Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Proto Labs, Inc. (NYSE:PRLB)

Q3 2013 Earnings Conference Call

October 31, 2013; 08:30 AM ET

Executives

Brad Cleveland - Chief Executive Officer

Jack Judd - Chief Financial Officer

Bill Dietrick - Vice President of Marketing

Analysts

Troy Jensen - Piper Jaffray & Co

Nicole DeBlase - Morgan Stanley

Brian Drab - William Blair & Company

Jim Ricchiuti - Needham & Company

John Baliotti - Janney Capital Markets

Jason North - Jefferies

Tom Hayes - Thompson Research Group

Greg McKinley - Dougherty

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Proto Labs, third quarter 2013 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 Thursday, October 31, 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.

Bill Dietrick

Thank you, operator and good morning everyone. This morning before the market opened, Proto Labs issued a press release announcing its third quarter financial results for the period ended September 30, 2013. 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 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 annual report filed on Form 10-K 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 cost 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’d like to turn the call over to Brad Cleveland, Chief Executive Officer of Proto Labs. Brad?

Brad Cleveland

Good morning everyone. Thank you for joining us today on our third quarter 2013 conference call. With me today is Jack Judd, our Chief Financial Officer.

I will provide a brief overview of our third quarter 2013 financial results and some related commentary and update on some of the new processes and development within our Protoworks R&D division and a high-level description of one of our recent customer projects. Then Jack will provide a more detailed look at our financial results and offer our views on the outlook for the fourth quarter of 2013. After some final remarks from me, we will be glad to take your questions.

I am glad to report that for the sixth consecutive quarter, Proto Labs has achieved record revenue of $42 million, a 29% increase over the third quarter of 2012. This organic growth is strong evidence that there is a growing demand for our existing services, which obviously makes it even more exciting to develop additional accelerated manufacturing services within Protoworks, one of which we will be introducing to you today.

But first I would like to take a few moments to pass along some thoughts related to each of our three global operations. Proto Labs U.S. achieved record revenue of $31.9 million, a 25% increase over the same quarter in 2012. This marks the seventh consecutive quarter of sequential revenue growth in the U.S. As our largest geographic location, this is a very impressive rate of continued growth.

Proto Labs Europe also achieved an impressive revenue record of 5.5 million pounds, a very strong 51% increase over the same quarter in 2012. Our European team has performed wonderfully in 2013, coming off all the economic problems in the euro zone in 2012.

As a reminder, our European factory is located in Telford, United Kingdom and ships to customers in England, Germany, France, Italy and other countries throughout Europe. I would like to congratulate everybody in Europe on their breakthrough success during the most recent quarter.

And to round out all of our geographic success stories in the third quarter, Proto Labs Japan achieved record revenue of 157 million yen or 81% above the revenue of the same quarter during 2012. I am pleased to report that our Japanese operation has seen five consecutive quarters of strong growth.

Our progress towards break-even operations is on track and we continue to expect to be profitable during the last half of 2014. The combination of these record revenues allow the Global Proto Labs organization to achieve a record net income for the third quarter of 2013 of $8.9 million or $0.34 per diluted share.

As we mentioned in our second quarter earnings release, we now report on the number of product developers we do business with, regardless of the number of companies from which they come. We feel this is a more relative metric as it mirrors our go-to-market strategy of finding more product developers as the top priority, and adding new customer companies as the next priority.

During the third quarter of 2013, we did business with approximately 7,300 product developers. This is 23% higher than the same quarter in 2012. Our press release contains information both on product developers and customer companies to continue to allow a smooth transition to this new metric.

As we have discussed in prior calls, our R&D organization is called Protoworks and within it we have a number of very active initiatives under way. In past calls we have featured two initiatives; Magnesium Thixomolding and Metal Injection Molding or MIM. We continued to make steady progress in our rollout plans. Both of these new services are currently on our website and we are taking orders for these services selectively.

