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Proto Labs Inc. (NYSE:PRLB)

Morgan Stanley Industrials & Autos Conference (Transcript)

September 17, 2013 04:15 PM ET

Executives

Jack Judd - CFO

Analysts

Nicole DeBlase - Morgan Stanley

Jack Judd

I guess we can get going now, we had a little bit technical difficult. So, hi my name Jack Judd, I am Chief Financial Officer for Proto Labs. Proto Labs located in Maple Plain, Minnesota, which is about 20 miles or 25 miles direct to west from downtown Minneapolis.

I’m just kind of over a couple of slides, not every one of them, and make sure that everybody kind of understands what we do. We’re really a company that combines traditional manufacturing processes with technology, and we’ve created a company that has extremely higher returns on assets and extremely high growth rate for revenue, but our mission is quite simple, as we desire to make real parts for product developers and do them really, really fast and that’s our slogan, Real Parts Really Fast.

And we use real engineering grade material, we use real engineering processes, and we do it really, really fast. We can get things done in a day, if somebody needs something done that fast. That’s really unheard of when it comes to real part manufacturing. We do play in the space that we have friends in the additive industry like Stratasys and 3D Systems. But they do not use real manufacturing processes, they don’t use real materials, they are highly complementary to us. And I think we both benefit from an awful lot of the same trends in product development, but we are not competitive.

So a little bit of a company background; we manufacture parts in three geographic locations, we have four factories in the twin cities, we are also in the United Kingdom in Shropshire, Northwest of London and also in Tokyo. We serve product developers, the people that are out there developing products. We market to product developers, they are the ones that make the choice. We like to joke sometime that our favorite customer of ours is a product developer that’s behind the schedule of a credit card.

We sell in thousands of dollars at a time, maybe even hundreds of dollars at a time. So our revenue for our quarter is made up of sales to thousands of different product developers in any given time. And our two services and this will be the last slide I will do before we go to questions. We have two main services one is we call Firstcut, which is CNC machining and Protomold which is injection molding, Firstcut, we can make parts out of plastic and/or certain metals and we generally make them a handful at a time. It’s got a really nice price point and maybe for $100 you can get a plastic part maybe even less, and you can get 10 aluminum parts, you can get stainless steel parts. But there comes a point in time where the value propositions drops off and that’s 10, 15, 20 parts maybe.

Now Protomold is traditional injection molding of plastic parts and we can use just about any plastic material that you can come up with. We make a mold, we sell 25 sample parts with it, and about half of the time somebody comes back and wants additional parts from us from a mold we have made. And to give you an idea of what we mean by short run; an average order for our mold, an average order on parts from a mold for us is like 200 parts. And so we really play in the short run manufacturing prototype space. Every so often we get asked to make 10,000 parts, but that’s really the exception for us and we own the mold and that’s one of the reason people come back to us. And so that’s a little bit of a short introduction and I am going to sit down and let Nicole ask me some direct questions

Question-and-Answer Session

Nicole DeBlase - Morgan Stanley

All right, sounds good, thanks, Jack that was a help overview. I am going to ask a few and then open it up to the audience. But I think you know it might be just helpful to kind of expand on bit of what you were talking about at the podium. So you talked about 3D printing or additive manufacturing is complimentary to what Proto Labs does. So maybe for the benefit of the audience, you could explain of that of how you are related to 3D printing?

Jack Judd

That’s a good question. It’s by far of the most common point I have to make, especially for the folks at Stratasys and 3D Systems. They make a part that is very valuable early on in the product developments phase, and I think that’s where they add the most value. And if you can imagine it, they can make it. But at a certain point in time, you have to go show your manufacturing people what you’ve got for an idea and they have to make sure that its manufacturable and you might get into material discussion and you might say, this has to be a real engineering grade material.

And so somewhere along that line in product development whether its half way through that’s open to discussion; the value proposition of an additive part fall apart pretty dramatically and our value proposition comes front and center, and so we really are complimentary. I think if Stratasys and 3D were here, they would say the exact same thing. A lot of the high [previly] you hear in the market place about real parts being made by addictive manufacturing, I think that its just microscopically small compared to the billions and billions of parts being made with traditional plastic injection molding and with machining.

