Proto Labs Inc (PRLB) FY 2021 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. 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 the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward- looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K.
Overview
We are one of the world’s largest and fastest digital manufacturers of custom prototypes and on-demand production parts. We manufacture prototypes and low-volume production parts for companies worldwide that are under increasing pressure to bring their finished products to market faster than their competition. We utilize injection molding, computer numerical control (CNC) machining, 3D printing and sheet metal fabrication to manufacture custom parts for our customers. Our proprietary technology eliminates most of the time-consuming and expensive skilled labor conventionally required to quote and manufacture parts. In January 2021, we acquired Hubs, a leading online manufacturing platform based in Amsterdam, Netherlands, that provides customers with on-demand access to a global network of premium manufacturing partners. This acquisition creates an extremely comprehensive digital manufacturing offer, offering the broadest set of manufacturing services with the help of a global network of premium manufacturing partners. Our customers conduct nearly all of their business with us over the Internet. We target our products at 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.
We have experienced significant growth since our inception. Since we first introduced our Injection Molding product line in 1999, we have steadily expanded the size and geometric complexity of the injection-molded parts we are able to manufacture, and we continue to extend the diversity of materials we are able to support. Similarly, since first introducing our CNC Machining product line in 2007, we have expanded the range of part sizes, design geometries and materials we can support. In 2014, we acquired FineLine Prototyping, Inc. (FineLine) to expand the number of process types we offer to include stereolithography (SL), selective laser sintering (SLS) and direct metal laser sintering (DMLS). In 2017, we acquired RAPID to expand the number of process types we offer to include sheet metal fabrication and expand our CNC machining capability. In 2019, we added Carbon DLS to our 3D printing processes, introduced precision color matching on Injection Molding parts and launched production capabilities for metal 3D printing. In 2021, we acquired Hubs to provide customers with on-demand access to a global network of premium manufacturing partners. We also continually seek to enhance other aspects of our technology and manufacturing processes, including our interactive web-based and automated user interface and quoting system. We intend to continue to invest significantly to enhance our technology and manufacturing processes and expand the range of our existing capabilities with the aim of meeting the needs of a broader set of customers. As a result of the factors described above, many of our customers tend to return to Proto Labs to meet their ongoing needs, with approximately 93%, 93% and 92% of our revenue in 2021, 2020 and 2019, respectively, derived from existing customers.
We have established our operations in the United States, Europe and Japan, which we believe are three of the largest geographic markets where product developers and engineers are located. We entered the European market in 2005 and launched operations in Japan in late 2009. We further expanded our operations in the United States through our acquisitions of Fineline in 2014, RAPID in 2017 and Hubs in 2021. Our operations were further expanded in Europe through our acquisitions of Alphaform in 2015 and Hubs in 2021. Our revenue outside of the United States accounted for approximately 21%, 20% and 22% of our consolidated revenue in the years ended December 31, 2021, 2020 and 2019, respectively. We intend to continue to expand our international sales efforts and believe opportunities exist to serve the needs of product developers and engineers in select new geographic regions.
We have grown our total revenue from $344.5 million in 2017 to $488.1 million in 2021. During this period, our operating expenses increased from $121.6 million in 2017 to $182.3 million in 2021. Our recent growth in revenue has been accompanied by increased cost of revenues and operating expenses. We expect to increase investment in our operations to support anticipated future growth as discussed more fully below.
In addition, we believe that a number of trends affecting our industry have affected our results of operations and may continue to do so. For example, we believe that many of our target product developer and engineer customers are facing three mega trends, which are disrupting long-term product growth models. We believe our customers are facing increased pressure to shorten product life-cycles, to embed products with connectivity driven by the internet of things technology, and to deliver products that are personalized and customized to unique customer specifications. We believe we continue to be well positioned to benefit from these trends, given our proprietary technology that enables us to automate and integrate the majority of activities involved in procuring custom parts. The COVID-19 pandemic has also impacted the manufacturing environment. For example, the pandemic accelerated the digitization of manufacturing as companies pivoted to a work-from-home and socially-distanced manufacturing plant environment. As a result, the adoption of e-commerce was accelerated, which allows opportunity for us to provide valuable solutions to manufacturers looking to build resiliency in their supply chains through fast, on-demand manufacturers. While our business may be positively affected by these trends, our results may also be favorably or unfavorably impacted by other trends that affect product developer and engineer orders for custom parts in low volumes, including, among others, economic conditions, changes in product developer and engineer preferences or needs, developments in our industry and among our competitors, and developments in our customers' industries. For a more complete discussion of the risks facing our business, see Part I, Item 1A. “Risk Factors” of this Annual Report on Form 10-K.
