Edgar Filing: Proto Labs Inc

prlb20140630_10q.htm

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, 2014


☐		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: 25,718,607 shares of Common Stock, par value $0.001 per share, were outstanding at July 31, 2014.

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	16
3.	Quantitative and Qualitative Disclosures about Market Risk	25
4.	Controls and Procedures	26
	PART II
1.	Legal Proceedings	27
1A.	Risk Factors	27
6.	Exhibits	28

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Proto Labs, Inc.

Consolidated Balance Sheets

(In thousands, except share and per share amounts)



	June 30, 2014			December 31, 2013
	(Unaudited)
Assets
Current assets
Cash and cash equivalents	$	22,854		$	43,039
Short-term marketable securities		25,255			36,339
Accounts receivable, net of allowance for doubtful accounts of $132 and $90 as of June 30, 2014 and December 31, 2013, respectively		25,187			18,320
Inventory		5,755			5,166
Prepaid expenses and other current assets		5,135			3,569
Income taxes receivable		2,051			2,907
Deferred tax assets		459			455
Total current assets		86,696			109,795
Property and equipment, net		87,313			56,101
Goodwill		28,916			-
Other intangible assets, net		4,456			-
Long-term marketable securities		57,325			64,023
Other long-term assets		251			256
Total assets	$	264,957		$	230,175

Liabilities and shareholders' equity
Current liabilities
Accounts payable	$	11,818		$	6,455
Accrued compensation		5,805			6,196
Accrued liabilities and other		3,491			808
Current portion of long-term debt obligations		194			204
Total current liabilities		21,308			13,663
Long-term deferred tax liabilities		3,731			3,682
Long-term debt obligations		77			159
Other long-term liabilities		759			1,028
Total liabilities		25,875			18,532

Shareholders' equity
Preferred stock, $0.001 par value, authorized 10,000,000 shares; issued and outstanding 0 shares as of each of June 30, 2014 and December 31, 2013		-			-
Common stock, $0.001 par value, authorized 150,000,000 shares; issued and outstanding 25,672,300 and 25,546,107 shares as of June 30, 2014 and December 31, 2013, respectively		26			26
Additional paid-in capital		172,538			166,861
Retained earnings		66,905			45,847
Accumulated other comprehensive income (loss)		(387	)		(1,091	)
Total shareholders' equity		239,082			211,643
Total liabilities and shareholders' equity	$	264,957		$	230,175

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

Proto Labs, Inc.

Consolidated Statements of Comprehensive Income

(In thousands, except share and per share amounts)

(Unaudited)


	Three Months Ended June 30,					Six Months Ended June 30,
	2014			2013		2014		2013

Statements of Operations:
Revenue	$	52,866		$	39,749	$	98,940	$	77,062
Cost of revenue		20,183			14,896		37,233		28,930
Gross profit		32,683			24,853		61,707		48,132
Operating expenses
Marketing and sales		7,261			5,550		13,678		10,813
Research and development		3,914			2,751		7,370		5,379
General and administrative		5,534			3,923		10,237		7,917
Total operating expenses		16,709			12,224		31,285		24,109
Income from operations		15,974			12,629		30,422		24,023
Other income (expense), net		(66	)		116		37		119
Income before income taxes		15,908			12,745		30,459		24,142
Provision for income taxes		4,952			4,134		9,401		7,244
Net income	$	10,956		$	8,611	$	21,058	$	16,898

Net income per share:
Basic	$	0.43		$	0.34	$	0.82	$	0.68
Diluted	$	0.42		$	0.33	$	0.81	$	0.66

Shares used to compute net income per share:
Basic		25,620,005			25,258,932		25,597,055		25,030,283
Diluted		26,146,848			25,850,247		26,132,265		25,627,382

Comprehensive Income (net of tax)
Comprehensive income	$	11,488		$	8,413	$	21,762	$	15,793

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

Proto Labs, Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


	Six Months Ended June 30,
	2014			2013

Operating activities
Net income	$	21,058		$	16,898
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		4,683			3,582
Stock-based compensation expense		2,248			1,736
Deferred taxes		107			307
Excess tax benefit from stock-based compensation		(1,623	)		(5,929	)
Loss on disposal of property and equipment		-			59
Amortization of held-to-maturity securities		854			633
Changes in operating assets and liabilities:
Accounts receivable		(5,742	)		(2,032	)
Inventories		(306	)		(360	)
Prepaid expenses and other		(372	)		1,715
Income taxes		2,431			3,066
Accounts payable		5,143			1,083
Accrued liabilities and other		(2,464	)		(1,310	)
Net cash provided by operating activities		26,017			19,448

