
   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 

(in thousands)

 

2015

   

2014

   

2015

   

2014

 

Foreign currency translation adjustments

                               

Balance at beginning of period

  $ (4,004 )   $ (919 )   $ (2,929 )   $ (1,091 )

Other comprehensive income before reclassifications

    1,274       532       199       704  

Amounts reclassified from accumulated other comprehensive income (loss)

    -       -       -       -  

Net current-period other comprehensive income

    1,274       532       199       704  

Balance at end of period

  $ (2,730 )   $ (387 )   $ (2,730 )   $ (387 )
                                 

 

Note 10 Income Taxes

 

The Company is subject to income tax in multiple jurisdictions and the use of estimates is required to determine the provision for income taxes. For the three months ended June 30, 2015 and 2014, the Company recorded an income tax provision of $5.6 million and $5.0 million, respectively. For the six months ended June 30, 2015 and 2014, the Company recorded an income tax provision of $10.6 million and $9.4 million, respectively. The income tax provision is based on the estimated annual effective tax rate for the year applied to pre-tax income. The effective income tax rate for the three months ended June 30, 2015 was 32.5 percent compared with 31.1 percent in the same period of the prior year. The effective income tax rate for the six months ended June 30, 2015 was 32.3 percent compared with 30.9 percent in the same period of the prior year.

 

The effective income tax rate for the three and six months ended June 30, 2015 differs from the U.S. federal statutory rate of 35 percent due primarily to the mix of income earned in domestic and foreign tax jurisdictions and deductions for which the Company qualifies.

 

The Company had liabilities related to unrecognized tax benefits totaling $1.5 million at June 30, 2015 and $1.3 million at December 31, 2014, all of which, if recognized, would affect the Company’s effective tax rate. The Company recognizes interest and penalties related to income tax matters in income tax expense, and reports the liability in current or long-term income taxes payable as appropriate.

 

During the six months ended June 30, 2015, the Company increased its current year uncertain tax positions by $0.2 million. The increase was due to certain tax positions not meeting the more-likely-than-not standard for accounting for uncertain tax positions under the Company’s current facts and circumstances.

 

Based upon the information available as of June 30, 2015, the Company anticipates the amount of uncertain tax positions will change in the next twelve months; however, the change is not expected to be material.

 

Note 11 Revenue and Geographic Information

 

The Company’s revenue is derived from its Protomold injection molding, Firstcut computer numerical control (CNC) machining and Fineline additive manufacturing (3D printing) product lines. Total revenue by product line is as follows:

             
             
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(in thousands)

 

2015

   

2014

   

2015

   

2014

 

Revenue:

                               

Protomold

  $ 39,932     $ 36,255     $ 77,550     $ 68,949  

Firstcut

    18,585       14,478       34,955       27,858  

Fineline

    5,452       2,133       10,000       2,133  

Total revenue

  $ 63,969     $ 52,866     $ 122,505     $ 98,940  
                                 

 

 
12

 

 

Revenue to external customers based on the billing location of the end user customer and long-lived assets by geographic region are as follows:

             
             
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(in thousands)

 

2015

   

2014

   

2015

   

2014

 

Revenue:

                               

United States

  $ 49,298     $ 39,966     $ 94,143     $ 72,988  

International

    14,671       12,900       28,362       25,952  

Total revenue

  $ 63,969     $ 52,866     $ 122,505     $ 98,940  
                                 

 

 

                 
   

June 30,

   

December 31,

 

(in thousands)

 

2015

   

2014

 

Long-lived assets:

               

United States

  $ 84,014     $ 76,923  

International

    16,907       14,703  

Total long-lived assets

  $ 100,921     $ 91,626  
                 

 

 
13

 

 

Item 2. 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 our unaudited consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Forward-Looking Statements

 

Statements contained in this report regarding matters that are not historical or current facts are “forward-looking statements” within the meaning of The Private Securities Litigation Reform Act of 1995. In some cases, you can identify forward-looking statements by the following words: “may,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. These statements involve known and unknown risks, uncertainties and other factors which may cause our results to be materially different than those expressed or implied in such statements. Certain of these risk factors and others are described in Item 1A. “Risk Factors” of our Annual Report on Form 10-K as filed with the SEC. Other unknown or unpredictable factors also could have material adverse effects on our future results. We cannot guarantee future results, levels of activity, performance or achievements. Accordingly, you should not place undue reliance on these forward-looking statements. Finally, we expressly disclaim any intent or obligation to update any forward-looking statements to reflect subsequent events or circumstances.

 

Overview

 

We are a leading online and technology-enabled, quick-turn, on-demand manufacturer of custom parts for prototyping and short-run production. We manufacture parts for product developers and engineers worldwide who are under increasing pressure to bring their finished products to market faster than their competition. We utilize injection molding, computer numerical control (CNC) machining and additive manufacturing to manufacture custom parts for our customers.