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Key Financial Measures and Trends
Revenue
Our operations are comprised of three geographic operating segments in the United States, Europe and Japan. Revenue is derived from our Injection Molding, CNC Machining, 3D Printing and Sheet Metal product lines. Injection Molding revenue consists of sales of custom injection molds and injection-molded parts. CNC Machining revenue consists of sales of CNC-machined custom parts. 3D Printing revenue consists of sales of custom 3D-printed parts. Sheet Metal revenue consists of sales of fabricated sheet metal custom parts and assemblies. Our revenue is generated from a diverse customer base, with no single customer company representing more than 3% of our total revenue in 2021. Our historical and current efforts to increase revenue have been directed at gaining new customers and selling to our existing customer base by increasing marketing and selling activities, including:
| • | expanding the breadth and scope of our products by adding more sizes and materials to our offerings; | |
|---|---|---|
| • | the introduction of our 3D Printing product line through our acquisition of FineLine in 2014; | |
| • | expanding 3D printing to Europe through our acquisition of Alphaform in October 2015; | |
| • | the introduction of our Sheet Metal product line through our acquisition of RAPID in 2017; | |
| • | continuously improving the usability of our product lines such as our web-centric applications; and | |
| • | providing customers with on-demand access to a global network of premium manufacturing partners through our acquisition of Hubs in January 2021. |
During 2021, we served 55,330 unique product developers and engineers who purchased our products through our web-based customer interface, an increase of 26.3% over the same period in 2020. The increase in product developers served was driven primarily by our acquisition of Hubs. Excluding the impact of Hubs, our product developers served increased 5.2% over the same period in 2020.
During 2020, we served 43,808 unique product developers and engineers who purchased our products through our web-based customer interface, a decrease of 15.7% over the same period in 2019. The unique product developers and engineers served for the year ended December 31, 2020 has been restated to include unique product developers and engineers who purchased injection molding parts only. Historically we included only those developers who purchased injection molds in our metric. In 2020, the economic uncertainty arising from the COVID-19 pandemic impacted the number of product developers and engineers who purchased our products.
Cost of Revenue, Gross Profit and Gross Margin
Cost of revenue consists primarily of raw materials, equipment depreciation, employee compensation including benefits and stock-based compensation, facilities costs and overhead allocations associated with the manufacturing process for molds and custom parts. We expect our personnel-related costs to increase in order to retain and attract top talent and remain competitive in the market. Overall, we expect cost of revenue to increase in absolute dollars.
Our business model requires that we invest in our capacity well in advance of demand to ensure we can fulfill the expectations for quick delivery of our products to our customers. Therefore, over the last several years, we have made significant investments in additional factory space, equipment and infrastructure across our geographic segments. We expect to continue to grow in future periods, which will result in the need for additional investments in factory space and equipment. We expect that these additional costs for factory and equipment expansion can be absorbed by revenue growth, and allow gross margins by product line to remain relatively consistent over time. Our addition of Hubs in 2021 provides a complementary opportunity to add revenue growth through the use of premium manufacturing partners, without the significant investments required by our legacy business model.
We define gross profit as our revenue less our cost of revenue, and we define gross margin as gross profit expressed as a percentage of revenue. Our gross profit and gross margin are affected by many factors, including our mix of revenue by product line, pricing, sales volume, manufacturing costs, the costs associated with increasing production capacity, the mix between domestic and foreign revenue sources, the mix between revenue produced in our internal manufacturing operations and outsourced to our external manufacturing partners, and foreign exchange rates.
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Operating Expenses
Operating expenses consist of marketing and sales, research and development and general and administrative expenses. Personnel-related costs are the most significant component in each of these categories.
Our recent growth in operating expenses is mainly due to the launch of our PL 2.0 project, an internal business systems initiative impacting both external customer-facing and internal back-end systems, in the fourth quarter of 2020. During the development of PL 2.0, certain research and development personnel costs were capitalizable as a software development asset. Since the system was placed in service in November 2020, the personnel costs have been expensed as incurred. In addition, amortization expense for the software asset is now being recorded over the systems’ estimated useful lives of seven to ten years. Our business strategy is to continue to be a leading online and technology-enabled manufacturer of quick-turn, on-demand injection-molded, CNC-machined, 3D-printed and sheet metal custom parts for prototyping and low-volume production. In order to achieve our goals, we anticipate continued substantial investments in technology and personnel, resulting in increased operating expenses.
Marketing and sales. Marketing and sales expense consists primarily of employee compensation, benefits, commissions, stock-based compensation, marketing programs such as electronic, print and pay-per-click advertising, trade shows and other related overhead, which includes an allocation of information technology expense including amortization of PL 2.0 software assets. We expect sales and marketing expense to increase in the future as we increase the number of marketing and sales professionals and marketing programs targeted to increase our customer base and grow revenue.
Research and development. Research and development expense consists primarily of personnel and outside service costs related to the development of new processes and product lines, enhancement of existing product lines, software developed for internal use, maintenance of internally developed software, quality assurance and testing. Costs for internal use software are evaluated by project and capitalized where appropriate under Accounting Standards Codification (ASC) 350-40, Intangibles — Goodwill and Other, Internal-Use Software. We expect research and development expense to increase in the future as we seek to enhance our e-commerce interface technology, internal software and supporting business systems, and continue to expand our product lines.
General and administrative. General and administrative expense consists primarily of employee compensation, benefits, stock-based compensation, professional service fees related to accounting, tax and legal and other related overhead, which includes an allocation of information technology expense including amortization of PL 2.0 software assets. We expect general and administrative expense to increase in the future as we continue to grow and expand as a global organization.