Investing activities
Purchases of property and equipment		(31,625	)		(6,069	)
Acquisitions, net of cash acquired		(33,864	)		-
Purchases of marketable securities		(38,463	)		(57,310	)
Proceeds from maturities of marketable securities		55,441			34,280
Net cash used in investing activities		(48,511	)		(29,099	)

Financing activities
Payments on debt		(954	)		(166	)
Acquisition-related contingent consideration		(400	)		-
Proceeds from exercises of stock options and other		1,806			2,870
Excess tax benefit from stock-based compensation		1,623			5,929
Net cash provided by financing activities		2,075			8,633
Effect of exchange rate changes on cash and cash equivalents		234			(295	)
Net decrease in cash and cash equivalents		(20,185	)		(1,313	)
Cash and cash equivalents, beginning of period		43,039			36,759
Cash and cash equivalents, end of period	$	22,854		$	35,446

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

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

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.

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, 2013 as filed with the Securities and Exchange Commission (SEC) on February 28, 2014.

The accompanying Consolidated Balance Sheet as of December 31, 2013 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 28, 2014 as referenced above.

Note 2 – Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board 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 on January 1, 2017 using one of two retrospective application methods. The Company is evaluating the application method and the impact of this new standard on our financial statements.

There are no other new accounting pronouncements that are expected to have a significant impact on the Company’s consolidated financial statements.

Note 3 – Business Combinations

On April 23, 2014, the Company acquired 100% of the outstanding shares of FineLine Prototyping, Inc. (“FineLine”) for $33.9 million net cash consideration, which was funded with cash available in the United States and the sale of $15.5 million of held-to-maturity securities. Under the terms of the Agreement, the Company is obligated to make an additional cash payment of up to $3.0 million, contingent upon both the achievement of 2014 revenue goals and certain milestones relating to the integration of FineLine’s operations with the Company. The shares of FineLine acquired through the Stock Purchase Agreement (“Agreement”) were issued in a private transaction exempt from the registration under the Securities Act of 1933 and the operations of FineLine will be integrated into the operations of the Company.

FineLine is based in Raleigh, North Carolina and is a leading producer of parts using additive manufacturing technologies, often times referred to as 3D printing. FineLine produces high-quality parts using stereolithography (SLA), selective laser sintering (SLS) and direct metal laser sintering (DMLS) technologies to customers in a wide variety of industries, including medical, aerospace, computer/electronics, consumer products and industrial machinery, among others. Along with Protomold and Firstcut, the Company will offer these technologies to its customers under the Fineline product name.

Consistent with the provisions of Accounting Standards Codification (ASC) 805, Business Combinations (ASC 805), the Company accrued the contingent payment on the date of acquisition after determining its fair value of $3.0 million in arriving at $36.9 million of total consideration, net of cash acquired. The contingent consideration liability is reflected in accrued liabilities and other as of June 30, 2014 and continues to be remeasured to fair value at each reporting period with changes in fair value reflected in the Consolidated Statements of Comprehensive Income. As of June 30, 2014 the contingent consideration balance totaled $2.6 million.

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

The fair value of the consideration paid for this acquisition was allocated to the assets purchased and liabilities assumed based on their estimated fair values as of the acquisition date, with any excess recorded as goodwill. The goodwill associated with the acquisition is deductible for tax purposes and represents the strategic and growth opportunities from strengthening the Company’s portfolio of rapid prototyping product offerings. The addition of additive manufacturing expands Proto Labs’ products to address a wider spectrum of need for the product developer. From concept models, to form and fit testing, to functional testing and short-run production, the acquisition of FineLine allows the Company to offer a broader range of quick-turn custom parts with speed, reliability and consistency.

The results of FineLine since the date of acquisition and pro forma disclosures of the consolidated results of the Company with the full year effects of FineLine have not been separately presented since the impact to the Company's results of operations was not material.