 

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. Our customers conduct nearly all of their business with us over the Internet. We target our products to the millions of product developers and engineers who use three-dimensional computer-aided design (3D CAD) software to design products across a diverse range of end-markets.

 

Our primary manufacturing product lines currently include Protomold, which is our injection molding product line, Firstcut, which is our CNC machining product line, and Fineline, which is our additive-manufactured (3D printing) product line. We continually seek to expand the range of size and geometric complexity of the parts we can make with these manufacturing processes, to extend the variety of materials we are able to support and to identify additional manufacturing processes to which we can apply our technology in order to better serve the evolving preferences and needs of product developers and engineers.

 

Protomold

 

Our Protomold product line uses our 3D CAD-to-CNC machining technology for the automated design and manufacture of thermoplastic, metal, or liquid silicone injection molds, which are then used to produce custom injection-molded parts on commercially available equipment. Our Protomold product line is used for prototype, on-demand and short-run production. Prototype quantities typically range from 25 to 100 parts. Because we retain possession of the molds, customers who need short-run production often come back to Protomold for additional quantities typically ranging up to 100,000 parts or more. They do so to support pilot production while their tooling for high-volume production is being prepared, because they need on-demand manufacturing due to disruptions in their manufacturing process, because their product will only be released in a limited quantity, or because they need end-of-life production support. These additional part orders typically occur on approximately half of the molds that we make, typically accounting for approximately half of our total Protomold revenue.

 

Firstcut

 

Our Firstcut product line uses commercially available CNC machines to cut plastic or metal bars and blocks into one or more custom parts based on the 3D CAD model uploaded by the product developer or engineer. Our efficiencies derive from the automation of the programming of these machines and a proprietary fixturing process. The Firstcut product line is well suited to produce small quantities, typically in the range of one to 200 parts.

 

 
14

 

 

Fineline

 

Our Fineline additive manufacturing product line, often referred to as 3D printing, includes stereolithography (SL), selective laser sintering (SLS) and direct metal laser sintering (DMLS) processes, which offer customers a wide-variety of high-quality, precision rapid prototyping. These processes create parts with a high level of accuracy, detail, strength and durability. The Fineline product line is well suited to produce small quantities, typically in the range of one to 50 parts.

 

Key Financial Measures and Trends

 

Revenue

 

The Company’s operations are comprised of three geographic business units in the United States, Europe and Japan, which we believe are three of the largest geographic markets where product developers and engineers are located. Revenue within each of our United States and Europe business units is derived from our Protomold, Firstcut and Fineline product lines. Revenue within our Japan business unit is derived from our Protomold and Firstcut product lines. 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 product lines such as our Fineline additive manufacturing technologies, often times referred to as 3D printing, which we added via the acquisition of FineLine Prototyping, Inc. (FineLine) in April 2014;

 

introducing our Firstcut product line in 2007;

 

expanding internationally, including the opening of our Japanese plant in 2009;

 

improving the usability of our product lines such as our web-centric applications; and

 

expanding the breadth and scope of our products, for example by adding more sizes and materials to our offerings such as liquid silicone rubber (LSR) and metal injection molding (MIM).

 

During the three months ended June 30, 2015, we served approximately 11,800 unique product developers and engineers, an increase of 28% over the same period in 2014. During the six months ended June 30, 2015, we served approximately 17,200 unique product developers and engineers, an increase of 31% over the same period in 2014. These product developers and engineers are served under all our product lines, including Fineline, which we added via our acquisition of FineLine Prototyping, Inc. in April 2014.

 

Cost of Revenue, Gross Profit and Gross Margin

 

Cost of revenue consists primarily of raw materials, equipment depreciation, employee compensation, benefits, stock-based compensation, facilities costs 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.

 

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 sales by product line, 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, available capacity 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.

 

 
15

 

 

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 additive-manufactured (3D printing), CNC-machined, CNC-turned 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 product line 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 in the future as we continue to grow and expand as a global organization.

 

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.