As we have reported during past calls, we expect to bring these offering to market in the coming month and our websites has been updated to help our customers understand the capabilities of these metal molding processes. Our initial marketing efforts have told us that both of these services will roll out slowly and we do not expect significant revenue contributions during 2014.

Also with regards to Protoworks, in past calls we have indicated we have other initiatives under way. Today I would like to introduce another process that is now moving out of research and into the development phase.

Liquid Silicone Rubber molding or LSR will be the newest offering within our Protomold series. We currently believe the global market for LSR to be approximately $11 billion with roughly 25% in the U.S., the same in Western Europe and 10% in Japan.

The market is growing 10% annually with the primary customer segments being medical, automotive, consumer, general industrial, aerospace and electronics. All markets where Proto Labs already has a strong presence. We are specially excited about LSR due it its established market and like plastic injection molding, we are not aware of any organization offering quick turn LSR services at scale.

We have sourced our first equipment and have already successfully produced several molds and parts. Over the next two to three quarters we will update our website and selectively take orders. We hope to be fully accepting orders for this service in mid-2014.

In the beginning we expect a slow ramp-up in orders, but feel there is a good possibility of a faster ramp due to a larger and more established market. We have other active projects ongoing in Protoworks and we hope to report on them over the next few quarters. Our expectation is that we will continue to transition them into full production, while continuing the progression of Thixomolding and Metal Injection Molding and liquid Silicone Rubber molding.

It is always fun to pass along a customer case study example, which this quarter is the form of some work we’ve done with Moxy Monitor, makers of a portable, low cost, muscle, oxygen-monitoring device for the athletic market.

Like many new companies, they experienced challenges around time to market with a very limited budget. Proto Labs was there from the start. Roger Schmitz from Moxy designed their system using aluminum parts to take advantage of Firstcut’s CNC machining service during early development process.

“I wanted to design something that was cheep for Firstcut to make and not outside its capabilities” said Roger. After refining the prototypes, other parts were designed to be affordably produced through Protomold’s injection molding service.

In explaining the value of Proto Labs services, Schmitz explained “we have three tools build by Proto Labs and one of them had a side action. If we had hard tooled that it would have been $50,000 to $75,000 and the product simply wouldn’t exists. It’s not like my second best options was just expensive. It’s that my second best option did not work. If I had to buy hard tooling, we literally would not be on the market.

The company’s goal is to product, sell and ship around 50 Moxy Monitors, which retail for $849 each per month in 2014 and eventually doubling that number. ‘There is a gazillion parts makers out there, but you guys are not like any of them’ says Schmitz about Proto Labs.

Now I would like to invite Jack to provide a deeper revenue of our financial results. Jack.

Jack Judd

Thank you, Brad. Revenue in our third quarter 2013 was $42 million, an increase of $9.6 million or 29% over third quarter 2012 revenue. Protomold revenue during the just completed quarter was $29.5 million and Firstcut revenue was $12.5 million.

During the quarter, Firstcut revenue represented 30% of total revenue, compared to 28% during the third quarter of 2012. Our international revenue was $11.4 million or 27% of total revenue during the third quarter of 2013, compared to $7.6 million or 24% of revenue during the same period in 2012.

The negative effects of currency were $500,000 this past quarter. As you viewed earlier, we are transitioning from looking at revenue growth from customer companies to the number of product developers we do business with each quarter. When looking at this new measurement, we did business with approximately 7,300 product developers in the just completed third quarter, compared to 5,900 the previous year.

Our gross and operating margins in the third quarter of 2013 were 61.8% and 31.9% respectively. During the third quarter of 2012 these were 60.7% and 29.5%. Our higher margins are a reflection of growing revenue, effective forecasting of labor and leveraging of our marketing and research and development expenses. Company wide at the end of September, we had 730 total employees versus 622 at the end of December 2012.

Diluted earnings per share in the third quarter of 2013 were $0.34. Adding back the after-tax cost of stock compensation, our non-GAAP diluted earnings per share in the quarter were $0.37. A 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 September 2013, our cash and investments totaled nearly $132 million.