The acquisition has been accounted for under the acquisition method of accounting in accordance with ASC 805. As of June 30, 2014, this allocation for FineLine remains preliminary as it relates to the valuation of certain working capital accounts, intangible assets and taxes. The preliminary allocation of the purchase price to assets acquired and liabilities assumed is as follows:

(in thousands)
Assets acquired:
Current assets	$	1,248
Intangible assets		4,580
Goodwill		28,916
Other long-term assets		3,849
Total assets acquired		38,593

Liabilities assumed:
Current liabilities		1,729
Total liabilities assumed		1,729
Net assets acquired		36,864

Cash paid		34,468
Cash acquired		(604	)
Net cash consideration		33,864
Contingent consideration		3,000
Total purchase consideration	$	36,864

Note 4 – Goodwill and Other Intangible Assets

The changes in the carrying amount of Goodwill for the six months ended June 30, 2014 were as follows:

(in thousands)	Six Months Ended June 30, 2014
Balance as of the beginning of the period	$	-
Goodwill acquired during the period		28,916
Balance as of the end of the period	$	28,916

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Intangible assets other than Goodwill at June 30, 2014 and December 31, 2013 were as follows:

	June 30, 2014							December 31, 2013
(in thousands)	Gross		Accumulated Amortization			Net		Gross		Accumulated Amortization		Net		Useful Life (in years)		Weighted Average Useful Life Remaining (in years)
Intangible Assets with finite lives:
Marketing assets	$	930	$	(15	)	$	915	$	-	$	-	$	-		10		10
Non-compete agreement		190		(16	)		174		-		-		-		2		2
Trade secrets		250		(8	)		242		-		-		-		5		5
Internally developed software		680		(38	)		642		-		-		-		3		3
Customer relationships		2,530		(47	)		2,483		-		-		-		9		9
Total intangible assets	$	4,580	$	(124	)	$	4,456	$	-	$	-	$	-

Amortization expense for intangible assets for each of the three and six months ended June 30, 2014 was $0.1 million. There was no amortization expense in the same periods of the prior year.

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

(in thousands)	Estimated Amortization Expense
Remaining 2014	$	373
2015		746
2016		682
2017		500
2018		424
Thereafter		1,731
Total estimated amortization expense	$	4,456

Note 5 – 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 the 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.

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

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


	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands, except share and per share amounts)	2014		2013		2014		2013

Net income	$	10,956	$	8,611	$	21,058	$	16,898

Basic - weighted-average shares outstanding:		25,620,005		25,258,932		25,597,055		25,030,283
Effect of dilutive securities:
Employee stock options and other		526,843		591,315		535,210		597,099
Diluted - weighted-average shares outstanding:		26,146,848		25,850,247		26,132,265		25,627,382
Net income per share:
Basic	$	0.43	$	0.34	$	0.82	$	0.68
Diluted	$	0.42	$	0.33	$	0.81	$	0.66

Note 6 – 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, 2014 and December 31, 2013 measured at fair value on a recurring basis follows:


	June 30, 2014						December 31, 2013
(in thousands)	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3

Financial Assets:
Cash and cash equivalents
Money market mutual fund	$	5,129	$	-	$	-	$	5,524	$	-	$	-
Total	$	5,129	$	-	$	-	$	5,524	$	-	$	-

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Note 7 – 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, 2014 and December 31, 2013 is as follows:


	June 30, 2014
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value

U.S. government agency securities	$	16,453	$	3	$	(20	)	$	16,436
Corporate debt securities		28,752		21		(35	)		28,738
Commercial paper		1,998		-		-			1,998
U.S. municipal securities		30,222		69		(2	)		30,289
Certificates of deposit/time deposits		5,155		9		(2	)		5,162

Total marketable securities	$	82,580	$	102	$	(59	)	$	82,623


	December 31, 2013
(in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value

U.S. government agency securities	$	21,713	$	2	$	(22	)	$	21,693
Corporate debt securities		29,480		30		(20	)		29,490
U.S. municipal securities		44,474		49		(22	)		44,501
Certificates of deposit/time deposits		4,695		5		(8	)		4,692

Total marketable securities	$	100,362	$	86	$	(72	)	$	100,376

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 to be temporary in nature. The Company intends 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, 2014 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.


(in thousands)	June 30, 2014

Due in one year or less	$	25,255
Due after one year through five years		57,325

Total marketable securities	$	82,580

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Note 8 – 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.

