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Proto Labs, Inc. (NYSE:PRLB)

Q4 2012 Earnings Call

February 13, 2012 8:30 am ET

Executives

William M. Dietrick – Vice President of Marketing

Bradley A. Cleveland – President and Chief Executive Officer

John R. Judd – Chief Financial Officer

Analysts

Troy Jensen – Piper Jaffray

Brian Drab – William Blair

Jim Ricchiuti – Needham & Company

Steve Dyer – Craig-Hallum

Nicole DeBlase – Morgan Stanley

Zach Larkin – Stephens Inc

Greg McKinley – Dougherty & Company

Tom Hayes – Thompson Research Group

Patrick Wu – Battle Road Research

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Proto Labs Fourth Quarter 2012 Conference Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator instructions)

This conference is being recorded today, Wednesday, February 13, 2013. I would now like to turn the conference over to Bill Dietrick, Vice President of Marketing at Proto Labs. Please go ahead, Mr. Dietrick.

William M. Dietrick

Thank you operator, and good morning everyone. This morning before the market opened, Proto Labs issued a press release announcing its fourth quarter and fourth quarter financial results for the period ended December 31, 2012. The release is available on the company’s website at protolabs.com.

Before we get started, during the course of this conference call the company will provide financial projections and make other statements about its business that are forward-looking and are subject to many risks and uncertainties that could cause actual results to differ materially from expectations. A detailed discussion of the risks and uncertainties that affect the business is contained in the company’s IPO prospectus and other SEC filings, particularly under the heading risk factors.

Copies of these filings are available online from the SEC or on the Proto Labs website. The company’s projections and other forward-looking statements are based on factors that are subject to change, and therefore these statements speak only as of the date they are given. The company does not undertake to update any projection or forward-looking statement.

In addition, to supplement the GAAP numbers, we have provided non-GAAP adjusted net income and basic and diluted net income per share information that excludes the after-tax costs of stock compensation. We believe that this non- GAAP number provides meaningful supplemental information and is helpful in assessing our historical and future performance. A table reconciling the GAAP information to the non-GAAP information is included in our financial release.

Now I would like to turn the call over to Brad Cleveland, President and CEO of Proto Labs. Brad.

Bradley A. Cleveland

Good morning everyone. Thank you for joining us today on our fourth quarter 2012 conference call. With me today is Jack Judd, our Chief Financial Officer. I will begin with a brief overview of our fourth quarter and 2012 fiscal year financial results, as well as provide some related commentary. Then Jack will provide a more detailed look at our financial results and offer our views on the outlook for the first quarter of 2013.

At the end of our remarks, we will be glad to take your questions. In our recently completed fourth quarter of 2012, Proto Labs generated record revenue of $33.6 million, an increase of 31% over the fourth quarter of 2011. For the full year, we generated revenue of $126 million, 27% above our 2011 revenue of $98.9 million.

These excellent results in the fourth quarter were the result of record quarterly revenues from each of our global operations in the United States, Europe and Japan. As a result of this strong global revenue, we were also able to achieve record quarterly earnings. Our net income for the fourth quarter was $7.4 million or $0.29 per diluted share. This in turn allowed us to grow our annual net income to $24 million or $0.98 per diluted share.

The number of customers we have served also continues to grow. During the full year of 2012, we served 2991 new customers, generating $20.8 million in revenue, and 4763 existing customers, generating $105.2 million in revenue. Jack will walk through our record financial results in greater detail later.

Right now though I would like provide an update on each of our geographic locations, our Protoworks initiative and our Cool Idea program. During the just completed fourth-quarter record revenue from our US operations increased to $26 million, 36% over the fourth quarter of 2011. US revenue for our full year 2012 increased to $98.7 million or 29% above that of 2011. I would like to congratulate our outstanding US marketing and sales colleagues for their successful efforts.

