Hi all,
My 10K project continues. I recently did a fair bit of digging into PRLB. Sharing the notes here with the community.
Anirban
Company, industry, sector.
Company: Proto Labs, Inc.
Ticker: PRLB
Exchange: NYSE
Stock price: $68.08 (close of 10/20/2014)
Business overview.
Proto Labs is a leading manufacturer of custom parts for prototyping and short run productions. Prototyping and short production runs (which are production runs a product for an initial trial or initial supply while the manufacturing processes & supply chains are being setup) are inherently low volume manufacturing. Low volume manufacturing is not new. Its being going on for ages, but there are many inefficiencies in the traditional low-volume manufacturing industry because of the inefficiencies inherent in the quotation, equipment setup and non-recurring engineering processes required to produce custom parts. Proto Labs’ solution provides product developers with an exceptional combination of speed, competitive pricing, ease of use and reliability that they typically cannot find among conventional custom parts manufacturers.
Proto Labs offers the following services:
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Firstcut service uses commercially-available CNC machines to cut plastic or metal blocks into one or more custom parts based on the 3D CAD model uploaded by the product developer. The Firstcut service is targeting small quantities, typically in the range of one to ten parts.
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Protomold service uses their 3D CAD-to-CNC machining technology for the automated design and manufacture of aluminum injection molds, which are then used to produce custom injection-molded parts on commercially-available equipment. The Protomold service is used for both prototype and short-run production. Prototype quantities typically range from 25 to 100 parts. Proto Labs retains the molds, and customers who need short-run production often come back to Protomold for additional quantities typically ranging up to 10,000 parts.
Company strengths, advantages, and strategy.
Custom prototyping is a necessary step for product developers to confirm their product’s performance and also for them to explore other alternative designs. Early in the product development process, so called “additive rapid prototyping” (e.g., processes such as stereolithography, selective laser sintering, fused deposition modeling or 3D printing) can be used. Often, this step does not yield a product that meets the developers’ requirements for dimensional accuracy, cosmetics, and material properties. The alternative or complementary solution is CNC machining for low volume production of high-quality custom parts in either metal or plastic; for follow-on testing, evaluations, and production runs, parts are typically manufactured using injection molding. Both CNC machining and injecting molding result in parts that have the look, feel and performance of the finished product.
What is Proto Labs’ secret sauce?
Proto Labs is in the market producing prototype and short production run parts using CNC machining and injection moulding. Proto Labs targets product developers who use three-dimensional computer-aided design (3D CAD) software to design products across a diverse range of end-markets. Customers submit their 3D CAD design via a Web interface. The submitted design is quickly analysed for its manufacturability using complex proprietary algorithms. Their software may provide design modification suggestions that enhance manufacturability and quality of the final part. Also included is an automated pricing algorithm, which allows the product developer to change a variety of parameters and instantly receive an updated price. Once the order is entered online, their manufacturing software calculates the required instructions for a CNC machine to make the part or related mold.
Overall, the process is highly scalable and capable of processing a large number of design submissions. Proto Labs processed 390,000 design submissions in 2013. Customers who have used their services in the past tend to return, with more than 80% of the revenue generated by customers who have used their services in the past.
Strengths & competitive advantages:
- Sophisticated front end technology that reduces turnaround time for product developers
- automating design submissions
- automating manufacturability analysis & feedback
- online pricing and design changes, material section, finish, shipping schedule etc
- Proto Labs can ship parts in as little as one day
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Highly automated and interactive online design submissions and processing provides an enhanced user experience.
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Scalability of the front end with respect to their ability to process a large number of designs enables them to process a large number of designs at low costs. Conventional prototyping would require significant skilled human resources to manage to design submission and processing steps. Note that here the iterative process of fine-tuning the design is also automated through their fronted processes.
The following paragraph in the 10-K nicely summaries the front-end technology and its importance:
Our proprietary technology automates much of the skilled labor conventionally required to quote and manufacture low-volume custom parts, including the often time-consuming steps of design submission, manufacturability analysis and feedback, quotation, order submission, mold design, tool path generation, mold or part manufacture, and production management. This technology has been developed and continually expanded and refined over our 14 years of providing custom mold and part manufacturing services to our customers. We believe our proprietary technology gives us significant advantages over our competitors, who typically lack the expertise and resources to develop similar technology.
Their stated growth strategy includes the following:
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Get more design submissions from existing customer companies. For example, leverage highly satisfied product developers in one group to influence sales to other product developers in the same company (“word of mouth” strategy).
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Access new companies via sales & marketing.
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Focus R&D on expanding the range of parts they can support. The following para from the 10-K nicely summarised this objective:
We regularly analyze the universe of customer design submissions that we are currently unable to manufacture and focus a significant portion of our research and development efforts on expanding the range of parts that we can produce. Since we first introduced our Protomold injection molding service in 1999, we have steadily expanded the size and geometric complexity of the injection-molded parts we are able to manufacture, and we continue to extend the diversity of materials we are able to support. Similarly, since first introducing our Firstcut CNC machining service in 2007, we have expanded the range of part sizes, design geometries and materials we can support. For example, during 2012 we expanded the number of materials we offer to include a variety of high temperature resins available through our Protomold injection molding service and steel, stainless steel, magnesium and copper in our Firstcut machining service. As we continue to expand the range of our existing process capabilities, we believe we will meet the needs of a broader set of product developers and consequently convert a higher number of quotation requests into orders. -
Expand to new geographies. Currently, Proto Labs is focussed on the US, Europe, and Japan.
Competition.
The low-volume manufacturing market is highly fragmented and as such there are no direct competitors to Proto Labs’ offerings. Large companies may have in-house prototyping facilities. Then, there are the CNC machining and injection moulding shops worldwide. The most serious competitive threat is from rapid additive prototyping technologies such as 3D printing. However, it should be noted that there’s no reason to believe that Proto Labs will not be able to apply its time tested automation technologies to produce parts using 3D printing technologies.
Risks.
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Third-party CAD software companies may develop software that mold-makers, injection molders and CNC machine shops could use to compete with our business model.
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Additive manufacturers may develop stronger, higher temperature resins or introduce other improvements that could more effectively compete with us on part quality.
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Global economic slowdown would hurt their business.
Additional details.
Q2 2014 Transcripts: http://seekingalpha.com/article/2338995-proto-labs-prlb-ceo-…
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Q2 14 revenues was $52.9 M, a 33% increase over Q2 13
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Included $2.1M revenue recognition from Fineline 3D printing acquisition (excluding the acquisition, there would be 28% QoQ growth)
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Proto Labs’ revenue came from nearly 8,200 unique product developers, a 19% increase over the second quarter of 2013. By geography, revenue growth in the U.S. was 34% compared to the second quarter of 2013. Revenue growth rates in Europe and Japan were less than in the United States.
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A record quarterly revenue allowed the global consolidated Proto Labs organization to achieve record net income for the second quarter of 2014 of $11.0 million or $0.42 per diluted share. This compares to $8.6 million or $0.33 per diluted share in the same quarter of 2013. Excluding the after-tax cost of stock compensation and amortization of intangibles, the non-GAAP EPS was $0.45 per diluted share during the second quarter of 2014.
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Revenue splits between Protomold, Firstcut and FineLine services were 69%, 27% and 4%. International revenue during the second quarter of 2014 totaled $12.9 million or 24% of total revenue compared to $9.6 million or 24% during the second quarter of 2013.
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At the end of June 2014, cash and investments totaled $105.4 million.
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I would now like to provide some guidance into our projected results for the third quarter of 2014 including Fineline’s results we currently expect revenue in the third quarter of 2014 to be in the range of $54 million to $57 million. Of this amount are additive services or 3D printing revenues are forecasted to be approximately $3 million. Stock compensation costs in the second quarter will be approximately $1.4 million.
Non-GAAP EPS b/w 0.44 and 0.48.
Growth initiative (1):
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FirstCut machining service is adding the capability to manufacture turned part produced on a lathe in as little as one day. This will significantly increase the machined part geometries that Proto Labs can rapidly manufacture for customers. Turned parts will be fully commercially available in metal such as aluminum and steel in early 2015.
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Proto Labs estimates the global market for turned parts to be approximately the same size as the market for milled parts. They believe there is a large market demand for turned parts with fast lead-times and customers have expressed a willingness to pay a premium for speed.
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Turned parts are used in a broad range of industries, including many industries that have historically been strong for Proto Labs such as medical devices, aerospace, automotive, and industrial products. Proto Labs expects to soft launch this expansion of Firstcut services in the middle of August and will continue development over the next several months and selectively take orders.
The service is expected to be fully operational in early 2015.
- Growth initiative (2):
- In order to support the expected increase in FineLine sales, they have purchased approximately $2.5 million in new capital equipment for the FineLine operation. The new equipment is divided between stereolithography and selective laser centering product lines.
- Additive manufacturing services to be rolled out in Europe as well.
I found the following discussion regarding market opportunity relevant and interesting:
when you refer to a $35 billion total market for machine parts, that’s total machine parts. We really focus on that segment of the market that – is desired speed and smaller volume. So, as you know, we did a study a year ago to take a look at what our total available market is. And with the services that we had back in 2013, we estimated that total available market to be $6 billion with some of the added service we’ve got, we now look at that to be the $7 billion range.
The turned parts really opens the door for us to service a wider number of geometries, particularly the cylindrical type parts that a turned part via a lathe can produce much better quality, speed and at a lower cost, frankly, than with CNC machining. So it opens the door for us there. We think the market for the turned parts within speed and the size and capability, its going to be approximately the same size as the mill part. So this is a big growth opportunity for us in Firstcut.
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Fineline and legacy Proto Labs had about 2% customer overlap. Opportunity to cross sell.
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Operating margins expected to track around 29% mark down from 30-31% as they intend to spend a bit more on sales & marketing.
Concluding remarks.
The data feed I am using is showing me a TTM EPS of 1.51, which gives us a PE of 45. In the last two years, the PE has been as high as 66 and as low as 25. A PE of 45 is certainly on the expensive side. Now, let’s look at revenue and earnings growth:
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YR 2011 2012 2013
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Rev (M) 99 126 163
EPS ($) 0.47 0.98 1.36
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The numbers above translate into 28% growth rate for sales and 70% growth rate for earnings. That’s pretty solid. Suppose that we assume earnings can grow at about a 20% rate over the next 5 years. I think this might be achievable given PRLB is pretty much unchallenged in its niche operating space and its got itself well tuned to scale the business. I am also basing this partly on the fact that earnings growth seems to be hovering around the 20 to 30% mark in the recent quarters.
I also did look at analysts predictions (Morningstar, Zacks, Reuters) and it appears the longest analysts are looking out is to 12/2015 and expect growth rate to be around 25%. The long-term 5-year earnings growth forecast is 29% based on 2 estimates.
With a 20% earnings growth, we get 2019 Q2 EPS of 3.76. Assuming PRLB can command a PE of 35 (still a growth story), I get a future stock price of $132 (PE of 35 x EPS of 3.76), so roughly a double from here on. I know this is a lot of assumptions, but it seems to me to be reasonable to get a sense of where PRLB can be in 5 years time. Higher growth rates will let it potentially command a higher PE, which will push the price upwards.
I like the opportunity in front of PRLB. I like how they have used technology to create a scalable business model where scale generally didn’t exist. They operate in a highly fragmented industry and with their focus on using technology to make the process of building prototypes easy and seamless I believe they have the opportunity to service a large portion of this fragmented market place. Overall, the price looked attractive and if the company can grow earnings even at a 20% rate over the long-term, I think this investment will easily double in the next 5-years.