The Company’s inventory consists of the following:


(in thousands)	June 30, 2014			December 31, 2013

Raw materials	$	5,417		$	4,875
Work in process		530			410
Total inventory		5,947			5,285
Allowance for obsolescence		(192	)		(119	)

Inventory, net of allowance	$	5,755		$	5,166

Note 9 – 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 $1.2 million and $0.9 million for the three months ended June 30, 2014 and 2013, respectively, and $2.2 and $1.7 million for the six months ended June 30, 2014 and 2013, respectively.

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Stock Options

A summary of stock option activity for the six months ended June 30, 2014 is as follows:


	Stock Options			Weighted- Average Exercise Price

Options outstanding at December 31, 2013		1,143,250		$	19.03
Granted		108,860			72.70
Exercised		(103,648	)		10.56
Forfeited		(3,604	)		22.41
Options outstanding at June 30, 2014		1,144,858		$	24.89

Exercisable at June 30, 2014		535,033		$	15.36

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, 2014 was $32.73.

The following table provides the assumptions used in the Black-Scholes pricing model valuation of options during the six months ended June 30, 2014 and 2013, respectively:


	Six Months Ended June 30,
	2014				2013

Risk-free interest rate		0.43	-	2.14%		1.03	-	1.30%
Expected life (years)		2.00	-	6.50		5.50	-	6.50
Expected volatility		48.87	-	49.30%		53.32	-	53.54%
Expected dividend yield			0%				0%

As of June 30, 2014, there was $8.9 million of unrecognized compensation expense related to unvested stock options, which is expected to be recognized over a weighted-average period of 3.4 years.

Restricted Stock

Restricted stock are non-vested stock that include grants of restricted stock awards (RSA) and grants of restricted stock units (RSU). During the six months ended June 30, 2014, the Company granted both RSA and RSU.

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Non-vested restricted stock as of June 30, 2014 and changes during the six months ended June 30, 2014 were as follows:


	Restricted Stock Awards		Weighted- Average Grant Date Fair Value Per Share

Nonvested restricted stock at December 31, 2013		-	$	-
Granted		74,137		69.42
Vested		-		-
Forfeited		-		-
Nonvested restricted stock at June 30, 2014		74,137	$	69.42

As of June 30, 2014, there was $4.8 million of unrecognized compensation expense related to non-vested restricted stock, which is expected to be recognized over a weighted-average period of 4.0 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, 2014 and 2013, respectively:


	Six Months Ended June 30,
	2014				2013

Risk-free interest rate		0.01%	-	0.11%		0.11	-	0.13%
Expected life (months)			6.00				6.00
Expected volatility		39.16%	-	39.80%		53.14%	-	53.32%
Expected dividend yield			0%				0%

Note 10 – Accumulated Other Comprehensive Income

Other comprehensive income (loss) is comprised entirely of foreign currency translation adjustments. The following table presents the changes in accumulated other comprehensive income balances during the three and six months ended June 30, 2014 and 2013, respectively:


	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands)	2014			2013			2014			2013

Foreign currency translation adjustment, net of tax
Balance at beginning of period	$	(919	)	$	(1,835	)	$	(1,091	)	$	(928	)
Other comprehensive income before reclassifications		532			(198	)		704			(1,105	)
Amounts reclassified from accumulated other comprehensive income		-			-			-			-
Net current-period other comprehensive income		532			(198	)		704			(1,105	)
Balance at end of period	$	(387	)	$	(2,033	)	$	(387	)	$	(2,033	)

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

Note 11 – 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, 2014 and 2013 the Company recorded an income tax provision of $5.0 million and $4.1 million, respectively. For the six months ended June 30, 2014 and 2013 the Company recorded an income tax provision of $9.4 million and $7.2 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, 2014 was 31.1 percent compared with 32.4 percent in the same period of the prior year. The effective income tax rate for the six months ended June 30, 2014 was 30.9 percent compared with 30.0 percent in the same period of the prior year.

The effective income tax rate for the three and six months ended June 30, 2014 differs from the U.S. federal statutory rate of 35 percent due primarily to the mix of revenue earned in domestic and foreign tax jurisdictions and deductions for which the Company qualifies.