Other Income, Net
Other income, net primarily consists of foreign currency-related gains and losses and interest income on cash balances and investments. Our foreign currency-related gains and losses will vary depending upon movements in underlying exchange rates. Our interest income will vary each reporting period depending on our average cash balances during the period, composition of our marketable security portfolio and the current level of interest rates.
Provision for Income Taxes
Provision for income taxes is comprised of federal, state, local and foreign taxes based on pre-tax income. Overall, our effective tax rate for 2021 and beyond may differ from historical effective tax rates due to increases in losses in foreign operations that are not eligible for tax benefits on account of valuation allowances, as well as any future tax law changes that may impact the effective tax rate.
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Results of Operations
The following table summarizes our results of operations and the related changes for the periods indicated. The results below are not necessarily indicative of the results for future periods.
| Year Ended | Year Ended | |||||||||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| December 31, | Change | December 31, | Change | |||||||||||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2021 | 2020 | $ | % | 2020 | 2019 | $ | % | ||||||||||||||||||||||||||||||||||||||||
| Revenue | $ | 488,098 | 100.0 | % | $ | 434,395 | 100.0 | % | $ | 53,703 | 12.4 | $ | 434,395 | 100.0 | % | $ | 458,728 | 100.0 | % | $ | (24,333 | ) | (5.3 | ) | ||||||||||||||||||||||||
| Cost of revenue | 265,407 | 54.4 | 216,568 | 49.9 | 48,839 | 22.6 | 216,568 | 49.9 | 223,438 | 48.7 | (6,870 | ) | (3.1 | ) | ||||||||||||||||||||||||||||||||||
| Gross profit | 222,691 | 45.6 | 217,827 | 50.1 | 4,864 | 2.2 | 217,827 | 50.1 | 235,290 | 51.3 | (17,463 | ) | (7.4 | ) | ||||||||||||||||||||||||||||||||||
| Operating expenses: | ||||||||||||||||||||||||||||||||||||||||||||||||
| Marketing and sales | 82,175 | 16.8 | 69,309 | 16.0 | 12,866 | 18.6 | 69,309 | 16.0 | 72,976 | 15.9 | (3,667 | ) | (5.0 | ) | ||||||||||||||||||||||||||||||||||
| Research and development | 44,241 | 9.1 | 36,940 | 8.5 | 7,301 | 19.8 | 36,940 | 8.5 | 32,692 | 7.1 | 4,248 | 13.0 | ||||||||||||||||||||||||||||||||||||
| General and administrative | 68,436 | 14.0 | 51,742 | 11.9 | 16,694 | 32.3 | 51,742 | 11.9 | 49,766 | 10.9 | 1,976 | 4.0 | ||||||||||||||||||||||||||||||||||||
| Changes in fair value of contingent consideration | (12,503 | ) | (2.6 | ) | - | - | (12,503 | ) | * | - | - | - | - | - | - | |||||||||||||||||||||||||||||||||
| Total operating expenses | 182,349 | 37.3 | 157,991 | 36.4 | 24,358 | 15.4 | 157,991 | 36.4 | 155,434 | 33.9 | 2,557 | 1.6 | ||||||||||||||||||||||||||||||||||||
| Income from operations | 40,342 | 8.3 | 59,836 | 13.8 | (19,494 | ) | (32.6 | ) | 59,836 | 13.8 | 79,856 | 17.4 | (20,020 | ) | (25.1 | ) | ||||||||||||||||||||||||||||||||
| Other income, net | (158 | ) | - | 3,109 | 0.7 | (3,267 | ) | (105.1 | ) | 3,109 | 0.7 | 1,337 | 0.3 | 1,772 | 132.5 | |||||||||||||||||||||||||||||||||
| Income before income taxes | 40,184 | 8.2 | 62,945 | 14.5 | (22,761 | ) | (36.2 | ) | 62,945 | 14.5 | 81,193 | 17.7 | (18,248 | ) | (22.5 | ) | ||||||||||||||||||||||||||||||||
| Provision for income taxes | 6,812 | 1.4 | 12,078 | 2.8 | (5,266 | ) | (43.6 | ) | 12,078 | 2.8 | 17,538 | 3.8 | (5,460 | ) | (31.1 | ) | ||||||||||||||||||||||||||||||||
| Net income | $ | 33,372 | 6.8 | % | $ | 50,867 | 11.7 | % | $ | (17,495 | ) | (34.4 | %) | $ | 50,867 | 11.7 | % | $ | 63,655 | 13.9 | % | $ | (12,788 | ) | (20.1 | %) |
*Percentage change not meaningful
Stock-based compensation expense included in the statements of comprehensive income data above is as follows:
| Year Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | 2021 | 2020 | 2019 | ||||||||
| Stock options and grants | $ | 17,553 | $ | 13,327 | $ | 9,591 | |||||
| Employee stock purchase plan | 1,542 | 1,346 | 1,190 | ||||||||
| Total stock-based compensation expense | $ | 19,095 | $ | 14,673 | $ | 10,781 | |||||
| Cost of revenue | $ | 2,595 | $ | 2,451 | $ | 2,056 | |||||
| Operating expenses: | |||||||||||
| Marketing and sales | 3,736 | 3,121 | 2,632 | ||||||||
| Research and development | 2,833 | 2,440 | 1,851 | ||||||||
| General and administrative | 9,931 | 6,661 | 4,242 | ||||||||
| Total stock-based compensation expense | $ | 19,095 | $ | 14,673 | $ | 10,781 |
Comparison of Years Ended December 31, 2021 and 2020
Revenue
Revenue by reportable segment and the related changes for 2021 and 2020 is summarized as follows:
| Year Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||||||||||||||||
| (dollars in thousands) | $ | % of Total Revenue | $ | % of Total Revenue | $ | % | ||||||||||||||||||
| Revenue | ||||||||||||||||||||||||
| United States | $ | 384,458 | 78.8 | % | $ | 345,708 | 79.6 | % | $ | 38,750 | 11.2 | % | ||||||||||||
| Europe | 90,399 | 18.5 | 74,796 | 17.2 | 15,603 | 20.9 | ||||||||||||||||||
| Japan | 13,241 | 2.7 | 13,891 | 3.2 | (650 | ) | (4.7 | ) | ||||||||||||||||
| Total revenue | $ | 488,098 | 100.0 | % | $ | 434,395 | 100.0 | % | $ | 53,703 | 12.4 | % |
Our revenue increased $53.7 million, or 12.4%, for 2021 compared with 2020. Our revenue for 2021 includes revenue of $33.3 million provided by our acquisition of Hubs. By reportable segment, revenue in the United States increased $38.8 million, or 11.2%, for 2021 compared with 2020. Revenue in Europe increased $15.6 million, or 20.9%, for 2021 compared with 2020. Revenue in Japan decreased $0.7 million, or 4.7%, for 2021 compared with 2020. Excluding Hubs, revenue in the United States increased $21.1 million, or 6.1%, and revenue in Europe decreased $0.1 million, or 0.2%, for 2021 compared to the same period in 2020. International revenue was positively impacted by $3.3 million during 2021 compared to the same period in 2020 as a result of foreign currency movements, primarily the strengthening of the British Pound and Euro relative to the United States Dollar.
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During 2021, we served 55,330 unique product developers and engineers, an increase of 26.3% over 2020. The increase in product developers served was driven primarily by our acquisition of Hubs. Excluding the impact of Hubs, our product developers served increased 5.2% over the same period in 2020. Our growth in product developers and engineers served increased at a greater rate than our revenue growth, resulting in a decrease in the average spend per product developer and engineer. The decrease in average spend per product developer and engineer was driven by a change in the mix of products with a lower average order size purchased during the year by product developers and engineers we serve.
Revenue by product line and the related changes for 2021 and 2020 is summarized as follows:
| Year Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | Change | ||||||||||||||||||||||
| (dollars in thousands) | $ | % of Total Revenue | $ | % of Total Revenue | $ | % | ||||||||||||||||||
| Revenue | ||||||||||||||||||||||||
| Injection Molding | $ | 226,117 | 46.3 | % | $ | 217,992 | 50.2 | % | $ | 8,125 | 3.7 | % | ||||||||||||
| CNC Machining | 166,811 | 34.2 | 131,587 | 30.3 | 35,224 | 26.8 | ||||||||||||||||||
| 3D Printing | 72,721 | 14.9 | 62,502 | 14.4 | 10,219 | 16.3 | ||||||||||||||||||
| Sheet Metal | 20,397 | 4.2 | 18,838 | 4.3 | 1,559 | 8.3 | ||||||||||||||||||
| Other Revenue | 2,052 | 0.4 | 3,476 | 0.8 | (1,424 | ) | (41.0 | ) | ||||||||||||||||
| Total revenue | $ | 488,098 | 100.0 | % | $ | 434,395 | 100.0 | % | $ | 53,703 | 12.4 | % |
By product line, our revenue increase was driven by a 26.8% increase in CNC Machining revenue, a 16.3% increase in 3D Printing revenue, a 3.7% increase in Injection Molding revenue, and an 8.3% increase in Sheet Metal revenue, which was partially offset by a 41.0% decrease in Other Revenue, in each case for 2021 compared with 2020.
Cost of Revenue, Gross Profit and Gross Margin
Cost of Revenue. Cost of revenue increased $48.8 million, or 22.6%, for 2021 compared to 2020, which was greater than the rate of revenue increase of 12.4% for 2021 compared to 2020. The increase in cost of revenue was driven by a $28.2 million increase resulting from our acquisition of Hubs. The $20.6 million increase in cost of revenue in our legacy business was driven by increased volumes and labor shortage resulting in wage inflation, increased overtime and increased recruiting costs, leading to personnel and related cost increases of $12.1 million and an increase in raw material and product costs of $9.6 million, which were partially offset by a decrease in equipment and facility related costs of $1.1 million.
Gross Profit and Gross Margin. Gross profit increased from $217.8 million in 2020 to $222.7 million in 2021. Gross margin decreased from 50.1% of revenue in 2020 to 45.6% of revenue in 2021 primarily due to labor and materials cost inflation and the mix of revenue.
Operating Expenses
Marketing and Sales. Marketing and sales expense increased $12.9 million, or 18.6%, for 2021 compared to 2020. In our legacy business, the increase was driven by personnel and related cost increases of $3.0 million and information technology allocation cost increases, including amortization of PL 2.0 software assets, of $4.4 million. In addition, our acquisition of Hubs provided $5.5 million in marketing and sales expense during 2021.
Research and Development. Our research and development expense increased $7.3 million, or 19.8%, for 2021 compared to 2020 primarily due to personnel and related cost increases of $4.2 million driven by personnel and contractor resources dedicated to the launch of our PL 2.0 system. During the development of PL 2.0, certain research and development personnel costs were capitalizable as a software development asset. Since the system was placed in service in November 2020, the continuing personnel costs have been expensed as incurred. In addition, increases of $3.2 million resulted from our acquisition of Hubs.
General and Administrative. Our general and administrative expense increased $16.7 million, or 32.3%, for 2021 compared to 2020 primarily due to an increase of $9.3 million resulting from our acquisition of Hubs, other professional service cost increases of $5.0 million, stock-based compensation cost increases of $0.9 million, and personnel and related cost increases of $1.6 million.
Changes in fair value of contingent consideration. The fair value of contingent consideration associated with the acquisition of Hubs decreased $12.5 million during 2021. We had no contingent consideration liabilities recorded during 2020.
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Income from Operations
Income from operations decreased $19.5 million, or 32.6%, for 2021 compared with 2020. By reportable segment, income from operations for the United States and Europe decreased 0.8% and 93.8%, respectively, and loss from operations and expenses included in Corporate Unallocated and Japan increased 15.3% for 2021 compared with 2020. The decrease in income from operations is primarily driven by the acquisition of Hubs, increases in cost of revenue due to wage and material inflation and the additional costs of PL 2.0, including the amortization of the software asset.
Other (Expense) Income, Net and Provision for Income Taxes
Other (Expense) Income, Net. We recognized other expense, net of $0.2 million in 2021, a decrease of $3.3 million compared to other income, net of $3.1 million for 2020. Other expense, net for 2021 primarily consisted of a $0.9 million loss on foreign currency, which is partially offset by a $0.2 million in interest income and $0.5 million in other income. Other income, net for 2020 primarily consisted of $1.4 million in interest income on investments and a $1.5 million gain on foreign currency.
Provision for Income Taxes. Our income tax provision decreased by $5.3 million for 2021 compared to 2020. The decrease in the provision is primarily due to lower taxable income and the lower effective tax rate. Our effective tax rate of 17.0% for 2021 decreased 2.2% compared to 19.2% for the same period in 2020.
Comparison of Years Ended December 31, 2020 and 2019
For a comparison of our results of operations for fiscal years ended December 31, 2020 and December 31, 2019, see "Part II, Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC on February 19, 2021.
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Liquidity and Capital Resources
Cash Flows
The following table summarizes our cash flows for the years ended December 31, 2021, 2020 and 2019:
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (dollars in thousands) | 2021 | 2020 | 2019 | |||||||||
| Net cash provided by operating activities | $ | 55,242 | $ | 106,969 | $ | 116,052 | ||||||
| Net cash used in investing activities | (94,664 | ) | (95,473 | ) | (44,303 | ) | ||||||
| Net cash used in financing activities | (22,198 | ) | (10,726 | ) | (31,617 | ) | ||||||
| Effect of exchange rates on cash and cash equivalents | (54 | ) | 1,608 | 47 | ||||||||
| Net (decrease) increase in cash and cash equivalents | $ | (61,674 | ) | $ | 2,378 | $ | 40,179 |
Sources of Liquidity
We finance our operations and capital expenditures through cash flow from operations. We had cash and cash equivalents of $65.9 million as of December 31, 2021, a decrease of $61.7 million from December 31, 2020. The decrease in our cash was primarily due to cash used in investing activities for our acquisition of Hubs of $127.4 million, purchases of property, equipment and other capital assets of $34.2 million, and cash used in financing activities for repurchases of common stock of $23.3 million, which were partially offset by net proceeds from investments in marketable securities of $67.0 million and cash generated through operations of $55.2 million. We had cash and cash equivalents of $127.6 million as of December 31, 2020, an increase of $2.4 million from December 31, 2019. The increase in our cash was due primarily to cash generated through operations, partially offset by investing activity and repurchases of common stock. We had cash and cash equivalents of $125.2 million as of December 31, 2019, an increase of $40.2 million from December 31, 2018. The increase in our cash was due primarily to cash generated through operations.
As of December 31, 2021, the amount of cash and cash equivalents held by foreign subsidiaries was $20.6 million. Our intent is to continue to permanently reinvest these funds outside the U.S. and our current plans do not demonstrate a need to repatriate them to fund our domestic operations. We believe that our existing cash and cash equivalents together with cash generated from operations will be sufficient to meet our working capital expenditure requirements for at least the next 12 months.