Our European operations achieved record revenue of 3.9 million pounds during the fourth quarter, increasing our full year 2012 European revenues to 17% over that of 2011 in constant currency. In recent meetings with investors, one of the more common questions we have been asked is how we go about monitoring the impact of economic variables. So we thought we would offer a couple of examples, specifically related to Europe.

During economic slowdowns, new product development cycles are extended and customers, while still active, generally order fewer parts for a smaller number of projects. When we look at the growth of Protomold orders in Europe, we can see that the follow-on orders for production parts grew more slowly than those for initial sample parts.

As another example looking at the growth of new European customers during 2012, we see that the number of new customers was well down from what we saw in 2010 or 2011. Clearly these are indications of the economic challenges our European sales team has encountered in 2012, and they have earned our thanks for a job well done despite them.

Although our Japanese results continued to be a small fraction of our consolidated results, we are also pleased to report that our fourth-quarter revenue in Japan of 113 million yen, was 46% above the fourth quarter of 2011, which increased our annual Japan revenue to 384 million yen, or 71% above 2011.

Since our last earnings call, we have been very busy working with our Japanese colleagues, especially in areas such as marketing, sales and manufacturing. For example, during the fourth quarter of 2012 we added a key Japanese sales leader and temporarily stationed one of our top US sales leaders in Japan to provide the necessary training.

In addition, during the fourth quarter we added a key Japanese manufacturing leader, and we now have our top European operations leader playing the same role in Japan for the next two months. Our general approach is to work closely with our colleagues in Japan to help them accelerate their marketing, sales and manufacturing processes with the goal of achieving profitability by the end of 2014.

I would like to take this opportunity to personally thank and congratulate our very hard-working Japanese colleagues for their successful efforts during the fourth quarter. We still have work ahead of us to achieve our goal of breaking even before the end of 2014, but it is exactly these types of results that keep us moving forward.

With respect to our Protoworks process development initiatives, the fourth quarter of 2012 was very productive. As you may recall, we have two metal molding processes under development, thixo molding of magnesium, and metal injection molding of steel alloys. During the fourth quarter of 2012, we were successful in getting thixo molding processes operational with Protoworks, and we have been shipping molded magnesium parts to a small group of very supportive customers.

On the metal injection molding side of Protoworks, we successfully installed a complete manufacturing line, including injection molding presses, CNC machining centers, shared with other Protoworks initiatives, debinding and sintering equipment, and we are already beginning the process of manufacturing and testing sample parts. Overall, I am very pleased with the progress of each of these processes, and looking forward to seeing how far we can get towards their commercialization over the course of 2013.

As I mentioned in a prior earnings release, Proto Labs promotes a program we call Cool Idea, in support of promising product developers with new ideas, in need of a little help to get to market faster. We now offer up to $250,000 worth of free Protomold or Firstcut parts to selected developers. And in October we selected Soloshot as a winner. Soloshot, an object tracking system that combines with virtually any camera to track a single subject and capture video from up to 2000 feet away, received Protomold injection molded production services as part of their Cool Idea Award. Ideal for sports enthusiasts looking for high quality video footage of themselves, the Soloshot employs remote and base units that are in constant radio communication, allowing the user to move anywhere within range and keep the camera focused on themselves.

If this sounds interesting, I suggest you check them out at soloshot.com and watch them of their very cool videos. Over the course of 2012, Proto Labs was featured in dozens of publications, including [Wired Magazine] as a result of our Cool Idea program, which clearly makes it a win-win investment all around.

With that I would like to turn the call around to Jack for a more in-depth review of our fourth-quarter financial results, and our outlook for the first quarter of 2013. Jack.

John R. Judd

Thank you Brad, and good morning to everyone. Revenue in the fourth quarter of 2012 was $33.6 million, an increase of $8 million or 31% over fourth quarter 2011 revenue. Protomold revenue during the just completed quarter was $23.7 million, and Firstcut revenue was $9.9 million.

During the quarter, Firstcut revenue represented 30% of total revenue, compared to 26% during the fourth quarter of 2011. Our international revenue was $8.6 million or 26% of total revenue during the fourth quarter of 2012 compared to $7.4 million or 29% of revenue during the same period in 2011.