On January 2, 2013, the American Taxpayer Relief Act of 2012 (the Act) was signed into law. Included in the Act was the extension of the research and development credit for years 2012 and 2013. As the Act was enacted during 2013, the federal portion of the 2012 research and development credit was recognized in the first quarter of 2013. As a result, during the three months ended March 31, 2013, the Company recorded a tax benefit of $0.3 million. Absent the impact of the Act, the effective income tax rates would have been similar for the six month periods ended June 30, 2014 and 2013, respectively.

The Company has liabilities related to unrecognized tax benefits totaling $0.7 million at each of June 30, 2014 and December 31, 2013. There were no material adjustments to the unrecorded tax benefits during the six months ended June 30, 2014, and the Company does not anticipate that total unrecognized tax benefits will materially change in the next twelve months. 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.

Note 12 – Revenue and Geographic Information

The Company’s revenue is derived from its Protomold 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)	2014		2013		2014		2013

Revenue:
Protomold	$	36,255	$	27,924	$	68,949	$	54,804
Firstcut		14,478		11,825		27,858		22,258
Fineline		2,133		-		2,133		-
Total revenue	$	52,866	$	39,749	$	98,940	$	77,062

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)	2014		2013		2014		2013

Revenue:
United States	$	39,966	$	30,106	$	72,988	$	58,254
International		12,900		9,643		25,952		18,808
Total revenue	$	52,866	$	39,749	$	98,940	$	77,062

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)


(in thousands)	June 30, 2014		December 31, 2013

Long-lived assets:
United States	$	72,014	$	48,381
International		15,299		7,720
Total long-lived assets	$	87,313	$	56,101

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, 2013.

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 manufacturer of quick-turn additive-manufactured (3D printed), CNC-machined and molded custom parts for prototyping and short-run production. We provide “Real Parts, Really Fast” to product developers worldwide, who are under increasing pressure to bring their finished products to market faster than their competition. We believe low-volume manufacturing has historically been an underserved market due to the inefficiencies inherent in the quotation, equipment set-up and non-recurring engineering processes required to produce custom parts. Our proprietary technology eliminates most of the time-consuming and expensive skilled labor conventionally required to quote and manufacture parts in low volumes, and our customers conduct nearly all of their business with us over the Internet. We target our services to the millions of product developers who use three-dimensional computer-aided design (3D CAD) software to design products across a diverse range of end-markets. Our primary manufacturing products currently include Fineline, which is our additive-manufacturing (3D printing) product line, Firstcut, which is our CNC machining product line, and Protomold, which is our molding product line.

Key Financial Measures and Trends

Revenue

The Company’s operations are comprised of three geographic business units in the United States, Europe and Japan. Revenue within each of our business units is derived from our Fineline, Firstcut and Protomold product lines. Fineline revenue consists of sales of additive-manufactured custom parts, often referred to as 3D printed parts. Firstcut revenue consists of sales of CNC-machined custom parts. Protomold revenue consists of sales of custom molds and molded parts. Our historical and current efforts to increase revenue have been directed at gaining new customers and selling to our existing customer base by:

●

increasing marketing and selling activities,

●

offering additional services such as the acquisition in April 2014 of FineLine Prototyping, Inc. leading to the offering of Fineline additive manufacturing technologies, often times referred to as 3D printing,

●

introducing our Firstcut product line in 2007,

●

expanding internationally such as the opening of our Japanese plant in 2009,

●

improving the usability of our services such as our web-centric applications, and

●

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

Excluding product developers we gained through the acquisition of FineLine, during the three months ended June 30, 2014, we served approximately 8,200 unique product developers, an increase of 19% over the same period in 2013. Excluding product developers we gained through the acquisition of FineLine, during the six months ended June 30, 2014, we served approximately 12,100 unique product developers, an increase of 18% over the same period in 2013.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of raw materials, equipment depreciation, employee salaries, benefits, stock-based compensation, bonuses 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 pricing, sales volume and manufacturing costs, the costs associated with increasing production capacity, the mix between domestic and foreign revenue sources and foreign exchange rates.

Operating Expenses

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

Our recent growth in operating expenses is mainly due to higher headcounts to support our growth and expansion, and we expect that trend to continue. Our business strategy is to continue to be a leading online and technology-enabled manufacturer of quick-turn additive-manufactured (3D printing), CNC-machined and molded custom parts for prototyping and short-run production. For us to achieve our goals, we anticipate continued substantial investments in technology and personnel, resulting in increased operating expenses.