 

                         
   

Three Months Ended June 30,

   

Change

   

Six Months Ended June 30,

   

Change

 

(dollars in thousands)

 

2015

   

2014

    $     %     2015       2014       $     %  

Revenue

  $ 63,969       100.0 %   $ 52,866       100.0 %   $ 11,103       21.0 %   $ 122,505       100.0 %   $ 98,940       100.0 %   $ 23,565       23.8 %

Cost of revenue

    26,419       41.3       20,183       38.2       6,236       30.9       49,701       40.6       37,233       37.6       12,468       33.5  

Gross profit

    37,550       58.7       32,683       61.8       4,867       14.9       72,804       59.4       61,707       62.4       11,097       18.0  

Operating expenses:

                                                                                               

Marketing and sales

    9,502       14.8       7,261       13.7       2,241       30.9       18,356       15.0       13,678       13.8       4,678       34.2  

Research and development

    4,397       6.9       3,914       7.4       483       12.3       8,711       7.1       7,370       7.4       1,341       18.2  

General and administrative

    6,304       9.9       5,534       10.5       770       13.9       12,549       10.2       10,237       10.4       2,312       22.6  

Total operating expenses

    20,203       31.6       16,709       31.6       3,494       20.9       39,616       32.3       31,285       31.6       8,331       26.6  

Income from operations

    17,347       27.1       15,974       30.2       1,373       8.6       33,188       27.1       30,422       30.8       2,766       9.1  

Other income (expense), net

    (36 )     -       (66 )     (0.1 )     30       (45.5 )     (493 )     (0.4 )     37       -       (530 )     *  

Income before income taxes

    17,311       27.1       15,908       30.1       1,403       8.8       32,695       26.7       30,459       30.8       2,236       7.3  

Provision for income taxes

    5,625       8.8       4,952       9.4       673       13.6       10,556       8.6       9,401       9.5       1,155       12.3  

Net income

  $ 11,686       18.3 %   $ 10,956       20.7 %   $ 730       6.7 %   $ 22,139       18.1 %   $ 21,058       21.3 %   $ 1,081       5.1 %
                                                                                                 

* Percentage change not meaningful

 

 
16

 

 

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

 

             
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(dollars in thousands)

 

2015

   

2014

   

2015

   

2014

 

Stock options and restricted stock

  $ 1,436     $ 1,147     $ 2,655     $ 2,060  

Employee stock purchase plan

    131       103       254       188  

Total stock-based compensation expense

  $ 1,567     $ 1,250     $ 2,909     $ 2,248  
                                 

Cost of revenue

  $ 132     $ 97     $ 243     $ 179  

Operating expenses:

                               

Marketing and sales

    271       240       507       435  

Research and development

    336       268       630       483  

General and administrative

    828       645       1,529       1,151  

Total stock-based compensation expense

  $ 1,567     $ 1,250     $ 2,909     $ 2,248  
                                 

 

Comparison of Three Months Ended June 30, 2015 and 2014

 

Revenue

 

Revenue by product line and the related changes for the three months ended June 30, 2015 and 2014 were as follows:

 

                       
   

Three Months Ended June 30,

                 
   

2015

   

2014

   

Change

 

(dollars in thousands)

       

% of Total

Revenue

         

% of Total

Revenue

         

%

 

Revenue

                                               

Protomold

  $ 39,932       62.4 %   $ 36,255       68.6 %   $ 3,677       10.1 %

Firstcut

    18,585       29.1       14,478       27.4       4,107       28.4  

Fineline

    5,452       8.5       2,133       4.0       3,319       155.6  

Total revenue

  $ 63,969       100.0 %   $ 52,866       100.0 %   $ 11,103       21.0 %
                                                 

 

Revenue by geographic region, based on the billing location of the end customer, for the three months ended June 30, 2015 and 2014 is summarized as follows:

 

                                                 
   

Three Months Ended June 30,

                 
   

2015

   

2014

   

Change

 

(dollars in thousands)

       

% of Total

Revenue

       $    

% of Total

Revenue

         

%

 

Revenue

                                               

United States

  $ 49,298       77.1 %   $ 39,966       75.6 %   $ 9,332       23.3 %

International

    14,671       22.9       12,900       24.4       1,771       13.7  

Total revenue

  $ 63,969       100.0 %   $ 52,866       100.0 %   $ 11,103       21.0 %
                                                 

 

Our revenue increased $11.1 million, or 21.0%, for the three months ended June 30, 2015 compared to the same period in 2014. By geographic region, this revenue growth was driven by a 23.3% increase in United States revenue and a 13.7% increase in international revenue. By product line, this revenue growth was driven by a 10.1% increase in Protomold revenue, 28.4% increase in Firstcut revenue and 155.6% increase in Fineline revenue in each case for the three months ended June 30, 2015 compared to the same period in 2014. Fineline revenue for the three months ended June 30, 2014 commenced upon the completion of our acquisition of FineLine Prototyping, Inc. on April 23, 2014.

 

Our revenue growth during the three months ended June 30, 2015 was the result of increased volume of the product developers and engineers we served. During the three months ended June 30, 2015, we served approximately 11,800 unique product developers and engineers, an increase of 28% over the same period in 2014. Average revenue per product developer or engineer decreased 6% during the three months ended June 30, 2015 when compared to the same period in 2014.

 

 
17

 

 

Our revenu