prlb20150930_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 September 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: 26,163,402 shares of Common Stock, par value $0.001 per share, were outstanding at October 28, 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

2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

24

3.

 

Defaults Upon Senior Securities

 

24

4.

 

Mine Safety Disclosures

 

24

5.

 

Other Information

 

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)


 

   

September 30,

   

December 31,

 
   

2015

   

2014

 
   

(Unaudited)

         

Assets

               

Current assets

               

Cash and cash equivalents

  $ 64,131     $ 43,329  

Short-term marketable securities

    28,062       30,706  

Accounts receivable, net of allowance for doubtful accounts of $222 and $198 as of September 30, 2015 and December 31, 2014, respectively

    32,897       24,226  

Inventory

    7,228       6,194  

Prepaid expenses and other current assets

    5,733       3,406  

Income taxes receivable

    4,029       -  

Deferred tax assets

    460       483  

Total current assets

    142,540       108,344  

Property and equipment, net

    108,626       91,626  

Goodwill

    28,916       28,916  

Other intangible assets, net

    3,523       4,083  

Long-term marketable securities

    57,801       54,318  

Other long-term assets

    520       227  

Total assets

  $ 341,926     $ 287,514  
                 

Liabilities and shareholders' equity

               

Current liabilities

               

Accounts payable

  $ 11,552     $ 7,882  

Accrued compensation

    10,519       6,067  

Accrued liabilities and other

    2,424       2,718  

Income taxes payable

    -       1,953  

Current portion of long-term debt obligations

    39       139  

Total current liabilities

    24,534       18,759  

Long-term deferred tax liabilities

    1,488       1,846  

Long-term debt obligations

    -       10  

Other long-term liabilities

    1,716       1,360  

Total liabilities

    27,738       21,975  
                 

Shareholders' equity

               

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

    -       -  

Common stock, $0.001 par value, authorized 150,000,000 shares; issued and outstanding 26,159,735 and 25,838,110 shares as of September 30, 2015 and December 31, 2014, respectively

    26       26  

Additional paid-in capital

    195,856       180,960  

Retained earnings

    122,002       87,482  

Accumulated other comprehensive loss

    (3,696 )     (2,929 )

Total shareholders' equity

    314,188       265,539  

Total liabilities and shareholders' equity

  $ 341,926     $ 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

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2015

   

2014

   

2015

   

2014

 
                                 

Statements of Operations:

                               

Revenue

  $ 67,842     $ 54,574     $ 190,347     $ 153,514  

Cost of revenue

    27,517       21,492       77,218       58,725  

Gross profit

    40,325       33,082       113,129       94,789  

Operating expenses

                               

Marketing and sales

    10,027       7,351       28,383       21,029  

Research and development

    4,760       4,555       13,471       11,925  

General and administrative

    8,134       5,733       20,683       15,970  

Total operating expenses

    22,921       17,639       62,537       48,924  

Income from operations

    17,404       15,443       50,592       45,865  

Other income (expense), net

    593       (56 )     100       (19 )

Income before income taxes

    17,997       15,387       50,692       45,846  

Provision for income taxes

    5,615       5,003       16,171       14,404  

Net income

  $ 12,382     $ 10,384     $ 34,521     $ 31,442  
                                 

Net income per share:

                               

Basic

  $ 0.47     $ 0.40     $ 1.33     $ 1.23  

Diluted

  $ 0.47     $ 0.40     $ 1.31     $ 1.20  
                                 

Shares used to compute net income per share:

                               

Basic

    26,083,405       25,757,593       25,952,451       25,651,156  

Diluted

    26,381,313       26,200,741       26,290,758       26,109,539  
                                 

Comprehensive Income (net of tax)

                               

Comprehensive income

  $ 11,416     $ 9,011     $ 33,754     $ 30,773  

 


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

 

 

 
4

 

 

 

Proto Labs, Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)


 

   

Nine Months Ended

 
   

September 30,

 
   

2015

   

2014

 
                 

Operating activities

               

Net income

  $ 34,521     $ 31,442  

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

               

Depreciation and amortization

    10,422       7,696  

Stock-based compensation expense

    4,515       3,561  

Deferred taxes

    (310 )     487  

Excess tax benefit from stock-based compensation

    (5,212 )     (4,383 )

Amortization of held-to-maturity securities

    936       1,194  

Changes in operating assets and liabilities:

               

Accounts receivable

    (8,827 )     (6,302 )

Inventories

    (1,117 )     (339 )

Prepaid expenses and other

    (2,596 )     (706 )

Income taxes

    (546 )     4,032  

Accounts payable

    3,744       1,414  

Accrued liabilities and other

    5,754       1,908  

Net cash provided by operating activities

    41,284       40,004  
                 

Investing activities

               

Purchases of property and equipment

    (27,259 )     (35,928 )

Acquisitions, net of cash acquired

    -       (33,864 )

Purchases of marketable securities

    (42,674 )     (47,338 )

Proceeds from sales and maturities of marketable securities

    40,899       61,896  

Net cash used in investing activities

    (29,034 )     (55,234 )
                 

Financing activities

               

Payments on debt

    (107 )     (1,005 )

Acquisition-related contingent consideration

    (1,400 )     (800 )

Proceeds from exercises of stock options and other

    5,165       3,962  

Excess tax benefit from stock-based compensation

    5,212       4,383  

Net cash provided by financing activities

    8,870       6,540  

Effect of exchange rate changes on cash and cash equivalents

    (318 )     (81 )

Net increase (decrease) in cash and cash equivalents

    20,802       (8,771 )

Cash and cash equivalents, beginning of period

    43,329       43,039  

Cash and cash equivalents, end of period

  $ 64,131     $ 34,268  

 


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

 

 

 
5

 

 

 

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.

 

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.

 

During the three months ended September 30, 2015, the Company adjusted the useful lives of its primary production equipment based on experience and condition of current equipment. This change in accounting estimate is accounted for prospectively, and therefore had no effect on property and equipment, net as previously reported. This change was not material.

 

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 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

 

 

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

   

Nine Months Ended

 
   

September 30,

   

September 30,

 

(in thousands, except share and per share amounts)

 

2015

   

2014

   

2015

   

2014

 

Net income

  $ 12,382     $ 10,384     $ 34,521     $ 31,442  
                                 

Basic - weighted-average shares outstanding:

    26,083,405       25,757,593       25,952,451       25,651,156  

Effect of dilutive securities:

                               

Employee stock options and other

    297,908       443,148       338,307       458,383  

Diluted - weighted-average shares outstanding:

    26,381,313       26,200,741       26,290,758       26,109,539  

Net income per share:

                               

Basic

  $ 0.47     $ 0.40     $ 1.33     $ 1.23  

Diluted

  $ 0.47     $ 0.40     $ 1.31     $ 1.20  

 


 

Note 4 – Goodwill and Other Intangible Assets

 

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

 


 

(in thousands)

 

Nine Months Ended September 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 September 30, 2015 and December 31, 2014 were as follows:

 


 

   

September 30, 2015

   

December 31, 2014

   

 

   

Weighted Average

 

(in thousands)

 

Gross

   

Accumulated

Amortization

   

Net

   

Gross

   

Accumulated

Amortization

   

Net

   

Useful Life

 (in years) 

   

Useful Life

Remaining (in years)

 

Intangible Assets with finite lives:

                                                               

Marketing assets

  $ 930     $ (132 )   $ 798     $ 930     $ (62 )   $ 868       10.0       8.6  

Non-compete agreement

    190       (135 )     55       190       (63 )     127       2.0       0.6  

Trade secrets

    250       (71 )     179       250       (33 )     217       5.0       3.6  

Internally developed software

    680       (321 )     359       680       (151 )     529       3.0       1.6  

Customer relationships

    2,530       (398 )     2,132       2,530       (188 )     2,342       9.0       7.6  

Total intangible assets

  $ 4,580     $ (1,057 )   $ 3,523     $ 4,580     $ (497 )   $ 4,083                  

 


 

Amortization expense for intangible assets for the three and nine months ended September 30, 2015 was $0.2 million and $0.6 million, respectively. Amortization expense for intangible assets, which were acquired in the purchase of FineLine in April 2014, was $0.2 million and $0.3 million for the three and nine months ended September 30, 2014, respectively.