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

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

General and administrative. General and administrative expense consists primarily of employee compensation, benefits, stock-based compensation, professional service fees related to accounting, tax and legal services, amortization of intangibles and other related overhead. We expect general and administrative expense to increase on an absolute basis as we continue to grow and expand our operations.

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)	2014					2013					$		%		2014				2013					$		%

Revenue	$	52,866		100.0	%	$	39,749	100.0	%	$	13,117		33.0	%	$	98,940	100.0	%	$	77,062	100.0	%	$	21,878		28.4
Cost of revenue		20,183		38.2			14,896	37.5			5,287		35.5			37,233	37.6			28,930	37.5			8,303		28.7
Gross profit		32,683		61.8			24,853	62.5			7,830		31.5			61,707	62.4			48,132	62.5			13,575		28.2
Operating expenses:
Marketing and sales		7,261		13.7			5,550	13.9			1,711		30.8			13,678	13.8			10,813	14.0			2,865		26.5
Research and development		3,914		7.4			2,751	6.9			1,163		42.3			7,370	7.4			5,379	7.0			1,991		37.0
General and administrative		5,534		10.5			3,923	9.9			1,611		41.1			10,237	10.4			7,917	10.3			2,320		29.3
Total operating expenses		16,709		31.6			12,224	30.7			4,485		36.7			31,285	31.6			24,109	31.3			7,176		29.8
Income (expense) from operations		15,974		30.2			12,629	31.8			3,345		26.5			30,422	30.8			24,023	31.2			6,399		26.6
Other income, net		(66	)	(0.1	)		116	0.3			(182	)	*			37	0.0			119	0.1			(82	)	(68.9	)
Income before income taxes		15,908		30.1			12,745	32.1			3,163		24.8			30,459	30.8			24,142	31.3			6,317		26.2
Provision for income taxes		4,952		9.4			4,134	10.4			818		19.8			9,401	9.5			7,244	9.4			2,157		29.8
Net income	$	10,956		20.7	%	$	8,611	21.7	%	$	2,345		27.2	%	$	21,058	21.3	%	$	16,898	21.9	%	$	4,160		24.6	%

*Percentage change not meaningful

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)	2014		2013		2014		2013

Stock options and restricted stock	$	1,147	$	778	$	2,060	$	1,554
Employee stock purchase plan		103		93		188		182
Total stock-based compensation expense	$	1,250	$	871	$	2,248	$	1,736

Cost of revenue	$	97	$	73	$	179	$	144
Operating expenses:
Marketing and sales		240		151		435		301
Research and development		268		181		483		354
General and administrative		645		466		1,151		937
Total stock-based compensation expense	$	1,250	$	871	$	2,248	$	1,736

Comparison of Three Months Ended June 30, 2014 and 2013

Revenue

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


	Three Months Ended June 30,
	2014					2013					Change
(dollars in thousands)		$	% of Total Revenue				$	% of Total Revenue				$	%

Revenue
Protomold	$	36,255		68.6	%	$	27,924		70.3	%	$	8,331		29.8	%
Firstcut		14,478		27.4			11,825		29.7			2,653		22.4
Fineline		2,133		4.0			-		-			2,133		100.0

Total revenue	$	52,866		100.0	%	$	39,749		100.0	%	$	13,117		33.0	%

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


	Three Months Ended June 30,
	2014					2013					Change
(dollars in thousands)		$	% of Total Revenue				$	% of Total Revenue				$	%

Revenue
United States	$	39,966		75.6	%	$	30,106		75.7	%	$	9,860		32.8	%
International		12,900		24.4			9,643		24.3			3,257		33.8

Total revenue	$	52,866		100.0	%	$	39,749		100.0	%	$	13,117		33.0	%

Our revenue increased $13.1 million, or 33.0%, for the three months ended June 30, 2014 compared with the same period in 2013. This revenue growth was driven by a 32.8% increase in United States revenue, 33.8% increase in international revenue, 29.8% increase in Protomold revenue, 22.4% increase in Firstcut revenue and $2.1 million increase in revenue from the FineLine acquisition, in all cases for the three months ended June 30, 2014 compared with the same period in 2013.