Our new factory here in the Twin Cities is progressing nicely. The building we purchased in August needs significant rehab work to make it appropriate for our manufacturing. Our current goal is to be open in manufacturing in Firstcut parts early in the second quarter of 2014.

We expect the operating cost to this move will approximately $400,000 and will be equally split between the first and second quarters of 2014. The total capital we will deploy for this new factory will be approximately $15 million, of which $5.5 million was spent this past quarter. The remaining capital will be spent equally between our current fourth quarter and next year’s first quarter.

I would now like to provide some guidance into our projected results for the fourth quarter of 2013.

We currently expect revenue in the current quarter to be between $42 million and $45 million. Stock compensation costs in the current quarter will be approximately $900,000. We estimate our tax rate for the upcoming fourth quarter to be approximately 32%. Taking all of the above factors into consideration, our quarterly non-GAAP EPS, adding back the after-tax cost of stock compensation is expected to be between $0.35 and $0.39.

I would now like to turn the call back to Brad for some final comments.

Brad Cleveland

Thanks Jack. As a final topic, before we open the floor for questions, I would like to take the opportunity to let everyone know that I have informed our Board of Directors that my time with Proto Labs will be ending in the coming months. The company has never been in better shape and the future has never looked brighter, so it may seem strange for me to be leaving when everything is going so well.

My Board feels the same way, but as I have explained to them, I thoroughly enjoyed the experience at Proto Labs and would love to have the chance to do it all over again in another industry some day. And given how strong the company is today and the exciting new processes we have coming online, we should be able to attract CEO candidates that have successfully taken a business to $1 billion revenue level or beyond, so we don’t have to learn it all on the fly.

I’ve been the CEO from $1 million in revenue until today, and it has been a wonderful experience all around. Building a world class management team, expanding internationally and taking the company public were all a lot of fun and right now the company has never been healthier and the future has never looked brighter. So I would feel great about handing it over to someone that has the background to take it the next level.

There is no rush to leave, and it will almost certainly take months to find someone with the background we need. So this represents a great deal of advance notice, but from our perspective, we need to keep our employees, shareholders and customers aware of our plans and also give yourselves the time required to find the ideal candidate to continue to move the company forward. I look forward to staying with the company through the entire leadership transition.

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

Question-and-Answer Session

Operator

Thank you. And the first question comes from the line of Troy Jensen of Piper. Please go ahead, your line is open.

Troy Jensen - Piper Jaffray & Co

Congratulations on the nice results gentlemen.

Brad Cleveland

Thank you, Troy.

Jack Judd

Thanks Troy.

Troy Jensen - Piper Jaffray & Co

Hey, so Brad I was wondering maybe if could just elaborate a little bit on your resignation. Are you just moving into early retirement here or off to a new venture and maybe touch a little bit on the bench strength and it sounds like you guys are looking externally for someone to run the company.

Brad Cleveland

Yes, thanks Troy. Well first of all, I am too young to retire. I’m 53 years old. So I’m going to leave Proto Labs within the next year or so as soon as we find a great person and as soon as I leave I’m going to start thinking about the next adventure. I might take a couple of months off, but that will be about it.

So our focus right now is on the business and on finding a great candidate. I’ve always told Larry Lukis that my goal was to spend the first half of my life doing well, which primarily means financially take care of my family, and then spend the second half of my life doing good, which means to try and leave the world better than I found it. And you know at 53 I’m late, but it’s been a hell of a ride over the last 12 years as CEO.

So, thanks to customers, employees and investors, I’m ready to move on to doing something good, as soon as we find the right person to replace me; it’s really as simple as that. The company is in great shape, has a very bright future and I’ll stay until we find a CEO with the experience to take the company to the next level.