Cash Flows from Operating Activities
Cash flow from operating activities of $55.2 million during 2021 primarily consisted of net income of $33.4 million, adjusted for certain non-cash items, including depreciation and amortization of $40.5 million and stock-based compensation expense of $19.1 million, which were partially offset by a decrease in the fair value of contingent consideration of $13.3 million and changes in operating assets and liabilities and other items totaling $24.5 million. The cash flow from operating activities during 2021 compared to 2020 decreased $51.7 million primarily due to decreases in net income of $17.5 million, increases in accounts receivable of $20.1 million driven by timing of cash receipts, a decrease in the fair value of contingent consideration of $13.3 million, decreases in deferred taxes of $7.2 million, and decreases of $6.0 million in other items, which were partially offset by increases in depreciation and amortization of $7.9 million and increases in stock-based compensation of $4.4 million.
Cash flow from operating activities of $107.0 million during 2020 primarily consisted of net income of $50.9 million, adjusted for certain non-cash items, including depreciation and amortization of $32.6 million, stock-based compensation expense of $14.7 million and deferred taxes of $7.6 million and changes in operating assets and liabilities and other items totaling $1.3 million. The cash flow from operating activities during 2020 compared to 2019 decreased $9.1 million due to decreases in net income of $12.8 million and changes in operating assets and liabilities and other items of $3.8 million, which were partially offset by increases in stock-based compensation expenses of $3.9 million, increases in deferred taxes of $1.5 million, increases in depreciation and amortization of $1.7 million driven by an increase in capital investments and increases in amortization of held-to-maturity securities of $0.4 million.
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Cash Flows from Investing Activities
Cash used in investing activities was $94.7 million for the year ended December 31, 2021, consisting of $127.4 million in cash used for acquisitions, net of cash acquired and $34.2 million for the purchases of property, equipment and other capital assets, which were partially offset by $67.0 million of net proceeds from investments in marketable securities.
Cash used in investing activities was $95.5 million for the year ended December 31, 2020, consisting of $47.0 million for the purchase of property, equipment and other capital assets, $113.2 million for the purchase of marketable securities and $3.0 in other investing activities, which were partially offset by $67.7 million in proceeds from maturities of marketable securities.
Cash Flows from Financing Activities
Cash used in financing activities was $22.2 million for the year ended December 31, 2021, consisting of $23.3 million in repurchases of common stock, $4.2 million in shares withheld for tax obligations associated with equity transactions, and $0.6 million for repayments of finance lease obligations, which were partially offset by $5.9 million in proceeds from the exercise of stock options.
Cash used in financing activities was $10.7 million for the year ended December 31, 2020, consisting of $14.7 million in repurchases of common stock, $3.4 million in purchases of shares withheld for tax obligations associated with equity transactions and $0.2 million in principal repayments of finance lease obligations, partially offset by $7.6 million in proceeds from exercises of stock options.
Operating and Capital Expenditure Requirements
We believe, based on our current operating plan, that our cash balances and cash generated through operations and interest income will be sufficient to meet our anticipated cash requirements through at least the next 12 months. From time to time we may seek to sell equity or convertible debt securities or enter into credit facilities. The sale of equity and convertible debt securities may result in dilution to our shareholders. If we raise additional funds through the issuance of convertible debt securities or enter into credit facilities, these securities and debt holders could have rights senior to those of our common stock, and this debt could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on terms acceptable to us, or at all.
Our future capital requirements will depend on many factors, including the following:
| • | the revenue growth in Injection Molding, CNC Machining, 3D Printing and Sheet Metal product lines; | |
|---|---|---|
| • | costs of operations, including costs relating to expansion and growth; | |
| • | the emergence of competing or complementary technological developments; | |
| • | the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual product rights, or participating in litigation-related activities; and | |
| • | the acquisition of businesses, products and technologies, although we currently have no commitments or agreements relating to any of these types of transactions. |
Our recent annual capital expenditures have varied between 7% and 20% of annual revenue. We believe future growth capital expenditures, excluding any expenditures for buildings and maintenance capital we might purchase for our operations, are likely to vary between approximately 8% and 12% of annual revenue.
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Contractual Obligations
As of December 31, 2021, our contractual obligations are $7.4 million related to current and long-term operating and finance lease liabilities.
Financing Arrangements
We had no financing arrangements as of December 31, 2021 and 2020.
Inflation
We experience normal inflation and changing prices, primarily on our production materials and labor. In 2021 and 2020, wage inflation contributed to our lower gross margin. We do not believe inflation and changing prices had a material effect on our financial condition in 2019.
Off-Balance Sheet Arrangements
Since our inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.
Critical Accounting Policies and Use of Estimates
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amount of assets, liabilities, revenue, expenses and related disclosures. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, goodwill, capitalized software costs, other intangible assets, stock-based compensation, and income taxes. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Management has discussed the development, selection and disclosure of these estimates with the audit committee of our board of directors. Our actual results may differ significantly from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments used in the preparation of our consolidated financial statements. See the Notes to Consolidated Financial Statements included in Item 8. “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for additional information about these critical accounting policies, as well as a description of our other accounting policies.
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Revenue Recognition
We recognize revenue for our internal and outsourced manufacturing operations in accordance with ASC 606, Revenue from Contracts with Customers. We manufacture custom parts to specific customer orders that have no alternative use to us, and we believe there is a legally enforceable right to payment for performance completed to date on internally and outsourced manufactured parts. For manufactured parts that meet these two criteria, we will recognize revenue over time. Revenue is recognized over time using the input method based on time in production as a percentage of total estimated production time to measure progress toward satisfying performance obligations using the estimated total time necessary to complete the parts per the customer's order and an estimate of inventory and production costs incurred to date. The input method requires an analysis of the incurred time in production and an estimate of the total time necessary to complete the total parts per the customer's order. The majority of our CNC machining, 3D printing, and sheet metal contracts have a single performance obligation. The majority of our injection molding contracts have multiple performance obligations including one obligation to produce the mold and a second obligation to produce parts. For injection molding contracts with multiple performance obligations, we allocate revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling price based on the price charged to customers.
Goodwill
We recognize goodwill in accordance with ASC 350, Intangibles—Goodwill and Other. Goodwill is the excess of cost of an acquired entity over the amounts assigned to assets acquired and liabilities assumed in a business combination. Goodwill is allocated to our reporting units, which are determined by the discrete financial information available for the component and whether it is regularly reviewed by segment management. Our reporting units are the United States, Europe and Japan. Goodwill is not amortized.
Goodwill is tested for impairment annually at the beginning of the fourth quarter, and is tested for impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired. An impairment charge for goodwill is recognized only when the estimated fair value of a reporting unit, including goodwill, is less than its carrying amount. In 2021, we performed a quantitative analysis based on the performance of Europe in 2021 and the amount of goodwill recorded during the year from the Hubs acquisition. The quantitative impairment test requires judgment, including the identification of reporting units, the assignment of assets, liabilities and goodwill to reporting units, and the determination of fair value of each reporting unit. The impairment test requires the comparison of the fair value of each reporting unit with its carrying amount, including goodwill. In performing the impairment test, we determined the fair value of its reporting units through a combination of the income approach by using discounted cash flow (DCF) analyses and the market approach through the guideline company method. Determining fair value requires us to make judgments about appropriate discount rates, perpetual growth rates and the amount and timing of expected future cash flows. The cash flows employed in the DCF analysis for each reporting unit are based on the reporting unit's budget, long-term business plan and recent operating performance. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting unit and market conditions. Given the inherent uncertainty in determining the assumptions underlying a DCF analysis, actual results may differ from those used in our valuations. In assessing the reasonableness of the determined fair values, we also reconciled the aggregate determined fair value of the Company to the Company's market capitalization, which, at the date of its 2021 impairment test, included a 16 percent control discount. Significant assumptions used in the DCF analysis included long-term revenue growth rates. As a result of the analyses, no impairment was identified.
Capitalized Software Costs
We follow ASC 350-40, Intangibles – Goodwill and Other, Internal-Use Software, in accounting for internally developed software. Costs for internal-use software are evaluated by projected and capitalized where appropriate.
Other Intangible Assets
We recognize other intangibles assets in accordance with ASC 350, Intangibles—Goodwill and Other. Other intangible assets include software technology, customer relationships and other intangible assets acquired from independent parties. We used a multi-period excess earnings method under the income approach to measure the software platform. The significant assumptions used to estimate the value of the software platform included forecasted annual revenue growth, gross margin rates, operating expenses as a percentage of sales and the weighted-average cost of capital, which are affected by our business plans and expectations about future market or economic conditions. Other intangible assets with a definite life are amortized over a period ranging from two to 12 years on a straight line basis, and are tested for impairment whenever events or circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable. An impairment loss is recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows generated by the asset. As of December 31, 2021 no impairment charges for intangible assets have been recognized.
Stock-Based Compensation
We determine our stock-based compensation in accordance with ASC 718, Compensation—Stock Compensation (ASC 718), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and non-employee directors based on the grant date fair value of the award.
Determining the appropriate fair value model and calculating the fair value of stock option grants requires the input of subjective assumptions. We use the Black-Scholes option pricing model to value our stock option awards. Stock-based compensation expense is significant to our consolidated financial statements and is calculated using our best estimates, which involve inherent uncertainties and the application of management’s judgment. Significant estimates include our expected term and stock price volatility. If different estimates and assumptions had been used, our common stock valuations could be significantly different and related stock-based compensation expense may be materially impacted.
The Black-Scholes option pricing model requires inputs such as the risk-free interest rate, expected term, expected volatility and expected dividend yield. We base the risk-free interest rate that we use in the Black-Scholes option pricing model on zero coupon U.S. Treasury instruments with maturities similar to the expected term of the award being valued. The expected term of stock options is estimated from the vesting period of the award and represents the weighted average period that our stock options are expected to be outstanding. We estimated the volatility of our stock price based on the historic volatility of our common stock. We have never paid and do not anticipate paying any cash dividends in the foreseeable future and, therefore, we use an expected dividend yield of zero in the option pricing model. We account for forfeitures as they occur.
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The fair value of each new employee option awarded was estimated on the date of grant for the periods below using the Black-Scholes option pricing model with the following assumptions:
| Year Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | |||||||||
| Risk-free interest rate | 0.80 - 1.12% | 0.50 - 1.47% | 2.35 - 2.58% | ||||||||
| Expected life (years) | 6.25 | 6.25 | 6.25 | ||||||||
| Expected volatility | 45.28 - 45.53% | 42.40 - 43.83% | 42.52 - 42.74% | ||||||||
| Expected dividend yield | 0% | 0% | 0% | ||||||||
| Weighted average grant date fair value | $128.14 | $45.32 | $47.84 |
Our 2012 Employee Stock Purchase Plan (ESPP) allows eligible employees to purchase a variable number of shares of our common stock during each offering period at a discount through payroll deductions of up to 15% of their eligible compensation, subject to plan limitations. The ESPP provides for six-month offering periods with a single purchase period. At the end of each offering period, employees are able to purchase shares at 85% of the lower of the fair market value of our common stock on the first trading day of the offering period or on the last trading day of the offering period. We determine the fair value stock-based compensation related to our ESPP in accordance with ASC 718 using the component measurement approach and the Black-Scholes standard option pricing model.
The fair value of each offering period was estimated using the Black-Scholes option pricing model with the following assumptions:
| Year Ended December 31, | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| 2021 | 2020 | 2019 | |||||||||
| Risk-free interest rate | 0.06 - 0.17% | 0.12 - 0.17% | 1.59 - 2.35% | ||||||||
| Expected life (months) | 6.00 | 6.00 | 6.00 | ||||||||
| Expected volatility | 53.44 - 65.53% | 50.85 - 59.99% | 42.63 - 53.57% | ||||||||
| Expected dividend yield | 0% | 0% | 0% |
There are significant differences among option valuation models, and this may result in a lack of comparability with other companies that use different models, methods and assumptions. If factors change and we employ different assumptions in the application of ASC 718 in future periods, or if we decide to use a different valuation model, such as a lattice model, the stock-based compensation expense that we record in the future under ASC 718 may differ significantly from what we have recorded using the Black-Scholes option pricing model and could materially affect our operating results.
We recognize stock-based compensation expense on a straight-line basis over the requisite service period. We recorded stock-based compensation expense relating to stock options, restricted stock awards, performance stock units and our ESPP of $19.1 million, $14.7 million and $10.8 million during the years ended December 31, 2021, 2020 and 2019, respectively. As of December 31, 2021, we had $4.3 million of unrecognized stock-based compensation costs related to unvested stock options that are expected to be recognized over a weighted average period of 2.6 years. We issued options to purchase 57,901, 60,065 and 53,708 shares of our common stock in 2021, 2020 and 2019, respectively. As of December 31, 2021, we had $26.0 million of unrecognized stock-based compensation costs related to non-vested restricted stock, which is expected to be recognized over a weighted average period of 2.4 years. We issued restricted stock awards of 205,996, 108,179 and 115,471 shares of our common stock in 2021, 2020 and 2019, respectively. As of December 31, 2021, we had $0.8 million of unrecognized stock-based compensation costs related to non-vested performance stock, which is expected to be recognized over a weighted average period of 1.8 years. We issued performance stock awards of 15,078, 19,956 and 21,434 shares of our common stock in 2021, 2020 and 2019, respectively.
In future periods, our stock-based compensation expense is expected to increase due to our existing unrecognized stock-based compensation and the issuance of additional stock-based awards to continue to attract and retain employees and non-employee directors.
Income Taxes
We account for income taxes in accordance with ASC 740, Income Taxes (ASC 740). Under this method, we determine tax assets and liabilities based upon the differences between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of most events recognized in the current year’s financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities and equity, revenues, expenses, gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax basis of assets or liabilities and their reported amounts in the financial statements. Because we assume that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or liability and its reported amount in the balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or the reported amounts of the assets are recovered, giving rise to a deferred tax asset or liability. We establish a valuation allowance for any portion of our deferred tax assets that we believe will not be recognized.
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ASC 740 also clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. The Company recognizes the effect of income tax positions only if sustaining those positions is more likely than not. The Company records penalties and interest related to unrecognized tax benefits in income taxes in the Company’s Consolidated Statements of Income. Including interest and penalties, we have established a liability for uncertain tax positions of $5.7 million as of December 31, 2021.
The effective tax rate decreased by 2.2% for the year ended December 31, 2021 when compared to 2020 primarily due to a one-time benefit from the revaluation of contingent consideration and a benefit from the decrease in the tax liability for uncertain tax positions resulting from the expiration of the statute of limitations. These benefits were partially offset by an increase in the valuation allowances on losses from foreign operations.
Recently adopted accounting pronouncements
In December 2019, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (ASU 2019-12). ASU 2019-12 attempts to simplify aspects of accounting for franchise taxes and enacted changes in tax laws or rates, and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. ASU 2019-12 is effective for public business entities for fiscal years beginning after December 15, 2020, including interim periods within that fiscal year. The Company adopted ASU 2019-12 on January 1, 2021 and there was no material impact on the Company’s consolidated financial statements.
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