 

 
7

 

 

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

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

  $ 186  

2016

    682  

2017

    500  

2018

    424  

2019

    391  

Thereafter

    1,340  

Total estimated amortization expense

  $ 3,523  

 


 

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 September 30, 2015 and December 31, 2014 measured at fair value on a recurring basis follows:

 


 

   

September 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

  $ 15,698     $ -     $ -     $ 6,129     $ -     $ -  

Total

  $ 15,698     $ -     $ -     $ 6,129     $ -     $ -  

 


 

 

 

 

 

 

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

   

Note 6 – Marketable Securities

 

The Company invests in short-term and long-term agency, municipal, corporate 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 September 30, 2015 and December 31, 2014 is as follows:

 


 

    September 30, 2015  

(in thousands)

 

Amortized Cost

   

Unrealized Gains

   

Unrealized Losses

   

Fair Value

 

U.S. municipal securities

  $ 34,343     $ 32     $ (8 )   $ 34,367  

Corporate debt securities

    26,995       16       (19 )     26,992  

U.S. government agency securities

    18,866       11       (17 )     18,860  

Certificates of deposit/time deposits

    5,659       8       -       5,667  

Total marketable securities

  $ 85,863     $ 67     $ (44 )   $ 85,886  

 


 


 

    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 and certificates of deposit 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 September 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.

 


 

   

September 30,

 

(in thousands)

 

2015

 

Due in one year or less

  $ 28,062  

Due after one year through five years

    57,801  

Total marketable securities

  $ 85,863  

 


 

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

 

 

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

The Company’s inventory consisted of the following as of the dates indicated:

 


 

   

September 30,

   

December 31,

 

(in thousands)

 

2015

   

2014

 

Raw materials

  $ 6,528     $ 5,728  

Work in process

    905       653  

Total inventory

    7,433       6,381  

Allowance for obsolescence

    (205 )     (187 )

Inventory, net of allowance

  $ 7,228     $ 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 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 $1.3 million for the three months ended September 30, 2015 and 2014, respectively, and $4.5 million and $3.6 million for the nine months ended September 30, 2015 and 2014, respectively.

 

Stock Options

 

A summary of stock option activity during the nine months ended September 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

    (292,590 )     14.76  

Forfeited

    (25,915 )     52.22  

Options outstanding at September 30, 2015

    790,817     $ 35.69  
                 

Exercisable at September 30, 2015

    310,568     $ 22.45  

 


 

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 nine months ended September 30, 2015 was $32.42.

 

 
10

 

 

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

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

 


 

   

Nine Months Ended September 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%       47.82 - 49.30%  

Expected dividend yield

      0%           0%    

 


 

As of September 30, 2015, there was $7.9 million of unrecognized compensation expense related to unvested stock options, which is expected to be recognized over a weighted-average period of 3.2 years.

 

Restricted Stock

 

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, restrictions generally lapse in full on the first anniversary of the grant date.

 

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

 


 

           

Weighted-

 
           

Average

 
           

Grant Date

 
   

Restricted

   

Fair Value

 
   

Stock

   

Per Share

 

Restricted stock at December 31, 2014

    76,574     $ 69.27  

Granted

    68,580       68.89  

Restrictions lapsed

    (16,227 )     69.50  

Forfeited

    (1,858 )     78.59  

Restricted stock at September 30, 2015

    127,069     $ 68.90  

 


 

As of September 30, 2015, there was $7.3 million of unrecognized compensation expense related to non-vested restricted stock, which is expected to be recognized over a weighted-average period of 3.9 years.

 

Employee Stock Purchase Plan

 

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

 


 

   

Nine Months Ended September 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

 

 

 

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

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 nine months ended September 30, 2015 and 2014, respectively:

 


 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 

(in thousands)

 

2015

   

2014

   

2015

   

2014

 

Foreign currency translation adjustments

                               

Balance at beginning of period

  $ (2,730 )   $ (387 )   $ (2,929 )   $ (1,091 )

Other comprehensive loss before reclassifications

    (966 )     (1,373 )     (767 )     (669 )

Amounts reclassified from accumulated other comprehensive income (loss)

    -       -       -       -  

Net current-period other comprehensive loss

    (966 )     (1,373 )     (767 )     (669 )

Balance at end of period

  $ (3,696 )   $ (1,760 )   $ (3,696 )   $ (1,760 )

 


 

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 September 30, 2015 and 2014, the Company recorded an income tax provision of $5.6 million and $5.0 million, respectively. For the nine months ended September 30, 2015 and 2014, the Company recorded an income tax provision of $16.2 million and $14.4 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 September 30, 2015 was 31.2 percent compared to 32.5 percent in the same period of the prior year. The effective income tax rate for the nine months ended September 30, 2015 was 31.9 percent compared to 31.4 percent in the same period of the prior year.

 

The effective income tax rate for the three and nine months ended September 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 and credits for which the Company qualifies.

 

The Company had liabilities related to unrecognized tax benefits totaling $1.7 million at September 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 nine months ended September 30, 2015, the Company increased its current year uncertain tax positions by $0.4 million. Based upon the information available as of September 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 September 30,

   

Nine Months Ended September 30,

 

(in thousands)

 

2015

   

2014

   

2015

   

2014

 

Revenue:

                               

Protomold

  $ 41,971     $ 35,655     $ 119,521     $ 104,604  

Firstcut

    19,833       15,549       54,788       43,407  

Fineline

    6,038       3,370       16,038       5,503  

Total revenue

  $ 67,842     $ 54,574     $ 190,347     $ 153,514  

 


 

 
12

 

 

Proto Labs, Inc.

Notes to Consolidated Financial Statements

(Unaudited)

 

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 September 30,

   

Nine Months Ended September 30,

 

(in thousands)

 

2015

   

2014

   

2015

   

2014

 

Revenue:

                               

United States

  $ 50,214     $ 40,822     $ 144,357     $ 113,810  

International

    17,628       13,752       45,990       39,704  

Total revenue

  $ 67,842     $ 54,574     $ 190,347     $ 153,514  

 


 


 

   

September 30,

   

December 31,

 

(in thousands)

 

2015

   

2014

 

Long-lived assets:

               

United States

  $ 90,683     $ 76,923  

International

    17,943       14,703  

Total long-lived assets

  $ 108,626     $ 91,626  

 


 

Note 12 Subsequent Events

 

In October 2015, the Company acquired certain assets and shares of Alphaform AG, a provider of additive manufacturing, injection molding and other services. Total consideration paid for this acquisition was $5.5 million.

 

 

 
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 most recent 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 September 30, 2015, we served approximately 12,500 unique product developers and engineers, an increase of 24% over the same period in 2014. During the nine months ended September 30, 2015, we served approximately 22,600 unique product developers and engineers, an increase of 29% 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.

 

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.

 

 

 
15

 

 

 

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 September 30,

   

Change

   

Nine Months Ended September 30,

           

Change

 

(dollars in thousands)

 

2015

   

2014

   

$

   

%

   

2015

   

2014

   

$

   

%

 

Revenue

  $ 67,842       100.0 %   $ 54,574       100.0 %   $ 13,268       24.3 %   $ 190,347       100.0 %   $ 153,514       100.0 %   $ 36,833       24.0 %

Cost of revenue

    27,517       40.6       21,492       39.4       6,025       28.0       77,218       40.6       58,725       38.3       18,493       31.5  

Gross profit

    40,325       59.4       33,082       60.6       7,243       21.9       113,129       59.4       94,789       61.7       18,340       19.3  

Operating expenses:

                                                                                               

Marketing and sales

    10,027       14.7       7,351       13.5       2,676       36.4       28,383       14.9       21,029       13.7       7,354       35.0  

Research and development

    4,760       7.0       4,555       8.3       205       4.5       13,471       7.1       11,925       7.8       1,546       13.0  

General and administrative

    8,134       12.0       5,733       10.5       2,401       41.9       20,683       10.9       15,970       10.4       4,713       29.5  

Total operating expenses

    22,921       33.7       17,639       32.3       5,282       29.9       62,537       32.9       48,924       31.9       13,613       27.8  

Income from operations

    17,404       25.7       15,443       28.3       1,961       12.7       50,592       26.6       45,865       29.9       4,727       10.3  

Other income (expense), net

    593       0.9       (56 )     (0.1 )     649       *       100       0.1       (19 )     (0.0     119       *  

Income before income taxes

    17,997       26.6       15,387       28.2       2,610       17.0       50,692       26.7       45,846       29.9       4,846       10.6  

Provision for income taxes

    5,615       8.3       5,003       9.2       612       12.2       16,171       8.5       14,404       9.4       1,767       12.3  

Net income

  $ 12,382       18.3 %   $ 10,384       19.0 %   $ 1,998       19.2 %   $ 34,521       18.1 %   $ 31,442       20.5 %   $ 3,079       9.8 %

 


* Percentage change not meaningful

 

 

 
16

 

 

 

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

 


 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 

(dollars in thousands)

 

2015

   

2014

   

2015

   

2014

 

Stock options and restricted stock

  $ 1,483     $ 1,192     $ 4,138     $ 3,252  

Employee stock purchase plan

    123       121       377       309  

Total stock-based compensation expense

  $ 1,606     $ 1,313     $ 4,515     $ 3,561  
                                 

Cost of revenue

  $ 136     $ 103     $ 378     $ 282  

Operating expenses:

                               

Marketing and sales

    288       250       796       685  

Research and development

    335       287       964       770  

General and administrative

    847       673       2,377       1,824  

Total stock-based compensation expense

  $ 1,606     $ 1,313     $ 4,515     $ 3,561  

 


 

Comparison of Three Months Ended September 30, 2015 and 2014

 

Revenue

 

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

 


 

   

Three Months Ended September 30,

                 
   

2015

   

2014

   

Change

 

(dollars in thousands)

 

$

   

% of Total Revenue

   

$

   

% of Total Revenue

   

$

   

%

 

Revenue

                                               

Protomold

  $ 41,971       61.9 %   $ 35,655       65.3 %   $ 6,316       17.7 %

Firstcut

    19,833       29.2       15,549       28.5       4,284       27.6  

Fineline

    6,038       8.9       3,370       6.2       2,668       79.2  

Total revenue

  $ 67,842       100.0 %   $ 54,574       100.0 %   $ 13,268       24.3 %

 


 

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

 


 

   

Three Months Ended September 30,

                 
   

2015

   

2014

   

Change

 

(dollars in thousands)

 

$

   

% of Total Revenue

   

$

   

% of Total Revenue

   

$

   

%

 

Revenue

                                               

United States

  $ 50,214       74.0 %   $ 40,822       74.8 %   $ 9,392       23.0 %

International

    17,628       26.0       13,752       25.2       3,876       28.2  

Total revenue

  $ 67,842       100.0 %   $ 54,574       100.0 %   $ 13,268       24.3 %

 


 

Our revenue increased $13.3 million, or 24.3%, for the three months ended September 30, 2015 compared to the same period in 2014. By geographic region, this revenue growth was driven by a 23.0% increase in United States revenue and a 28.2% increase in international revenue. By product line, this revenue growth was driven by a 17.7% increase in Protomold revenue, 27.6% increase in Firstcut revenue and 79.2% increase in Fineline revenue in each case for the three months ended September 30, 2015 compared to the same period in 2014.

 

Our revenue growth during the three months ended September 30, 2015 was the result of increased volume of the product developers and engineers we served. During the three months ended September 30, 2015, we served approximately 12,500 unique product developers and engineers, an increase of 24% over the same period in 2014. Average revenue per product developer or engineer was consistent during the three months ended September 30, 2015 when compared to the same period in 2014.

 

 

 
17

 

 

 

Our revenue increases were primarily driven by increases in sales personnel and marketing activities. Our sales personnel focus on gaining new customer accounts and expanding the depth and breadth into existing customer accounts. Our marketing personnel focus on marketing activities that have proven to result in the greatest number of customer prospects to support sales activity.

 

International revenue was negatively impacted by $2.1 million for the three months ended September 30, 2015 compared to the same period in 2014 due to the strengthening of the United States dollar relative to the British Pound and Japanese Yen, as well as the strengthening of the British Pound relative to the Euro. The effect of pricing changes on revenue was immaterial for the three months ended September 30, 2015 compared to the same period in 2014.

 

Cost of Revenue, Gross Profit and Gross Margin

 

Cost of Revenue. Cost of revenue increased $6.0 million, or 28.0%, for the three months ended September 30, 2015 compared to the same period in 2014, which was faster than the rate of revenue increase of 24.3% for the three months ended September 30, 2015 compared to the same period in 2014. The increase in cost of revenue was due to raw material and production cost increases of $2.8 million to support increased sales volumes, an increase in direct labor headcount resulting in personnel and related cost increases of $3.1 million and equipment and facility-related cost increases of $0.1 million.

 

Gross Profit and Gross Margin. Gross profit increased from $33.1 million, or 60.6% of revenues, in the three months ended September 30, 2014 to $40.3 million, or 59.4% of revenue, in the three months ended September 30, 2015 primarily due to increases in revenue offset by the cost of revenue as discussed above. Gross margin decreased primarily as a result of increases in investments of additional manufacturing capacity and the impact of fluctuations in foreign currency exchange rates.

 

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

 

Marketing and Sales. Marketing and sales expenses increased $2.7 million, or 36.4%, during the three months ended September 30, 2015 compared to the same period in 2014 due primarily to an increase in headcount resulting in personnel and related cost increases of $2.3 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.

 

Research and Development. Our research and development expenses increased $0.2 million, or 4.5%, during the three months ended September 30, 2015 compared to the same period in 2014 due to an increase in headcount resulting in personnel and related cost increases of $0.7 million, partially offset by professional services cost decreases of $0.5 million.

 

General and Administrative. Our general and administrative expenses increased $2.4 million, or 41.9%, during the three months ended September 30, 2015 compared to the same period in 2014 due to an increase in headcount resulting in personnel and related cost increases of $0.8 million, stock-based compensation cost increases of $0.2 million, administrative cost increases of $0.6 million, professional services cost increases of $0.2 million and $0.6 million in costs related to our acquisition of Alphaform.

 

Other Income (Expense), net. Other expense, net decreased $0.6 million during the three months ended September 30, 2015 compared to the same period in 2014 due to changes in foreign currency rates.

 

Provision for Income Taxes. Our effective tax rate of 31.2% for the three months ended September 30, 2015 decreased 1.3% when compared to 32.5% for the same period in 2014. The decrease in the effective tax rate is primarily due to an increased benefit from domestic tax credits realized in the quarter ended September 30, 2015 when compared to the quarter ended September 30, 2014. As a result of an increase in income before income taxes, our income tax provision increased by $0.6 million to $5.6 million for the three months ended September 30, 2015 compared to our income tax provision of $5.0 million for the three months ended September 30, 2014.

 

 

 
18

 

 

 

Comparison of Nine Months Ended September 30, 2015 and 2014

 

Revenue

 

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

 


 

   

Nine Months Ended September 30,

                 
   

2015

   

2014

   

Change

 

(dollars in thousands)

 

$

   

% of Total Revenue

   

$

   

% of Total Revenue

   

$

   

%

 

Revenue

                                               

Protomold

  $ 119,521       62.8 %   $ 104,604       68.1 %   $ 14,917       14.3 %

Firstcut

    54,788       28.8       43,407       28.3       11,381       26.2  

Fineline

    16,038       8.4       5,503       3.6       10,535       *  

Total revenue

  $ 190,347       100.0 %   $ 153,514       100.0 %   $ 36,833       24.0 %

 


* Percentage change not meaningful

 

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

 


 

   

Nine Months Ended September 30,

                 
   

2015

   

2014

   

Change

 

(dollars in thousands)

 

$

   

% of Total Revenue

   

$

   

% of Total Revenue

   

$

   

%

 

Revenue

                                               

United States

  $ 144,357       75.8 %   $ 113,810       74.1 %   $ 30,547       26.8 %

International

    45,990       24.2       39,704       25.9       6,286       15.8  

Total revenue

  $ 190,347       100.0 %   $ 153,514       100.0 %   $ 36,833       24.0 %

 


 

Our revenue increased $36.8 million, or 24.0%, for the nine months ended September 30, 2015 compared to the same period in 2014. By geographic region, this revenue growth was driven by a 26.8% increase in United States revenue and a 15.8% increase in international revenue. By product line, this revenue growth was driven by a 14.3% increase in Protomold revenue and a 26.2% increase in Firstcut revenue, in each case for the nine months ended September 30, 2015 compared to the same period in 2014, as well as $10.5 million in Fineline revenue related to the FineLine acquisition completed in the second quarter of 2014.

 

Our revenue growth during the nine months ended September 30, 2015 was the result of increased volume of the product developers and engineers we served. During the nine months ended September 30, 2015, we served approximately 22,600 unique product developers and engineers, an increase of 29% over the same period in 2014. Average revenue per product developer or engineer decreased 4.0% during the nine months ended September 30, 2015 when compared to the same period in 2014.

 

In addition to 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 marketing activities that have proven to result in the greatest number of customer prospects to support sales activity.

 

International revenue was negatively impacted by $6.1 million for the nine months ended September 30, 2015 compared to the same period in 2014 due to the strengthening of the United States dollar relative to the British Pound and Japanese Yen, as well as the strengthening of the British Pound relative to the Euro. The effect of pricing changes on revenue was immaterial for the nine months ended September 30, 2015 compared to the same period in 2014.

 

Cost of Revenue, Gross Profit and Gross Margin

 

Cost of Revenue. Cost of revenue increased $18.5 million, or 31.5%, for the nine months ended September 30, 2015 compared to the same period in 2014, which was faster than the rate of revenue increase of 24.0% for the nine months ended September 30, 2015 compared to the same period in 2014. The increase in cost of revenue was due to raw material and production cost increases of $7.2 million to support increased sales volumes, an increase in direct labor headcount resulting in personnel and related cost increases of $9.4 million and equipment and facility-related cost increases of $1.9 million.

 

 

 
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Gross Profit and Gross Margin. Gross profit increased from $94.8 million, or 61.7% of revenues, in the nine months ended September 30, 2014 to $113.1 million, or 59.4% of revenue, in the nine months ended September 30, 2015 primarily due to increases in revenue offset by the cost of revenue as discussed above. Gross margin decreased primarily as a result of an increase in expense attributable to recent manufacturing capacity expansion, and the impact of fluctuations in foreign currency exchange rates.

 

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

 

Marketing and Sales. Marketing and sales expenses increased $7.3 million, or 35.0%, during the nine months ended September 30, 2015 compared to the same period in 2014 due primarily to an increase in headcount resulting in personnel and related cost increases of $6.0 million and marketing program cost increases of $1.3 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.

 

Research and Development. Our research and development expenses increased $1.5 million, or 13.0%, during the nine months ended September 30, 2015 compared to the same period in 2014 due to an increase in headcount resulting in personnel and related cost increases of $2.7 million and operating cost increases of $0.3 million, which were partially offset by professional services cost decreases of $1.5 million.

 

General and Administrative. Our general and administrative expenses increased $4.7 million, or 29.5%, during the nine months ended September 30, 2015 compared to the same period in 2014 due to an increase in headcount resulting in personnel and related cost increases of $2.8 million, stock-based compensation costs increases of $0.6 million, intangible amortization expense increases of $0.2 million, administrative cost increases of $0.7 million and $0.6 million in costs related to our acquisition of Alphaform, which were partially offset by a decrease in professional services costs of $0.2 million. Amortization expenses relate to intangible assets acquired in the purchase of FineLine in April 2014.

 

Other Income (Expense), net. Other expense, net decreased $0.1 million during the nine months ended September 30, 2015 compared to the same period in 2014 due to changes in interest income on investments.

 

Provision for Income Taxes. Our effective tax rate of 31.9% for the nine months ended September 30, 2015 increased 0.5% when compared to 31.4% for the same period in 2014. The increase in the effective tax rate is primarily due to changes in the mix of projected income earned in domestic and foreign tax jurisdictions for the tax year ending December 31, 2015. As a result of the increase in our effective tax rate combined with increased income attributable to the fluctuations described above, our income tax provision increased by $1.8 million to $16.2 million for the nine months ended September 30, 2015 compared to our income tax provision of $14.4 million for the nine months ended September 30, 2014.

 

Liquidity and Capital Resources

 

Cash Flows

 

The following table summarizes our cash flows during the nine months ended September 30, 2015 and 2014:

 


 

   

Nine Months Ended September 30,

 

(dollars in thousands)

 

2015

   

2014

 

Net cash provided by operating activities

  $ 41,284     $ 40,004  

Net cash used in investing activities

    (29,034 )     (55,234 )

Net cash provided by financing activities

    8,870       6,540  

Effect of exchange rates on cash and cash equivalents

    (318 )     (81 )

Net increase (decrease) in cash and cash equivalents

  $ 20,802     $ (8,771 )

 


 

Sources of Liquidity

 

Historically we have financed our operations and capital expenditures primarily through cash flow from operations and, to a lesser extent, lease financing. We had cash and cash equivalents of $64.1 million as of September 30, 2015, an increase of $20.8 million from December 31, 2014. The increase in our cash was primarily due to cash generated through operations and, to a lesser extent, proceeds from exercises of stock options and purchases through our employee stock purchase plan, which were partially offset by investing activity.

 

 

 
20

 

 

 

Cash Flows from Operating Activities

 

Cash flows from operating activities of $41.3 million during the nine months ended September 30, 2015 primarily consisted of net income of $34.5 million, adjusted for certain non-cash items, including depreciation and amortization of $10.4 million, stock-based compensation expense of $4.5 million and amortization of held-to-maturity securities of $0.9 million, which were partially offset by deferred taxes of $0.3 million and excess tax benefit from stock-based compensation expense of $5.2 million. Cash flows from operating activities increased $1.3 million during the nine months ended September 30, 2015 compared to the same period in 2014 due to increases in net income of $3.1 million, depreciation and amortization of $2.7 million and stock-based compensation expense of $1.0 million, which were partially offset by a decrease in amortization of held-to-maturity securities of $0.3 million, an increase in excess tax benefits of $0.8 million, changes in operating assets and liabilities of $3.6 million and deferred taxes of $0.8 million.

 

Cash flows from operating activities of $40.0 million during the nine months ended September 30, 2014 consisted of net income of $31.4 million, adjusted for certain non-cash items, including depreciation and amortization of $7.7 million, stock-based compensation expense of $3.6 million, amortization of held-to-maturity securities of $1.2 million and deferred taxes of $0.5 million, which were partially offset by $4.4 million of excess tax benefit on stock-based compensation.

 

Cash Flows from Investing Activities

 

Cash used in investing activities was $29.0 million during the nine months ended September 30, 2015, consisting of $27.2 million for the purchases of property and equipment and $42.7 million for the purchases of marketable securities, which were partially offset by $40.9 million in proceeds from maturities and call redemptions of marketable securities.

 

Cash used in investing activities was $55.2 million during the nine months ended September 30, 2014, consisting of $35.9 million for the purchases of property and equipment, $33.9 million for the payments on business acquisitions and $47.3 million for the purchases of marketable securities, which were partially offset by $61.9 million in proceeds from maturities, sales and call redemptions of marketable securities.

 

Cash Flows from Financing Activities

 

Cash provided by financing activities was $8.9 million during the nine months ended September 30, 2015, consisting of proceeds from exercises of stock options of $5.2 million and $5.2 million in excess tax benefit on stock-based compensation, which were partially offset by $1.4 million for payments of acquisition-related contingent consideration and $0.1 million for payments of debt.

 

Cash provided by financing activities was $6.5 million for the nine months ended September 30, 2014, consisting of proceeds from exercises of stock options of $3.9 million and $4.4 million in excess tax benefit on stock-based compensation, which were partially offset by $1.0 million for payments of debt and $0.8 million for payments of acquisition-related contingent consideration.

 

Off-Balance Sheet Arrangements

 

Since our inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.

 

Critical Accounting Policies and Use of Estimates

 

We have adopted various accounting policies to prepare the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). Our significant accounting policies are disclosed in Note 2 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2014. There were no material changes in our significant accounting policies during the nine months ended September 30, 2015.

 

Recent Accounting Pronouncements

 

For information on recent accounting pronouncements, see Note 2 to the consolidated financial statements appearing in Part I, Item 1 in this Quarterly Report on Form 10-Q.

 

 

 
21

 

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Foreign Currency Risk

 

As a result of our foreign operations, we have revenue, expenses, assets and liabilities that are denominated in foreign currencies. We generate revenue in British Pounds, Euro and Japanese Yen. Our production costs are incurred in British Pounds and Japanese Yen. A number of our employees are located throughout Europe and in Japan. Therefore, a portion of our payrolls and operating expenses are incurred and paid in British Pounds, Euro and Japanese Yen.

 

Our operating results and cash flows are adversely impacted when the United States dollar appreciates relative to other foreign currencies. Additionally, our operating results and cash flows are adversely impacted when the British Pound appreciates relative to the Euro. As we expand internationally, our results of operations and cash flows will become increasingly subject to changes in foreign currency exchange rates.

 

We have not used forward contracts or currency borrowings to hedge our exposure to foreign currency risk. Foreign currency risk can be quantified by estimating the change in results of operations or financial position resulting from a hypothetical 10% adverse change in foreign exchange rates. We believe such a change would generally not have a material impact on our financial position, but could have a material impact on our results of operations. We recognized foreign currency income of $0.4 million and foreign currency loss of $0.4 million in the three and nine months ended September 30, 2015, respectively. We recognized foreign currency losses of $0.2 million and $0.4 million in the three and nine months ended September 30, 2014, respectively.