A philosophical note, one thing I’ve learnt over the last 10 years is that with rare exceptions, and a few comes to mind, but with rare exceptions I have seen that CEOs fall into three categories. The first category is the inventor, and that’s the person that gets the company started, proves the technology, gets the business model working and then focuses on the technology and hires someone else to get things organized. In our case that’s Larry Lukis and the great thing about Larry is he remains Chairman of the Board and we will have that continuity going forward.

The second type of CEO that companies bring on is the organizer and in that case, this is me. So at Proto Labs I’ve been the organizer to go from $1 million to over $100 million in revenue and I would love to do that again someday. That’s what’s really driving me to make the change.

And finally the next CEO that you need in a company is someone to be the builder, someone to take the $100 million or $200 million and get it to $1 billion level; that’s the person we are looking for. We are going to find somebody who has done it before, who has taken a $100 million company and built it into a $1 billion and we are looking for them right now. So we’ve hired a search firm, and we are seeking candidates. It could take months, but we are in no big hurry.

In terms of the bench strength, I think I mentioned this in the call. We have an amazing bench strength. Internationally we’ve got fantastic leaders in Europe and in Japan and in the Untied States we have world-class marketing, sales, manufacturing, human resources and administration. So we are in a fantastic place to be, for me to make this transition. I can’t imagine a better situation.

Troy Jensen - Piper Jaffray & Co

Good luck Brad, you’ll be missed.

Brad Cleveland

Thank you.

Troy Jensen - Piper Jaffray & Co

If I could just add one follow up question, maybe on the new and existing customers. New customers are flat on a year over year basis. I know you’ve been focusing more on, doing more with existing that holds up nicely, but if you could just kind of touch on those metrics, that would be great.

Brad Cleveland

Sure. Go ahead Jack.

Jack Judd

Thanks for noticing the metrics. I think this past quarter you saw that we on the customer company metric we added about the same number of companies that we had previously added in the quarters since last year sometime. So I think that metric proves that there are marketing and sales methods to find companies at about 700 or 750 a quarter.

But we are obviously digging deeper in those accounts, because of product developers that we are doing business with exceed that metric. So, I think that it does speak to the success of our marketing efforts going after product developers Troy.

Troy Jensen - Piper Jaffray & Co

All right, guys, I’ll cede the floor and good luck.

Brad Cleveland

Thanks Troy.

Jack Judd

Next question.

Brad Cleveland

Go ahead Mark.

Operator

Next question comes from the line of Nicole DeBlase from Morgan Stanley. Please proceed.

Nicole DeBlase - Morgan Stanley

Yes, thanks guys. Brad it’s sad to see that you’re leaving. So I guess focusing on margins a little bit. I was surprised at the continued strength of the margins given that you have a new facility. I thought we might be facing some cost absorption. Will we expect this to start hitting margins in 4Q or is that more of a 2014 event?

Brad Cleveland

It’s more of a 2014 event. We’ve had some fantastic progress on reducing the cost of our manufacturing, especially in Firstcut, but also in Protomold and also we don’t need to move into the new facility because of that quite as fast. So, I think you can expect to see some margin impact maybe in the second quarter of next year. So it has been great to delay that.

Jack Judd

The costs that we’ve incurred so far this year for the new facility are all capital and that’s sitting on the balance sheet. It really hasn’t impacted our gross margin at all, that will next year at …

Nicole DeBlase - Morgan Stanley

Okay, understood, that makes sense. And then marketing and sales expense stepped down to 12.9% of sales this quarter that was below, I think we’ve seen this like 14% run rate for a while. Was there anything to highlight there and then is it expected to stay at this level in 4Q?

Jack Judd

I think that you saw some leveraging especially going on with the marketing side. I would like to personally spend more money on sales and marketing as we have good ideas and so I still think 14% is a good number going forward. I think that this was more of a little bit of an aberration on the low side as we continue to try to add sales people and come up with great marketing ideas that bring us good effective leads.

Nicole DeBlase - Morgan Stanley

Okay, got it. Thanks for the color guys. I’ll pass it on, but nice quarter.

Brad Cleveland

Thanks Nicole.