During the just completed quarter, the impact of revenue due to changes in currency was insignificant. For the full year, revenue was negatively impacted by approximately $250,000. Full year 2012 consolidated revenue was $126 million, an increase of $27.1 million or 27% over 2011 revenue. For 2012, our international revenue was $31.1 million, an increase of 20% over $25.9 million in 2011.

Our increases in revenue were driven both by new customer acquisition and increased orders from our existing customers. During 2012, we did business with 2991 new customers, generating $20.8 million in revenue, and 4763 existing customers, generating $105.2 in revenue. This compares to 2598 new and 3429 existing customers, generating $18.4 million and $80.5 million in revenue respectively during 2011.

Our gross margin in the fourth quarter of 2012 was 62.5% compared to 56.8% in the same quarter in 2011, and 60.7% in the third quarter of 2012. While we are very pleased with the quarterly results of our gross margin, I do want to reinforce that our fourth quarter 2012 results exceed our long-term model for gross margins of 60% to 62%. Our gross margin can vary and generally is based on how well the timing of our capacity investments align with the rate of increasing orders.

If order growth exceeds capacity expansion, the gross margin will be on the higher side of our target model. In the opposite case, it will be on the lower side of our target model. This has been a very normal part of managing our business since inception, and we expect it to continue.

Our operating income was $10.3 million, or 30.5% of revenue in the fourth quarter. For 2012, our operating income was $34.9 million or 27.7% of revenue. Operating expenses were approximately $1.1 million higher in the quarter than the previous year. This increase is mostly driven by greater spending on our R&D initiatives. Companywide at the end of the summer we had 622 total employees versus 511 at the end of December 2011.

Our diluted earnings per share in the fourth-quarter of 2012 were $0.29. After adding back the after-tax costs of stock compensation, our non-GAAP diluted earnings per share in the quarter were $0.31. Our reconciliation of net income and EPS to non-GAAP net income and EPS was included in our earnings release this morning.

At the end of 2012, our cash and investments totaled $98.9 million. Our capital spending during 2012 totaled $17.4 million, almost all of which was spent on factory expansion, additional CNC mills, and injection molding presses to support our revenue growth. Very little of our capital spending is for maintenance or replacement. The capital we spend supports future growth and pays for itself in quarters, not years.

I would now like to provide some guidance into our projected results for the first quarter of 2013. We currently expect revenue in the current quarter to be between $35 million and $38 million, stock compensation costs in the current quarter will be approximately $750,000. We estimate our tax rate to be 32% for 2013. Taking all of the above factors into consideration, our quarterly non-GAAP EPS adding back the after-tax cost of stock compensations is expected to be between $0.28 and $0.32 per share.

We are currently in preliminary discussions to acquire additional factory capacity. Depending on the results of these discussions, our full-year Capex in 2013 could vary significantly. When these plans are finalized we will provide an outlook on capital spending for 2013.

This concludes our prepared remarks. Operator, we will now open up the call for questions.

Question-and-Answer Session

Operator

Okay. The first question we have comes from Troy Jensen from Piper Jaffray. Please go ahead sir.

Troy Jensen - Piper Jaffray

Hi guys. Congratulations on a really nice quarter here.

Bradley A. Cleveland

Thank you.

Troy Jensen - Piper Jaffray

So a couple of questions, first could you just talk maybe about the ramp in the materials, specifically various metals and then I think there is also two others that popped up in the quarter, [peak]?

Bradley A. Cleveland

Yes. This is Brad. We added some new metals to Firstcut during the quarter. The key ones, the big key one was stainless steel, which we have been very pleased with how quickly our customers have started ordering that. And yes, pretty recently we started using steel tools in our Protomold service, which allows us to go to some higher temperature plastics that are very difficult to do in aluminum tools.

The additional metals for Firstcut we think could be a significant revenue enhancement over time. I do not expect that the higher temperature plastics for Protomold will be that big of a deal though.