Within our legacy Firstcut and Protomold product lines, our revenue growth in the three months ended June 30, 2014 was the result of increased number and spending of the product developers we served. During the three months ended June 30, 2014, excluding product developers who purchased Fineline products, we served approximately 8,200 unique product developers, an increase of 19.4% over the same period in 2013. Average revenue per product developer, excluding product developers who purchased Fineline products, also increased 6.9% during the three months ended June 30, 2014 compared to the same period in 2013.

Excluding revenue gained through the acquisition of FineLine, our revenue increases were primarily driven by increases in sales personnel and marketing activities. Our sales personnel focus on gaining new customer accounts and expanding the depth and breadth into existing customer accounts. Our marketing personnel focus on trade show and marketing activities that have proven to result in the greatest number of customer leads to support sales activity. International revenue was favorably impacted by $0.7 million in the three months ended June 30, 2014 compared to the same period in 2013 due to weakening of the United States dollar relative to certain foreign currencies, particularly the British Pound. The effect of pricing changes on revenue was immaterial for the three months ended June 30, 2014 compared to the same period in 2013.

Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue increased $5.3 million, or 35.5%, for the three months ended June 30, 2014 compared to the same period in 2013, which was faster than the rate of revenue increase of 33.0% for the three months ended June 30, 2014 compared to the same period in 2013. The increase in cost of revenue was due to raw material and production cost increases of $1.8 million to support increased sales volumes, equipment and facility-related cost increases of $0.7 million and an increase in direct labor headcount resulting in personnel and related cost increases of $2.8 million.

Gross Profit and Gross Margin. Gross profit increased to $32.7 million, or 61.8% of revenues, for the three months ended June 30, 2014 from $24.9 million, or 62.5% of revenues, for the three months ended June 30, 2013 due to increases in revenue offset by the cost of revenue as discussed above. Gross margin decreased primarily as a result of additional costs incurred related to the integration of FineLine and the move to our new facility in Plymouth, Minnesota.

Operating Expenses, Other Income (Expense), net and Provision for Income Taxes

Marketing and Sales. Marketing and sales expense increased $1.7 million, or 30.8%, for the three months ended June 30, 2014 compared to the same period in 2013 due primarily to an increase in headcount resulting in personnel and related cost increases of $1.3 million and marketing program cost increases of $0.4 million. The increase in marketing program costs is the result of our focus and concentration on funding those programs which have proven to be the most effective in growing our business. Marketing and sales expense as a percentage of revenue decreased to 13.7% for the three months ended June 30, 2014 from 14.0% during the same period in 2013, primarily due to the fixed nature of certain marketing and sales costs as well as focus on effective marketing spending as previously discussed.

Research and Development. Our research and development expense increased $1.2 million, or 42.3%, for the three months ended June 30, 2014 compared to the same period in 2013 due to an increase in headcount resulting in personnel and related cost increases of $1.0 million and operating cost increases of $0.2 million.

General and Administrative. Our general and administrative expense increased $1.6 million, or 41.1%, for the three months ended June 30, 2014 compared to the same period in 2013 due to an increase in headcount resulting in personnel and related cost increases of $0.7 million, stock-based compensation costs increases of $0.2 million, administrative cost increases of $0.1 million, intangible amortization expense cost increases of $0.1 and professional service cost increases of $0.5 million.

Other Income (Expense), net. Other income, net decreased $0.2 million for the three months ended June 30, 2014 compared to the same period in 2013 due to changes in foreign currency rates.

Provision for Income Taxes. Our effective tax rate of 31.1% for the three months ended June 30, 2014 decreased 1.3% when compared to 32.4% for the same period in 2013. The decrease in the effective tax rate is primarily due to an increase in tax benefit from the domestic manufacturing deduction projected for the tax year ending December 31, 2014. As a result of increased income attributable to the fluctuations described above, our income tax provision increased by $0.9 million to $5.0 million for the three months ended June 30, 2014 compared to our income tax provision of $4.1 million for the three months ended June 30, 2013.

Comparison of Six Months Ended June 30, 2014 and 2013

Revenue

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


	Six Months Ended June 30,
	2014					2013					Change
(dollars in thousands)		$	% of Total Revenue				$	% of Total Revenue				$	%

Revenue
Protomold	$	68,949		69.7	%	$	54,804		71.1	%	$	14,145