Operator

The next question comes from Brian Drab of Proto Labs. Please proceed.

Brian Drab - William Blair & Company

Good morning.

Jack Judd

Congratulations on joining the team here.

Brad Cleveland

I didn’t know you were part of the company, that’s great. Welcome.

Brian Drab - William Blair & Company

Excuse me.

Jack Judd

I don’t think Brian caught it. Brian, they’ve got you registered as Proto Labs not as William Blair.

Brian Drab - William Blair & Company

No, I can’t, I can’t see that. Yes, they didn’t ask me what company I was with. So I thought she was just being efficient and maybe had me in the system.

Brad congratulations obviously on building a great company. Obviously sorry to see you go, but it makes sense. One of the things that they always said when I was in business school is that you learn, earn and return and it sounds like you are moving on to the return phase, which makes great sense.

Brad Cleveland

Thanks Brian. Don’t be surprised if I’m on the next earnings call though. It’s going to take us a while to find the right person, but we’ll see.

Brian Drab - William Blair & Company

Okay. Well, we won’t mind having you around for a little while. So the first question on the SLR offering. It sounds very exciting and I’m wondering, is that the initiative that we first discussed at the beginning of 2012 and Brad, you actually referred to that opportunity at that time as a once in a decade type of opportunity. Is this the same thing?

Brad Cleveland

No actually. This was started since then. We have another five initiatives within Protoworks that we hope to announce over the next, who knows, year to two years. And the one I was talking about before is still there, coming along very nicely and we are just not talking about it yet.

Brian Drab - William Blair & Company

Okay and that one I remember you saying that we would – I think you had an update towards the end of 2013 as to whether you felt it had a commercial viability. Is that still the plan?

Brad Cleveland

Considering it right now, I think it has a commercial viability. But we are not prepared to go into any details about what it is.

Brian Drab - William Blair & Company

Got it, got it, and then turning to Europe. I mean just really incredible growth there. Can you talk at all about which verticals or which specific countries, geographies within Europe that you saw strength in?

Brad Cleveland

Yes, I looked at that and in Europe what we see is growth in all of our markets and the success of all of our marketing campaigns and fantastic success by our sales team in Germany and in the United Kingdome and in Italy and all the other countries. So it’s just an overall sort of rising of the tide. Everything is working much, much better there. There is no big breakthrough, there is no big discovery, it’s just the people there are doing a fantastic job.

Brian Drab - William Blair & Company

Okay, great. And then just one point of clarification; the earlier question was around the new customer company growth, which as you reported on a year-to-date basis was flattish in the third quarter compared to the third quarter least year though. You are up 11% and you added 826 new customer companies if I’m doing the math correctly. And I’m wondering if you have any comment as to why that may have stepped up and if this 80/20 allocation of your sales initiative between 80% on existing customers, 20% roughly on new customer company generation, has that shifted or changed. Can you give any comment there?

Brad Cleveland

Well, not much to say about that. We continue to try and attract new companies to do business with us. And we have had a big shift towards doing more and more work to find product developers and companies that already know us and there is an enormous potentially for finding additional product developers inside existing customer companies.

And there is just a natural fluctuation in the amount of companies when they need us, that haven’t done business with us before that are willing to give us a try. So there is no specific reason why all of a sudden its up. We expected it to go up, because we are putting a lot of work into it.

Brian Drab - William Blair & Company

Okay, thanks very much and congratulations again Brad.

Brad Cleveland

Sure. Thanks Brian.

Operator

The next question comes from Jim Ricchiuti of Needham & Company. Please proceed.

Jim Ricchiuti - Needham & Company

Thank you. Good morning. I wanted to focus maybe a little bit more on the LSR market opportunity. Can you talk a little bit about the go-to-market strategy for this? How intense of a launch is there going to be and I’ve got some follow up questions regarding that.