Troy Jensen - Piper Jaffray

Those higher temps, that is all (inaudible)?

Bradley A. Cleveland

Yes.

Troy Jensen - Piper Jaffray

Great, perfect. But as far as like revenue, is modest revenue contribution now, but potentially bigger ramp this year?

Bradley A. Cleveland

I would say the additional metals for Firstcut should be pretty significant revenue. I don’t think that the additional higher temperature of Protomold revenue will be a significant revenue enhancement. That is just the continual thing we are always doing.

Troy Jensen - Piper Jaffray

Okay. Great, perfect. Hi, then just capacity expansion plan, you kind of alluded to it, I mean are you guys looking at this buying land, building a property, or buying an existing facility. And when do you think you will know whether or not you are going to be pulling off a capital purchase here soon?

Bradley A. Cleveland

This is Brad. We are growing pretty fast, so we are constantly looking at all of the different options of expanding our factory space. And so I would guess within the next few months, we will have a decision on that, and we’re just talking the United States.

John R. Judd

I would expect that by the end of the second quarter all our plans will be firm.

Bradley A. Cleveland

It is just normal business for us, right.

Troy Jensen - Piper Jaffray

No, no, no, I get that. I mean, (inaudible) so that ties into my next question about just the business model targets, Jack you said 60% to 62% is your target range, but you just hit 62.7%, right, if we’re going to get good sequential growth here in the March quarter and we don’t have any new capacity coming on in March, it just seems that 60% to 62% is little conservative with what you have just proven you can do. And arguably the same discussion on the operating line, I think I am shown 27% plus, you just hit 32.6% and it seems to me that there is going to be some more scale efficiencies as you continue to grow?

Bradley A. Cleveland

We sure hope that we can have some more efficiencies. But like we have said in previous quarters is that we like being conservative, and while we think the business has some room to grow, we are in terms of margins, we are really not forecasting that right now.

Troy Jensen - Piper Jaffray

Okay. All right guys. Well, keep up the good work.

Bradley A. Cleveland

Thanks Troy.

Operator

The next question we have comes from Brian Drab from William Blair. Please go ahead.

Brian Drab - William Blair

Good morning. Congratulations on a great finish to the year.

John R. Judd

Thanks Brian.

Bradley A. Cleveland

Thank you, Brian.

Brian Drab - William Blair

So the first question is just around your expectations for revenue per customer in 2013, and maybe you could talk about it in terms of revenue for customers in total and even specifically what you are expecting for revenue per new customer and revenue per existing customer?

John R. Judd

I think Brian overall the revenue that we got overall this year for new customer and existing customer at least on a worldwide basis was similar and within the range that we would expect based upon our previous year’s experience in those numbers. In terms of -- as you look at any one individual market, there is obviously a bit more variability. We do not project revenue per new or existing customer as part of our internal metrics that we manage to. We measure it on an historical basis, but we don’t have necessarily quarterly goals to reach certain numbers.

Brian Drab - William Blair

So, yes, I understand you haven’t talked about specific goals, but could you even talk about it directionally, would you expect that since Firstcut growth has been outpacing Protomold growth that we are going to continue to see some modest decline in revenue per customer, or are there initiatives ongoing here that are -- and new materials that might even push up revenue per customer slightly.

John R. Judd

I would say that the initiative that we have going that could create some variability in the numbers, is our efforts to go deeper and wider in international accounts. And so we have more and more of our sales efforts going in and trying to find more engineers within our present customer base. And so that would create more revenue, but it wouldn’t necessarily create new customers. And so that has been an active thing going on.

But overall in this past year it didn’t seem to influence our numbers too much. And even though we had obviously an increase in Firstcut business versus total revenue, the numbers are still in line. Brad I don’t know if you want to say anything additional.

Bradley A. Cleveland

What I would add to that is, sure, the Firstcut sales point is a little bit lower than the average price. But as we ramp up our mold and metal products over the next couple of years that should more than offset that. So I would agree, I don’t really see a whole lot changing on a revenue per customer, new or existing.

Brian Drab - William Blair

Okay thanks that is very helpful. And then I just want to ask one more for now and that is if you look at the new customer growth in 2013, it was about 15%, and it had been stronger than that in past periods. What would you expect for 2014, well, first of all did that 15% growth in new customers meet your expectations, or was it kind of depressed against some of the macro factors that you mentioned earlier in the call, and have been putting some pressure on the business. Would you expect it to be better than 15% going forward?

Bradley A. Cleveland

This is Brad. What I would say is that if you will look at our 10-K when it comes out and look at the new customer accounts for the US versus Europe, you will find that it was really slow in Europe. The US really wasn’t too bad. So I really associate it with the economic conditions. And if things pick up, my assumption is that that will pick up as well, which is what we have seen in the past.

Brian Drab - William Blair

Okay, great. Thank you.

Operator

The next best thing we have comes from Jim Ricchiuti from the Needham & Company. Please go ahead.

Jim Ricchiuti - Needham & Company

Thank you. Good morning. Maybe just to pick up on that last point, is there anything we can in terms of the sequential growth in new customers in Europe, is there anything you can tell us about what you are seeing in Q4 versus Q3?

John R. Judd

I think the new customer growth in the third quarter and fourth quarter in Europe wouldn’t be significant enough that it would really cause any special research or special comments. We did see slowing of new customers. We attribute it to the recession in the Eurozone, and you know, overall the new customer growth was better overall consolidated in the first half of the year than it was in the last half of the year. But I still like to say we still exceeded our revenue growth numbers that we all had projected for the year. And so if there is a little bit of vagaries in the numbers too.

Jim Ricchiuti - Needham & Company

Okay. If we look at the verticals in 2012 versus 2011, is there anything that stands out either from a new customer standpoint or perhaps from a revenue standpoint.

Bradley A. Cleveland

We just have been looking at that. And the same breakdown of markets that we serve, then the pie chart that breaks down the biggest market that we serve versus the next biggest and so on looks almost exactly the same for 2012 as it is for 2011. So there is very little change in the who’s our biggest market. Obviously we grew significantly, but the breakdown is about the same.

Jim Ricchiuti - Needham & Company

Hi, Brad, do you see that relatively steady in 2013, or it looks like with some of the new materials that there perhaps is a bigger focus on the medical market. Do you see the profile changing at all?

Bradley A. Cleveland

We haven’t looked at 2013 yet. But I would be surprised if it changes very much.

Jim Ricchiuti - Needham & Company

Okay, and just one final question just with respect to the facility expansion, Jack you are saying by Q2 we will know a little bit more, but it is capacity expansion in the US, is it going to be close to your corporate headquarters, are you looking at other sites?

John R. Judd

We anticipate it will be in the Twin cities area. We’re just been careful because if we would choose to buy a building versus lease a building, whether it would include buying land, all that has a lot of different financial numbers to it. And so, we do expect our decision to be made by the end of the second quarter. But again, it is for expansion because our revenue is growing.

Jim Ricchiuti - Needham & Company

Presuming you make that decision, when possibly could we see that facility begin operating, is that looking out to 2014?

John R. Judd

It may be as early as the fourth quarter of 2013.

Jim Ricchiuti - Needham & Company

Okay. Thank you.

Operator

The next question comes from the line of Steve Dyer from Craig-Hallum. Please go ahead.

Steve Dyer – Craig-Hallum

Good morning, and let me add my congratulations. Nice quarter.

Bradley A. Cleveland

Thank you.

Steve Dyer – Craig-Hallum

Most of mine I think by now have been answered. A couple of questions just as it relates to the Capex and the facilities expansion, I guess my understanding going forward was that it would be more was that the Rosemount facility certainly had the footprint that would set you up well for a while, and it would be more kind of adding machines and adding lines. Is that not the case, or is it probably another facility as well, or is it just an expansion of what you have?