Nicole DeBlase - Morgan Stanley

Do you think overtime, how much potential is there for printers to move up the curve and move into kind of your area of the market producing more I guess or is that pretty much impossible?

Jack Judd

I don't think that it's impossible; I think that it's unlikely in anybody's near term investment propositions. The technology that the additive people are using is 20 and 25 years old, and so it's not new. You might think from the PR right now that it's brand new, but that's not the case. They have been saying for a long time, that they were going to be advancing, and I guess if you would go back to 1990 and you would see where they are today from 1990, you would say they have advanced.

But the material issues that they have, the speed issues that they have will be quite large for them to overcome and maybe in 20 years or something, maybe we'll be talking more real uses for theirs. But I think in anybody's near term future, whether it would be 5 years or 10 years, I think the manufacturing processes to create value are going to be there.

Nicole DeBlase - Morgan Stanley

Okay, got it. So it's really clear that 3D printing companies aren't your competitors, there is no question about that. But.

Jack Judd

No, they're not. Our competitors are Mom and Pop entrepreneurial machine shops that have been around for decades.

Nicole DeBlase - Morgan Stanley

And I mean would you tend to say so, I mean there is obviously a lot of R&D going on in this country, a lot of it is at the multinational level. So really the corporations, do they have the ability to do is in-house or would you get business from those sort of customers as well?

Jack Judd

Most large manufacturers have internal capacity to do, what we do, they have the same general problems that individual machine shops have, and many times they have priority issues. And so, somebody coming in and needing three parts is not a very high priority. And so, yesterday in the afternoon I listened to many of large corporations, whether it be Boeing, Danaher or any one of the other ones, Dover, come forward and say what's going on. I look at them and I say there are customers.

Now someone like Boeing, they don’t do millions of dollars with us, but just about every large national at some case uses us for something, because we have capacity and we have ability that their own internal models shops won’t have.

Nicole DeBlase - Morgan Stanley

Okay, great. And I think it’s probably worth talking a little bit about what's really unique to Proto Labs business model. So you talked about how quickly you can get these parts to your customers and what really enables you guys to do that?

Jack Judd

Yeah. Our parts really are nothing special, so we don’t have technology in the machines that make the parts. Our parts, you might even make an argument that our parts are not up to the highest specifications as some that you might have, we make prototype parts. But what we’re able to do is we are able to make them fast and we are able to do that is that we have removed much of the non-recurring engineering to make parts and we’ve done it through technology.

Back in 1999, when our company got started 3D CAD modeling was relatively new and the founder of our company Larry Lukis was frustrated as a product developer at another company that he could get a circuit board overnight, but it would take him 12 weeks to get a plastic part. He said there is something wrong with that.

And so he sat down and taught himself software and figured out how to write software to remove and also lot of the engineering, mostly the process in creating tool paths for CNC mills. And in the beginning there was simple parts fast, right now we’re able to make quite complicated parts, but it’s through the software, it’s the coding parts, in the Twin Cities we quote a thousand jobs today.

A traditional machine shop would take days, maybe even a whole week to do just one code, but we are able to do it through technology. When an order is coded we have already done all the machine tool path and so somebody says order, it can converted to be in a machine in minutes being manufactured. Our factories set up to do everything that’s quick turn. So what it comes to being, it’s setting up the business to do what we do and then having software that enables it.

Nicole DeBlase - Morgan Stanley

Okay. And I have got plenty of questions on just not just the business model but potentially what’s going on right now, but I wanted to open up to audience in case there is any questions about what Proto Labs actually does? Okay, okay so we are going to move on. So, I mean, you guys have shown really, really impressive revenue growth over the past since you have been public essentially. So can you just talk about sustainability of revenue growth in the 20% plus range and how reliant is your growth upon just the global macro environment?

Jack Judd

Great question, Nicole. I guess I invited everybody to go off and look at the camp study that we finally had done. One of the weaknesses when we were all doing our IPO 19, 20 months ago was everybody want to know the size of the market. And since we are really the only ones in the world that do what we do, there is no concept of quick turn manufacturing for what we do besides with us. There was no definitive study of how big the market was. So we paid a couple of companies to do the study early this year in the first half of the year and the study came forward with a $6 billion market opportunity.

So we are living in a huge marketplace and we’re able to go and realize that really by going off and finding individual product developers that are needing to get something done. And most of the time the way we find them is that they have got a problem, maybe there has been an acceleration of their development cycle, maybe somebody said that they were going to do something that they didn’t get done. It could be that something changed at the last moment.

Whatever was is that our number one way someone finds this is that they have a problem. And so in other words, one of our biggest issues is customer awareness. But the way we had grown this business so successfully over the past years is to going out and needing more product developers every day, selling them successfully and to the highest extent having these product developers then act as marketing agents for us within the company.

So we do feel the macro environment. As an example last year, we thought Europe, I would say that our growth rate in Europe shrunk by two-thirds last year from what we were expecting and there was no doubt that everybody in Europe for, I would say two or three quarters stop spending. And for us stop spending means, we only grow about 20%, but for everybody else it’s probably more dramatic, but Europe is recovered nicely and I think that our revenue increases in Europe last quarter demonstrated that.

We do feel the macro environment a little bit, but even in 2008 and ‘09 we were basically flat. So we probably are not going to feel to be extent a traditional machinery manufactures who were might be down 30 or 40% one year over another.

Nicole DeBlase - Morgan Stanley

Yeah, Proto homerun in that period, and the question about it. So, I mean, you brought up the market study which I think was really interesting work. And I think $6 billion first of all has got a global number, and second of all how do you size the market, so what does that include?

Jack Judd

So one of the great news about that $6 billion is geographies we compete in which is Western Europe, North America and Japan, so it does have a limited geography and it’s the services we provide. So it’s not all prototyping, it’s just the prototypes that we can make with our own limitations. Since we do everything fast, we don’t do everything and so $6 billion I think it starts all with the prototyping market of around $20 billion. So it’s quite dramatic, the market is large, that does not include additive by the way. And so it's getting done some way, it's just not getting done fast.

Nicole DeBlase - Morgan Stanley

Okay, got it. And so if you were to add, continue to add new materials through offering that would essentially expand your total market size, correct?

Jack Judd

Yes, there is lot of ways to make parts that we don't do. I'll just do an example right now die casting, we don't die cast. And so if you could die cast, you would increase [your term] significantly for what we think will often accomplish. And hopefully over the next couple of three years, you will see us announce a lot more ways for us to make parts, that’s one of the major R&D efforts that we have right now just trying to create new services and new materials, so that we can satisfy more of the needs of product developers.

Nicole DeBlase - Morgan Stanley

Okay, got it. And when you guys recently announced the acquisition of the new manufacturing facility. Can you just talk a little bit about what you've actually purchased and how it's going to help your customers from a increased capacity standpoint?

Jack Judd

It's really interesting to talk about how we're manufacturer and I think everybody here is business industrial companies where they surge around factories at 90%, 95% capacity because that's where they need to run them to be able to get their best margins.

Our factories run at about 80% capacity when they really run well. When we get up and we’re 90% busy, we start to have problems because we sell time. And so we have to have a factory that always can take another order. We don't like factories to be down in 50% or 55%, because that's not good, that's not good to have that 95%. So we are always buying capacity ahead of what we actually needed for our current revenue stream or even our short-term revenue stream.

So we recently announced that we bought a building that's going to need a lot of renovation in the Twin Cities area, which will then make four factories in the Twin Cities area that we make parts in. It's a 175,000 square feet and when that comes on board we are going to do all of North American Firstcut and that’s what we anticipate and I think all of our Firstcut in North America will be done out of that building, but it will still only be, may be half full, so we’ll have a lot of empty force space. That’s not a big drag on our gross marginal, and we will buy equipment and we’ll hire people as we need them. So we would be putting new equipment and new people onboard this quarter that we will need maybe second quarter or third quarter of next year. So we are always trying to put the equipments and people capacity on about six months in advance. Of course space much earlier.

Nicole DeBlase - Morgan Stanley

Okay got it. Why don’t we open for the audience question up here?

Unidentified Analyst

Hi Jack, so you got three facilities I believe so globally, there’s hundreds of countries, any desire to expand that footprint anytime?

Jack Judd

Yes. But not all geographic areas are known for product development. You really need to be in the geography that you are going to sell into for shipping purposes that you are going to sell things for time. So if you were going to be in Brazil, you’d have to be down in Brazil, you couldn’t effectively market Brazil out of the United States. So if we ever desire to be in other geography, we’ll have to probably open up, whether it would be Korea, China, India, maybe Eastern Europe. But a lot of those markets are not big product development markets.

And then as some of you if you have heard me talk before is, we don’t make money in Japan right now. We are a conservative mid-western company, and we can have enrolled one [believer] at a time. So I think that our concentration in geographies anyway is getting Japan often running and successful. We’ll then we’ll consider another geography, but it’s probably going to be a country more well known than the third world.

Unidentified Analyst

And then do you have any competitors anyone that you would describe as doing some of the work you are doing.

Jack Judd

We are not aware of anybody that can do what we could do at scale anywhere in the world. Now there are people that can machine parts, machine shops if they decided to dedicate themselves an Injection Molding company, decide to dedicate themselves they could do something pretty fast but of course that’s not a scale and it’s not duplicable. So we don’t really call them a competitor. There is an element of a service bureau aspect to our business where people run service bureaus and you would give them your job that you needed and then they would call their network of suppliers and see whether something could get done. Again they can’t get it done as fast as we do it, and it’s definitely not as convenient. But there is some ways of getting it done fast, but it’s always a smaller more individualistic method.

Unidentified Analyst

And finally as you have the new facility in the U.S. is that going to put pressure on your margins and so do you absorb that capacity?

Jack Judd

Yeah factories, new factories come aboard, I think the pressure that you are going to see in margins is more of a cost of putting the facility in place to quarterly move-in. We currently do our Firstcut out of our headquarters building. So we’ll move all that factory capacity to the new building and it will probably take us a quarter to get complete, and so I would say for that quarter we’ll see some lowering of our gross margin. We’ve not given guidance exactly on that. I think if you listen to our conference call for earnings on October 31, we’ll probably have something for the marketplace. But it will be a couple of points maybe even less than that, it will be more of a one quarter phenomena and I would guess that our margins to pop backup to what they have been recently shortly after the move. Good question, [Nigel] thank you.

Nicole DeBlase - Morgan Stanley

And you talked about customer awareness as one of biggest hurdles you face right now. Can talk about what the way you think about advertising and what you can do to kind of overcome that?

Jack Judd

Like a lot of companies marketing has a lot of ideas and then there becomes a value proposition with the marketing and it falls off. So in our history we’ve tried just about everything that we can marketing wise, and so attending more trade shows might cost more, but I am not so sure we are going to get the payback doing more trade publication advertising, I am not so sure we’d have to pay backs. So we are always looking for the next creative idea to get product developers onto our websites so that we can start marketing on.

Our goal is to get somebody to register with us some way or another. We go to a trade show, we send them something through an email blast, they come back to us and when somebody registers with us, we start selling them. Our number one marketing spend is search engines, that’s where we spend most of the money for people to put in key words, so we do like a lot of people do, we buy key words. But the number one way we get new names is viral marketing and that is that one engineer in the company tells us about other engineers in the company and that’s why we spent so much of our energy marketing within companies first is trying to go up and find a garage inventors.

Nicole DeBlase - Morgan Stanley

Question up there.

Unidentified Analyst

How much of your quote is automated versus a salesmen coming in and looking at the plans and stuff?

Jack Judd

A great question; a potential customer will upload a 3D CAD model to us and our software analysis it and depending upon the customer there is some manual interventions. So if you are a customer that has done ten different jobs with us, it probably goes through without any intervention because you know how to make molds or make parts that we can make, you understand the materials. If you are somebody that’s brand new, you are probably guaranteed to get a call back from somebody. From us making sure that when that call comes back, you understand what it is, we might also be giving you some design tips when we give you [core packs], so we're going to help you work through design types. So that's a manual intervention.

And there is some manual intervention in the mold design. So that make sure that we can design a mold properly, that happens all in the background. So if it’s 1 o’clock on a Monday or Tuesday and you have given us a 3D CAD model, you most like are going to call back to us within a couple of hours with an offer to call in to somebody or somebody might call you back saying you understand what you have, but there is a very little true manual intervention, there is minutes of manual intervention [per quote].

Nicole DeBlase - Morgan Stanley

Okay. I’ll continue. So just thinking about how you go about generating new accounts. Can you talk a little bit about what you've done from a sales person perspective over the past couple of years and your plans for adding more sales people in the future?

Jack Judd

All of our sales is done over the telephonic. If you think about the value proposition, putting somebody on the road for a $3,000 or a $4,000 order, when somebody might have business with you once a year, you can see that the money side if it wouldn't work out to have face to face sales force. So we do all of our selling over the phone, it takes about 6 months to 12 months to train somebody to sell, they have to know a lot about plastic injection-molding, they have to know a lot about machining.

And so it's not as if it’s like a lot of telephone sales where somebody could be productive in a month, but we add people in tranches and we generally sell the same way in all our markets so we do in the U.S. But we do them for training purpose in tranches and like maybe we hired 10 at the first of the year and I’m going to guess that we are in the process right now of adding other tranche of sales people.

But it’s a case of within a week, they are on the phone with somebody sitting side by side with them calling up product developers that they can get trained life. But it’s a case of continually adding sales people. I think we’re up over 90 people on the phone directly right now worldwide. And I think we were at 60 some a year ago.

Now for every three sales people that we hire, we need to hire two support people. So whether it’s customer service or whether it’s customer service engineers, people that will answer questions from our customers on materials or if they knew the technical advice, we do have some people that can do that. So I expect this coming year we’ll add 30 to 50 people in the greater selling organization.

Nicole DeBlase - Morgan Stanley

That’s quite a while. So, I mean, it sounds just about new account. So, I mean, you guys have done a really good job generating a lot of revenue from your existing account. So how do you do that and then how do you incentivize your sales people?

Jack Judd

It’s a lot faster when you have somebody that’s really happy customer, and people when they do business with us, we solve problems. We take an emergency and we make it easy for them. So people are very happy to recommend us and so employee, A, says, you got to talk to employee, B. And so we spend more of our selling efforts going deeper and wider into our present customer base than we do necessarily calling somebody that’s never done business with us before. And that’s why we talk about product developers. What was the second half of that question again?

Nicole DeBlase - Morgan Stanley

How are sales people incentivized?

Jack Judd

People are incentivized by selling to new customers or new product developers. I think that if somebody sells somebody knew, they retain that person for commission purposes for nine months. And so if you are not selling new people all the time, your commissions are going to go down. A salesman typically I believe has about a 70% base, 30% commission. So 95% of our selling efforts is to get new product developers and to get them in. We believe that our services are sticky enough that once people see our value they come back easier. So we don’t need to continually sell them.

Nicole DeBlase - Morgan Stanley

Got it. And we probably have time for one more question if there is anything burning in the audience.

Unidentified Analyst

In terms of your equipment as 3D printing hardware becomes better, more capabilities, more advanced, faster, whatever it is, is it one of those businesses that you are going to essentially have to upgrade most of your capital base every couple of years or essentially end up with outdated infrastructure?

Jack Judd

Our machinery is CNC mills, we buy them from [past automation]. They really if you maintain them properly have a life of 10 to 12 years. Injection molding press is currently we’re buying Toshiba Electric presses and they also have lives of 10 years if maintained properly. I think the type of machinery that the additive people have is extremely different from what we do and probably does have some element of obsolescence and a little bit (inaudible) basis than what we use. Our machinery is off the shelf standard, so it’s not really, it’s not meant just for us. And so I believe it will have a longer life within our factories than custom made machinery.

Nicole DeBlase - Morgan Stanley

Okay, great. Well, thanks so much for your time.

Jack Judd

Thank you, everybody.

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