Brad Cleveland

Sure. The launch will be soft at first. This is new to us in the terms of selling materials of that nature, but the market is huge and it breaks down into all the markets we are already serving. So our go-to-market strategy will be the same as it is for plastic injection molding, which is marketing directly to product developers who are in a hurry to get their products to market. Its just that now we can offer in additional sets of materials. It also runs of machines that are modified specifically for those materials. So we have to ramp up those machines and operators and so on in parallel.

Jim Ricchiuti - Needham & Company

Brad, would you anticipate a similar kind of margin profile?

Brad Cleveland

Yes.

Jim Ricchiuti - Needham & Company

Okay, and this is another question just relating to – you talked on a number of occasions about the need to really build awareness out there in the market and I know you don’t have direct overlap with the 3D printing world, its more complementary. But what I’m wonders is, with the attention that’s been focused on that segment of the market, is it creating more attention and awareness for what you guys do.

Brad Cleveland

Yes, absolutely. As people can print parts of their desktop, they expect to get injection molded or machined or LSR parts of any kind of molded parts faster and faster. So as we come out with the ability do that in days instead of weeks or months, that’s a wonderful thing. So what 3D printing has done for us is raised expectations on how fast you should be able to get parts made with standard manufacturing processes and that’s fantastic for us, we love it. So we think those guys are great and we wish them all the best.

Jim Ricchiuti - Needham & Company

I think so far as the last few months, the last six months or so with all the attention, are you guys noticing more inbound type queries.

Brad Cleveland

I don’t think so. No, the product developers, they know the difference between the processes and I just think that people are becoming more and more of a hurry all the time and that’s really good for us.

Jim Ricchiuti - Needham & Company

Okay and I’ll offer my congratulations. Quite an accomplishment building this company.

Brad Cleveland

Thank you. Its been a blast. It still is. Next question

Operator

The next question comes from the line of John Baliotti of Janney Capital Markets. Please proceed.

John Baliotti - Janney Capital Markets

Thank you. Good morning. Brad, I want to pass my congratulations on as well.

Brad Cleveland

Thank you.

John Baliotti - Janney Capital Markets

Just a question, your unique product developers served, some of the new data your giving us and the granularity is great and the growth rates continue to be at pretty significant levels, despite the comps obviously not being easy. Any color around what’s going on in that in terms of the mix of those developers or is it and I assume this is a function of your marketing and sales effort.

Brad Cleveland

Sure. Yes, we have a fantastic marketing group and also a fantastic sales group and I would say globally in both cases. The trick to doing marketing and sales is in our business you can’t see somebody something until they need it, and so the key is to get on their mind, make sure they know about us, so that when they need us, they think of us and they give us a try and I think we’re getting better and better at doing that in lots of different ways. And I give all the credit to our marketing and sales in the United States and in Europe and in Japan to constantly improve in that way.

John Baliotti - Janney Capital Markets

With regard to Europe, and obviously growth is very strong and I think people are sort of calibrated to expect softer trends just because of what’s going on in the economy, but you guys are clearly outgrowing any expectation there. Do you think there’s anything to the fact that maybe because its weaker over there that it makes your relationship with them much more valuable, because of the less capital intensive you can help them be?

Brad Cleveland

Well, that’s a good theory, but I don’t think we have any data that tells us that that’s the case. I personally think that as things slowed down over there from an economic standpoint. There was kind of a pent up demand for products being developed and that helped us a lot, because people were in a hurry to get their products to the market. So I attribute most of the growth over there to fantastic work by our team and a little bit of pent up demand to help our third quarter.

John Baliotti - Janney Capital Markets

So you think they are trying to – because the companies are trying to stimulate demand, trying to become more innovate to try to find some growth in that tougher environment.

Brad Cleveland

No, I would just say that they were frustrated because they couldn’t get their new products to market, because their companies wouldn’t support them and now that the economy is starting to improve, now they are in a rush to get their products to the market fast and that’s perfect for us.

John Baliotti - Janney Capital Markets

Great. Okay, again congratulations.

Brad Cleveland

Thank you.