Bradley A. Cleveland

Yes, Steve, this is Brad. Yes, we have some empty space in one of our plants here in Maple Plain. And I think the Rosemount building is about only half full right now. But the reason that we are looking at yet another building is because we have Protomold and we Firstcut, and within Protomold we have got our toolmaking versus our production. So we’re trying to stay kind of ahead of the game.

The new facility would be for expanding things that we are not currently planning to put into our plant one, which is up the street here or in our Rosemount building. So yes, we have extra space now if we need it. If the orders ramp up faster than we expect we can expand into our existing building. So we basically have our base covered twice.

Steve Dyer – Craig-Hallum

Okay, that is helpful. And then as it relates to -- I’m sorry, R&D going forward, with Protoworks and some of the other initiatives, would you expect sort of the spending on that is sort of in-line with previous indications going forward?

John R. Judd

Yes.

Steve Dyer – Craig-Hallum

Okay. All right. Thanks guys.

John R. Judd

Thank you.

Operator

The next question we have comes from the line of Nicole DeBlase from Morgan Stanley. Please go ahead.

Nicole DeBlase - Morgan Stanley

Yes, good morning guys.

Bradley A. Cleveland

Hi Nicole.

John R. Judd

Hi Nicole.

Nicole DeBlase - Morgan Stanley

Congrats on a good quarter. So a couple here, most of mine have been answered as well. But, I mean I think that Europe looks really strong this quarter. You had sales up 13%, returned to growth, can you just talk about some of the trends outside of new customers that you saw there and what really drove the strength?

John R. Judd

I could try a little bit. It is pretty much just steady state business practices. From a marketing standpoint and a sales standpoint, we are looking at going deeper and wider within bigger companies, but it is just our folks in marketing and sales doing the same thing that they have been doing for quarter after quarter after quarter. There really wasn’t anything that stands out in terms of a new thrust or a new initiative or any kind of breakthrough. It is just a lot of hard work by some really smart people.

Nicole DeBlase - Morgan Stanley

Okay, got it. And then maybe shifting a little bit to the US, growth definitely accelerated there versus last quarter, I mean, have you seen strength continue into the first quarter, we have heard a lot of shorter cycle US manufacturing companies talk about things getting even better in January, and into February?

Bradley A. Cleveland

We feel [a little bit] the macro situation in the United States, and we have been hiring sales people and doing marketing programs all throughout the last couple of years. And we expect that -- good news out of those efforts in 2013.

Nicole DeBlase - Morgan Stanley

Perfect, okay and then one more if I may, marketing and sales growth continues to decelerate, do you think we are at a good run rate as a percent of sales for 2013?

Bradley A. Cleveland

Pretty much all of our financial statements, especially in the fourth quarter, were at our target model, or above our target model. Marketing programs can be somewhat flat. It depends upon as having good ideas to go do initial marketing. I can’t say that if we come up with additional ideas in marketing, we’re going to spend the money. And I expect that worldwide we will continue to regularly hire new sales reps to contact new and existing customers for business. And so those numbers will not stay flat that they will go up with sales but they are within the target model.

Nicole DeBlase - Morgan Stanley

Perfect. Thanks guys.

Bradley A. Cleveland

Thank you.

Operator

Okay. The next question we have comes from the line of Zach Larkin from Stephens. Please proceed.

Zach Larkin - Stephens Inc

Hi, good morning gentlemen. Thanks for taking my call.

Bradley A. Cleveland

Good morning Zach.

Zach Larkin - Stephens Inc

Hi, I wondered if we could talk maybe a little bit about what your expectations are in the distribution of revenues from Protomold and Firstcut as we move through the year. We’re obviously seeing and have seen an increase in the percentage of Firstcut, but are you expecting the growth rate to be kind of similar, how should we think about the distribution of revenues, maybe if we thought about 2013 versus 2014 on the two segments?

John R. Judd

Well, we market the two services to the same customer base with the same sales force. And so if somebody calls us up, it is generally pretty easy to see whether Firstcut is a good solution for them or whether Protomold is a good solution for them. So, you know, in that sense, we don’t necessarily try to sell one over the other.

Firstcut has a really good price point to it. And so it is probably a little bit of an easier sell or a quicker sell. So I would expect that Firstcut will increase as a percentage of our total revenue over time. I do not think it is going to be 50:50 in the near future at all. I think that Protomold still will exceed Firstcut by quite a bit. And the second thing is that especially when it comes to the gross margin, they are really targeted to be very similar. And so it isn’t as if one has a profit point that is significantly different than the others.

Zach Larkin - Stephens Inc

Thanks Jack that is helpful, and then Brad I wondered that maybe you could talk a little bit about as you are looking at these new materials that you are adding into the overall portfolio, what is the policy you go through in making a decision on adding a new portfolio, or a new material, is there a certain addressable market that you are going after, is there an internal ROI calculation, or how do you go about thinking about let us add magnesium, or whatever the new product that might be?

Bradley A. Cleveland

That is a good question. What we do is we track everything that people ask for that we currently say no to for some reason. We [parade] those, and then we look at them in terms of why do we say no? Is it just something that let us say it is for Firstcut, is it something where we would have to develop new machining software, or is it for Protomold, where maybe the material is too warm for the aluminum molds. So we [parade] them, we allocate our development dollars, and then we go after them.

And that is how we did the stainless steel for Firstcut, and that is how we did the high-temperature plastics for Protomold. So it is all based on actual market feedback.

Zach Larkin - Stephens Inc

And so is it kind of like you are saying, alright we are getting tons of requests for stainless steel, here is kind of the hurdle we would have to jump. Obviously it makes sense to do it, let us allocate some money basically?

Bradley A. Cleveland

Exactly right. And we made that decision about three years ago.

Zach Larkin - Stephens Inc

All right. Thank you very much.

Bradley A. Cleveland

Thank you.

Operator

The next question we have comes from Greg McKinley from Dougherty. Please go ahead.

Greg McKinley - Dougherty & Company

Yes, good morning.

Bradley A. Cleveland

Good morning Greg.

John R. Judd

Hi Greg.

Greg McKinley - Dougherty & Company

Could you talk a little bit about where your sales and marketing staff is today from an headcount standpoint versus it might have been a year ago, just so we could get a sense for how aggressively you are investing there?

Bradley A. Cleveland

Sure. We have sales and marketing staff in the United States and in Europe in several places, and in Japan. And the overall distribution today is about the same as it was a year ago, just a little bit bigger in each of those locations. So we did not change our allocation of resources geographically over the last year in any dramatic way.

Greg McKinley - Dougherty & Company

Okay. And in terms of the headcount there, did that grow similarly to what you had commented on in terms of your overall employee base, or is that something you are investing in more heavily?

Bradley A. Cleveland

On the sales side we invested in more heavily, on the marketing side it is probably aligned with the rest of the company.

Greg McKinley - Dougherty & Company

Okay. Could you also talk a little bit about any changes you are seeing in value per order trends, I know those are very different between Protomold and Firstcut, but my sense is maybe your value per order improved somewhat in Q4, versus where it had been earlier in the year, were there any trends of note there. And then did you also see any mix shift between maybe initial orders and follow on orders as you suggested you tend to see when economic conditions impact customers?

John R. Judd

The average part, the average mold, the average Firstcut part there was no significant change from the beginning of the year to the end of the year. We do have natural fluctuations in part orders off of our molds, and we did comment that that they did vary during the course of the year. And like Brad said in his script that is one of the ways we can kind of tell what is going on in the economy.

Greg McKinley - Dougherty & Company

But you didn’t really see much of a sequential change in those behaviors from Q3 to Q4?

John R. Judd

No.

Greg McKinley - Dougherty & Company

Okay. Thank you.

Operator

The next question we have comes from the line of Tom Hayes from the Thompson Research Group. Please go ahead sir.

Tom Hayes - Thompson Research Group

Thank you. Good morning gentlemen. Congratulations on the quarter.

Bradley A. Cleveland

Thank you.

Tom Hayes - Thompson Research Group

Most of my questions have been answered. I just maybe talk about the possibility, you guys have good detailed color on your thoughts on improving the profitability in Japan, just wondering for the quarter and for the year, was Europe kind of meeting your expectations and targets for profitability as well?

John R. Judd

Europe does well. Actually their P&L in Europe would look very similar to the P&L in the United States. You know, margin wise what it costs to operate, very similar between the two markets. But I would say considering that tightness of revenue over the course of the year, our European colleagues did a really wonderful job of managing their P&L for us.

Tom Hayes - Thompson Research Group

Good. I guess just secondly then maybe on kind of tied into the facility expansion and your R&D spending, which was up significantly for the year, would any of the new capacity be for R&D and are you on kind of R&D space as you continue to build out that wonderful process over there?

Bradley A. Cleveland

Yes. The capacity expansions that we talked about in our presentation earlier are entirely for our standard everyday business. They have nothing to do with Protoworks. Most of our capacity expansions for Protoworks are already done.

Tom Hayes - Thompson Research Group

Okay. Thank you.

Bradley A. Cleveland

Sure.

Operator

The next question we have comes from Patrick Wu from the Battle Road Research. Please go ahead.

Patrick Wu - Battle Road Research

Hi guys. Very nice quarter. So congratulations on that.

Bradley A. Cleveland

Thank you.

Patrick Wu - Battle Road Research

Yes, most of my questions are also answered as well, but I just wanted to maybe touch upon op margin real quick, it seemed like it regressed a little bit, what can be I guess expect in 2013, as sort of your target -- I know you guys talked about gross margin target, but maybe you guys can shed some color on that as well?

John R. Judd

So, Patrick, I want to see if I heard that question right. You are saying that our operating margin regressed during the year?

Patrick Wu - Battle Road Research

No, no, no. Just in the last quarter versus the previous quarter. It seemed like it is at 30.5%, and we have it around -- closer to 2% in the previous quarter, I just wanted to see obviously that is attributable to the increase in R&D. I just wanted to understand maybe for 2014 what is the progression there? Sorry, I am unfamiliar (inaudible) that is why you maybe…

John R. Judd

That is okay. I think that in the third quarter, actually in the fourth quarter of 2012 our operating margin was 30.5% compared to 29.5% in the third quarter. So I have -- our numbers would say that our operating margin increased fourth-quarter from the third quarter.

And it was significantly above the year ago. Last year in the fourth quarter a year ago, we did 19.1%, and so I think our operating margin increased nicely during the quarter compared to previous quarters and the same period last year.

Patrick Wu - Battle Road Research

Also, I must be looking at the wrong column there, but can you maybe shed some color on I guess the target for 2013 for you guys?

John R. Judd

I think our target is the same as we have been talking about and the same we would like our operating margin on a GAAP basis to be above 27%. And we have had some questions about target model, and over this past year, we had two quarters that nicely exceeded that target model, and we had two quarters that were below our target model.

So when it comes to trying to say what would we like to have in the future, I think these last two quarters provided us good evidence that our target model is reachable and attainable especially in 2013.

Patrick Wu - Battle Road Research

That is all I have, thanks.

John R. Judd

I think that is the end of our questions. Operator.

Operator

Hello. I would now like to hand over the call to Brad Cleveland for closing remarks.

Bradley A. Cleveland

Thank you, Michele. Well, thank you all for joining us today. I hope we have conveyed a sense of our confidence in the continuing strength of the Proto Labs business model, and our excitement about the growth opportunities ahead of us. We look forward to updating you on our progress during our second quarter conference call. Thank you very much. Thanks Michele.

Operator

Thank you for your participation in today’s conference call. This concludes the presentation. You may now disconnect. Good day.

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