Operator

The next question comes from the line of Peter Misek of Jefferies. Please proceed.

Jason North - Jefferies

Hi, this is Jason North for Peter. With those five additional product launches over the next year, what do you think about in terms of R&D to sales? Is it going to stay at this level or tick up a bit.

Brad Cleveland

Well, first of all we do have five additional processes in development that we haven’t announced. I am not saying that they will all be released over the next year, but I think over the next couple of years is a reasonable assumption, assuming they make it out of research, which is likely, but not certain, and I do not anticipate significant change in the amount that we spend on a percentage of revenue basis in either marketing or in sales. I think we’ve got systems and procedures in place to do marketing and sales and Jack has a comment as well.

Jack Judd

Yes, keep in mind also that the R&D line also has all of our software development for us to expand our envelop and everything else that it takes to bring parts to market, service to market and so the majority of money really in R&D is those kind of services versus distinct activities occurring in Protoworks.

Jason North - Jefferies

Great, thank you and the second question would be, with the additional capacity coming on next year, you said it would hurt the gross margins a bit in the second quarter. Any quantification you can apply to on that and how long would it be to ramp back up when the hit goes down. Thanks.

Brad Cleveland

During my comments on this call, I think we indicated that we thought there would be around $400,000 worth of cost hitting, our cost of goods sold or our gross margin line and then we said that they would approximate about half of it in the first quarter and half of it in the second quarter or thereabouts, maybe a touch bit more into the second quarter than the first quarter, but I guess it all depends.

Since the roll out of the factory is going to be around April 1, a couple of weeks of timing one way or another could move costs into either quarter. So I think we said a couple of hundred thousand each quarter would be a good way to model and then by the third quarter, those effects should be out the side of our P&L.

Jason North - Jefferies

Brad, thank you.

Brad Cleveland

Thank you.

Operator

The next question comes from the line of Tom Hayes of the Thompson Research Group. Please proceed.

Tom Hayes - Thompson Research Group

Thanks. Good morning guys.

Brad Cleveland

Good morning, Tom.

Tom Hayes - Thompson Research Group

Just wondering about Japan, nice year-over-year growth there. Is there any particular end market that’s driving and it doesn’t really sound like that’s changed your thoughts on the breakeven. I was just wondering, if you continue to see that growth, could you maybe see breakeven come sooner.

Brad Cleveland

Well, we’re projecting breakeven around the second half of next year, but we’ll have to wait and see how it holds. But, I couldn’t be happier with the performance in Japan.

To answer the first part of your question, it is a different set of markets over there. It’s the same markets we serve in the United States, but it kind of breaks down differently. They don’t have such a big medical device industry like we do in the U.S., but they have a very strong automotive industry of course. So we get a lot of our business over there out of the automotive industry.

The good news is that all markets are in a hurry to get to market faster, so our business case is the same. I could not be happier with how Japan is doing. They have, I think its five sequential quarters of growth and everybody there is very optimistic about the future. So its just a joy.

Tom Hayes - Thompson Research Group

Thank you.

Brad Cleveland

Sure.

Operator

And the next question comes from the line of Greg McKinley of Dougherty. Go ahead.

Greg McKinley – Dougherty

Thank you. I wonder, you’ve got so many new initiatives in the hopper. You’ve only talked about a few of them, but could you talk a little bit about your customer base in relations to those new product efforts.

Do you feel like you’ll be actually selling these new products to the same customer companies or to the same product developers that you are currently selling Firstcut and Protomold to or will it be an entirely different set of customers, because they are using different materials for different applications?

Brad Cleveland

That’s a good question. We have found that the same product developers designed parts to be made in plastic or in metals or in ceramics or in rubber or whatever. So as soon as someone gets to know us and they find out we have additional processes coming on line, they are very, very interested, because it helps them make their product. So the simple answer to your questions is yes, its the same group of people and we’ll use the same marketing and the same sales teams to sell them.

We just train our marketing and sales to advertise and to sell slightly different processes and you just have to use your imagination to look at all the different standard manufacturing processes that take a long time and whether or not this company could help accelerate them. In general the answer is yes, there’s a lot of opportunities for growth.

Greg McKinley – Dougherty

Okay. And in terms of – I mean you talked about it. It sounds like a massive addressable market for the liquid silicon rubber business. Is there any way for us to think about how your service would frame up versus how you’ve ramped the new offering when Firstcut a couple of years ago. Just to give us a sense for how you guys think those opportunities could shake out over a period of a couple of years or should we think of these as being very small incubator businesses for the next 36 months or so.

Brad Cleveland

Yes. Well, if you look at the size of the CNC machining industry in the world, its bigger than pretty much anything else. But liquid silicon rubber is a very large market, plenty big for us and we don’t know how fast people are going to demand parts from us, but my gut instinct is they are probably going to really enjoy getting their LSR parts dramatically faster than they otherwise could. So we don’t have a model, we don’t have a projection of how fast its going to grow, but we’re very optimistic.

Greg McKinley – Dougherty

And then will you describe that as a third business line, so Protomolds, we’ll have Firstcut and some other brand associated with it also.

Brad Cleveland

That’s very unlikely. Protomold in my opinion is a way to get fast parts that are molded. So LSR is molding, plus the Congestion Molding is molding. If we come out with other molding processes, it will be a part of Protomold as well is the current plan. If we come out with a third process, if we come out with a third trademark at some point, you can assume it will be very different from molding or from CNC machining.

Greg McKinley – Dougherty

Okay, thank you. And then Jack, just one clarification; the $400,000 in expenses that you indicated, so those are period expenses you expect to at least put between cumulative 400,000 between Q1 and Q2 next year as part of gross margin and that’s really maybe the only sort of margin implication we should think about in terms of this extra Firstcut capacity.

Brad Cleveland

That’s what we’re predicting right now and if you could remember back to when we opened our Rosemount facility; this means that we’ll actually spend less on opening and moving to this factory than we did with Rosemount. This will be cheaper than Rosemount.

Greg McKinley – Dougherty

Yes. Okay, thanks guys.

Brad Cleveland

Thank you.

Operator

And we have a question from Brian Drab of Proto Labs.

Brad Cleveland

Hi Brian.

Brian Drab - William Blair & Company

Hi, yes, I just wanted to ask one more question, and this is probably splitting hairs and doesn’t really matter that much, but the $11 billion of global market for the LSR, that’s obviously including a lot of high volume business and do you have any sense for what the quick turn, lower volume part of the business would be or do you expect that you’ll serve the higher volume niche of that market as well.

Brad Cleveland

Its actually a really good question Brian and not surprising coming from an engineer. Yes, we do not expect to change our business model and get into high volume production. We do not have that analysis of what the market size is for quick turn parts. So we will discover that on the fly, but my guess is it’s going to be a very significant demand for quick turn LSR molded parts. We will learn.

Brian Drab - William Blair & Company

Okay, great. And the reason I prefaced my questions the way I did is because even it’s a – clearly, even its only a couple of 100 million that you could service and you start to get a piece of that and you add $20 million to revenue, its going to add 10 points to your growth rate very quickly.

Brad Cleveland

I think that will be great.

Brian Drab - Proto Labs

Okay. Thanks very much.

Brad Cleveland

Thank you, Brian. Thank you.

Operator

You have no further questions, so I would now like to turn the call over to Brad Cleveland for closing remarks.

Brad Cleveland

Well, thank you all for joining us today. I hope we’ve conveyed a sense of our confidence and the continuing strength of Proto Labs business model and our excitement about the growth opportunities ahead of that. We look forward to updating you on our progress during our fourth quarter conference call and Happy Halloween everyone. Thank you.

Operator

Ladies and gentlemen, that concludes today’s presentation. Thank you for your participation and you may now disconnect. Please enjoy the rest of your day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Proto Labs' CEO Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts