Greetings. Welcome to Proto Labs Fourth Quarter 2021 Earnings Call. At this time, all participants will be in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. At this time, I’ll turn the conference over to Jason Frankman, Vice President and Corporate Controller. Jason, you may now begin.

Thank you, Rob, and welcome everyone to Proto Labs’ fourth quarter and full year 2021 earnings conference call. I’m joined today by Rob Bodor, Proto Labs’ President and Chief Executive Officer, and Dan Schumacher, interim Chief Financial Officer. This morning, Proto Labs issued a press release announcing its financial results for the fourth quarter and full year ended December 31, 2021. The release is available on the company’s website. In addition, a prepared slide presentation is available online at the web address provided in our press release. Our discussion today will include statements relating to future performance and expectations that are or may be considered forward-looking statements and subject to many risks and uncertainties that could cause actual results to differ materially from expectations. Please refer to our earnings press release and recent SEC filings, including our annual report on Form 10-K for information on certain risks that could cause actual outcomes to differ materially and adversely from any forward-looking statements made today. The results and guidance we will discuss include non-GAAP financial measures consistent with our past practice. Please refer to our press release and the accompanying slide presentation at the Investor Relations section of our company website for a complete reconciliation of non-GAAP to GAAP results. Now I’d like to turn the call over to Rob Bodor. Rob?

Thanks, Jason, and good morning, everyone. During 2021, like many companies, Proto Labs faced our fair share of disruptions, external and internal. Throughout the year, we overcame these disruptions and continued to invest in strategic areas that will drive further and future profitable growth, including our employees, hubs, Protolabs 2.0, and new customer offerings. Despite the challenging operating environment and external shocks over the past two years, our business fundamentals and market opportunity remain very strong. As we enter 2022, Proto Labs is a profitable, growing technology-enabled digital manufacturer with strong cash flow. The combination of Proto Labs’ best-in-class rapid manufacturing services and Hubs’ outsourced manufacturing partner network is truly a unique model in this market, a market that has grown rapidly with the continued digitalization of manufacturing. The external disruptions to our business in 2021 are well known. The global pandemic and new variants continue to add uncertainty and complexity to all businesses. Supply chains have been massively disrupted due to labor and material shortages. Brexit added additional logistics and import-export complications for companies that operate in the region, particularly Proto Labs given the quick turn nature of our manufacturing services; and last but certainly not least, the United States recently experienced its fastest rate of inflation in four decades. However, despite the challenging operating environment, 2021 was one of the most transformative years in our company’s 22-year history. We executed on our top priorities: to create an industry-leading digital manufacturing platform, to expand our portfolio of customer offerings, and to invest in our employees. The year was highlighted by two game-changing transformations for us. First, we completed the largest acquisition in our history and joined forces with Hubs to expand our offerings and serve more customer use cases. We are very excited about providing an integrated offer to…

Thanks, Rob. Good morning, everyone. I’ll take you through three areas of financial details. I will start with the fourth quarter, then go to full year highlights, and I will conclude with our outlook for the first quarter of 2022. Throughout my remarks, I will reference slides from our quarterly deck. Our fourth quarter financial results begin on Page 7 of the presentation. Fourth quarter revenue of $123.6 million was slightly above our guidance range and represents a 17.5% year-over-year increase, or 8.6% organic growth in constant currencies. Revenue came in ahead of our expectations due in part to strong production orders and execution on delivering these orders at the end of the quarter. Hubs generated $9.9 million of revenue in the fourth quarter, representing growth of approximately 40% year-over-year. Changes in foreign currency had a $600,000 unfavorable revenue impact in the quarter. During the fourth quarter, supply chain constraints and electronic shortages impacted demand for our quick turn Proto Labs services. As our customer endured near record lead times for production materials and components, they are willing to wait longer for custom metal and plastic parts. We offer the fastest lead times in the industry, but there are occasions when customers value price over speed. Meanwhile, the broader of range of lead times and pricing options offered by Hubs really resonates with customers in today’s climate, as evidenced by Hub’s 40% growth. As Rob highlighted a few minutes ago, this is how our hybrid model is more resilient to economic cycles than many of our peers. In Europe, fourth quarter revenue of $22.1 million amounted to growth of 20.4% year-over-year. Excluding Hubs’ revenue in Europe and the impact of foreign currencies, our Europe revenue declined 4% year-over-year in the fourth quarter, reflecting continued supply chain challenges in the overall…

Thank you Dan. In 2022, we are well positioned for success due to the work that we’ve done in the past few years. We are taking several measures to address the near term challenges facing our business, including thoughtful pricing changes to offset cost inflation, improving internal operating efficiency, and investing further in automation. We have pricing actions in place in every service in every region. Some actions were initiated in late 2021 and others went into effect in early 2022. It will take some time to realize the full benefit of these changes. Within the Protolabs 2.0 environment, our internal operating efficiency continues to improve given the efforts of our software teams and our employees as they adapt to the updated processes. Additionally, our 2022 plan includes continued investment in productivity through workflow automation and robotics to enable us to scale our revenues faster than the need for additional labor. All three of these measures will continue to be areas of emphasis for us as part of our 2022 strategic priorities. At our investor day in May 2021, we outlined our three-phase plan to double revenue by 2026: first, to establish the platform; second, to accelerate our growth; and third, to expand profitability. We are on track. We made great progress on positioning the company to achieve our plan during 2021 by developing and strengthening our platform with Hubs and the Protolabs 2.0 systems and by accelerating our growth throughout the year, culminating in strong double-digit growth in the fourth quarter. For 2022, we have four strategic priorities to keep us moving forward. First is accelerating our revenue growth. Resources will be focused on expanding the capabilities of our services, integrating Hubs’ offering, improving pricing, and continuing to expand our production use cases to drive revenue growth. We will…

Yes, thank you. [Operator instructions] Thank you. Our first question is from the line of Brian Drab with William Blair. Please proceed with your questions.

Good morning. Thanks for taking my questions. First, just wanted to ask about gross margin. Thanks for the guidance for the first quarter. Is there any sense you can give us for how gross margin might progress as we move through the quarters in ’22?

Yes. We would – so Brian, we would expect it to improve sequentially through the year and that we would have improved gross margin percent year-over-year as volume is increasing quarter by quarter.

Is there any aspirational range or something by the end of the year? I know Rob just mentioned for revenue, hoping to reach a double-digit revenue growth rate by the end of the year, but any idea where we should exit, maybe exit ’22?

Yes. So we’re not really giving a guide, but I would just say that we expect to be -- our gross margin percent to be above what it is, non-GAAP gross margin percent to be above what it was in 2021.

Okay. And then I wanted to make sure I understood that comment about double-digit revenue growth by the end of 2022. Does that imply -- I don’t want to put words in your mouth, obviously, but does that imply single-digit revenue growth until we get to the end of 2022? Is that the goal to get the company back to double digits by then?

Yes. So what we’re saying is, look, we ended Q4 well, right? With a strong trajectory, the organic business was 9% and Hubs was growing 40%. We saw a slowdown in orders at the end of December and first week or so of January, given what happened with omicron, but since then orders have been on a good trajectory. And so we’re feeling confident that we’ll be able to get to that double-digit growth later in the year.

Okay, thanks. And then another topic I wanted to touch on was the -- you mentioned the digital and seamless ordering platform. The user experience now on the website is still -- you still kind of get directed to a few different areas, right? You get - there’s Proto Labs legacy and then you could use MyRapid, and then Hubs still seems very separate. I’m just wondering if you could explain where we are today and where we’re headed, and the timing of when all of those are really -- I feel like it could be more seamless, and I was wondering if you could just comment on that.

Yes, we agree - that’s exactly what we’re working for. Hubs right now is separate. Hubs is - you’re absolutely right. Hubs is separate right now, and we learned from the integration with rapid how critical a really seamless customer experience is, and that’s what we’re building.

And then I’m just wondering, too, is Hubs in the state of things today, does Hubs benefit really from being part of Proto Labs? Or are they – are you just kind of running them? How do they benefit today since they’re not -- you don’t go to the Proto Labs website and then find Hubs very easily? Are they kind of on a standalone basis and going for their earn-outs, and then sort of in an improving stage still? How are you thinking about that?

So today, Hubs has been operating largely independently. We’ve been making continued investments in Hubs and we’ve seen good growth from them. We’re also continuing to invest in innovations within Hubs. You’ve seen pricing improvements, right, which have driven gross margin, improvements there, and there have been investments in the manufacturing partner platform to improve the experience for our MPs and make sure we’re continually optimizing the opportunities that we sent to the MPs that are really tailored to them. That’s the work that we’ve been doing, and alongside that working on the front-end integration to make that seamless.

Okay, great. Good luck with everything. I’ll talk to you more later this morning, thank you.

Thanks, Brian.

The next question comes from the line of Greg Palm with Craig-Hallum. Please proceed with your questions.

Yes, good morning, and thanks for taking the questions here. I guess when you look back at the quarter, was there anything that surprised you? Revenue came in nicely above expectations, so just curious whether that was certain end market strength or whether it was just better execution overall.

Yes. So we had really good execution, especially in our injection molding production area. In that business, we got the lead times back to where they were. We entered the quarter with quite a big backlog in that business and our lead times probably were not where we wanted them to be. And so I’ve got to give credit to our production group within injection molding for really performing well within the quarter. That was one place in which we ended up having higher revenue, getting back to those lead times that put us over the guide.

Okay, makes sense. And specifically on the Q1 guide, can you give us any more color specifically for what you’re seeing in January? I mean, it’s been, frankly, a long time I think since you’ve seen any sort of sequential decline in revenue from Q4 to Q1. And I think if my math is right, it basically implies flattish organic growth on a year-over-year basis.

Yes. So Greg, we’re a quick turn business and we’re projecting things like we always have, so we’re taking a look at how the orders came in through January. And then based on seasonality trends that we’ve seen, based on uploading activity, we’re projecting out what happened in the quarter. We talked a bit about this, but I know us as a company and our customers, as Omicron came through, there was a much higher rate of infection that occurred and there were a lot more people that were out of the office. And so as we came out of the holidays into January, our thinking is that that kind of delayed starting everything up again in terms of when we come out of the holidays, when do orders start picking up. So that was a week or two later for us than normal, and we believe that some of that, the Omicron variant had something to do with that. I hope that helps.

Well, I guess what I’m trying to get a sense for is, does the guidance assume that it’s maybe a slower ramp through the quarter than what is normal, or are you still expecting a pretty steady ramp, because I think March is typically the most important month anyway. So I’m just trying to get a sense for what the guidance assumes for maybe March specifically.

Yes, I think it assumes that we get back up to where we would project or assume that we would be, so probably a steeper ramp up February and March because of the slow start in January. It’s just the ramp is happening a little bit later, and we can’t make up for the revenue shortfall that we’re seeing in January.

Yes, okay. Got it. Then last one, just a clarification, I think you mentioned something about a $1 million positive impact to gross margin in Q4. I didn’t catch what that was.

Yes, it was various items that had occurred in the fourth quarter, and we’re going to have margin fluctuations quarter to quarter and I’m just not projecting to see those coming in, in the first quarter.

Okay, all right. Thanks so much. Good luck.

Our next question comes from the line of Jim Ricchiuti with Needham & Company. Please proceed with your questions.

Hi, thank you. Good morning. I’m just wondering, as you look at the activity that you’re seeing in the quarter, early in the quarter, you cited omicron. Are you seeing--since it appeared to hit Europe earlier and that has improved a bit, perhaps quicker than it has in the U.S, have you seen more of a pick-up there that gives you the confidence that that gets behind us and we start seeing that pick-up in activity midway to late in Q1 here in the U.S.?

The trend in Europe is a bit different, and I think one of the things that at least we’re seeing is on the Hubs side, we’re seeing things fairly strong within Europe. On our quick turn business, the legacy business that’s within Europe, we went out and surveyed customers and what they’re dealing with is a bottleneck in their supply chain around microchips and electronics. As that occurs, they can wait a little bit longer for some customer parts, and they have alternatives, great alternatives like Hubs who they can wait a little bit longer for those parts and get them at a different price point, so we do feel like within Europe, at least with the trending that we’re seeing within Europe, that that bottleneck within the supply chain is impacting our quick turn business, but businesses like Hubs are benefiting from that. But we do feel like that’s why this hybrid model is so important to us, so that we can offer the quick turn when the customer needs it, but we can also offer a little bit longer lead times at a different price point.

Got it, thanks for that. You alluded to pricing actions, which we’re hearing from a lot of companies. I’m wondering if you can shed a little bit more light on that in terms of how we should be thinking about the implementation and the impact of those pricing actions over the next one to two quarters.

Sure Jim, I can start, and Dan, please chime in. We looked at our pricing across the board by service, and our objective is really to offset inflation both from supply, materials, and then of course labor. We have several dimensions that we manage this on, right - there’s kind of the base part has a certain price because there’s certain cost to make a part at, let’s say, quantity one, and then of course with volume, that will change because we’ve got volume price curves. Then as you have different complexities, you’ll also have different prices for that base part, and then of course the lead times. We looked at all of those and we’ve made adjustments in pricing in some of the base parts, in some of the material costs and those components. We’ve made adjustments to cover those, and then the shape of those curves, looking at how pricing falls with volume or how pricing changes with lead time, those were all adjustments that we made across the board in a really thoughtful way, to make sure that we’re covering our inflationary costs.

But in terms of seeing the impact as we go forward, is that going to be--do you expect to see the full benefit in Q2?

We’re going to see continued improvement throughout the quarters as it relates to that. I said this in my prepared remarks - we are seeing an improvement in basically revenue per unit, pricing improvement in the first quarter. It’s just January was very soft from us from a revenue perspective, otherwise you would see that improvement in the Q1 margin as well, but it will be a driver to show sequential improvement in our gross margin percent throughout 2022.

One final question, if I may, just on Hubs. Rob, if I heard you correctly, I think you said you anticipate improvement in Hubs gross margins in the current quarter, and I assume going forward. I wonder if you could talk to that. You had noted in recent quarters just about some of the branding challenges around Hubs in Europe. Are you guys past that, do you think?

Yes, we’re past that. The point about gross margin is that we’re continuing to invest in pricing optimization, and we’ve seen gross margins improve in Hubs in part because of that work. Over time, we expect to continue to see gross margin improvement.

One thing, Jim, just to clarify, quarter over quarter gross margins are slightly lower for--there’s some seasonality with Hubs margins, they’re slightly lower in the first quarter basically due to Chinese New Year, but yes, for sure on the full year, we expect to see an improvement in the Hubs gross margin.

Got it, thank you.

Thank you, Jim.

The next question comes from the line of Jared Maymon with Berenberg Capital. Please proceed with your questions.

Hey, good morning guys. First question for me, it sounds like the Hubs business and the base business in Europe kind of moved from a little bit of sequential stagnation in Q2 to Q3, back to growth in Q3 to Q4. It kind of sounds like what you’re saying is maybe some of these automotive customers in Europe were kind of willing to accept the longer lead times because of some of these semi backups, and that’s providing a little bit of a boost to the Hubs business. Is that correct in what you’re saying, and if that’s correct, is that kind of a temporary tailwind or do you think that’s sustainable in this return to strong sequential growth in Europe, could stick around through ’22?

Yes, so we are seeing that as supply chain disruptions are happening and in this kind of economic cycle, where therefore there’s less need for the quick turn in that part of the business, by contrast we’re seeing our longer lead time business pick up nicely, as evidenced by Hubs continuing to grow. We did 40% last quarter and we had strong double-digit year-over-year growth in Hubs throughout the year last year.

Got it, okay. Then another question on Hubs - I know you guys have owned this for about a year now, so I’m just curious, do you have any information on what percentage of the customers of the base Proto Labs business or Protolabs 2.0 business are using Hubs at this point, and then is there any difference between the percentage of top 100 or top 1,000 customers that are using this in comparison to the other 20,000 some-odd customers you guys have quarterly?

The overlapping percentage between the customer bases is still relatively small today, and that’s part of the opportunity that we see as we do the integration and we bring the Hubs capabilities to our Proto Labs customer base.

Okay, got it. Then last one from me, and sorry if you already mentioned this and I missed it, but it seems like there was a slight drop sequentially in G&A this quarter, and I’m just wondering if that’s typical seasonality or if there was something else there that is more sustainable.

Are you looking from a GAAP or non-GAAP perspective?

Looking at GAAP specifically.

Yes, so there was some change in stock-based compensation quarter over quarter that impacted G&A.

We also recognized a benefit of a reduction in the contingent consideration related to the Hubs acquisition that appears in G&A. That was $4.7 million in the quarter.

Both of those are non-GAAP items.

Okay, got it. Thanks guys.

The next question is from the line of Ben Rose with Battle Road Research. Please proceed with your questions.

Yes, good morning gentlemen. Some questions on the on-demand manufacturing service that you offer. I’m wondering in this environment how much of a competitive advantage is it for Proto Labs having its own facilities and not having the customers’ design shopped around to multiple sources. The question is really, is it an advantage that you have being able to maintain the security and the privacy of your customers’ product designs?

Yes Ben, we definitely hear that from our customers because oftentimes when they’re looking for a production vendor, they want to be able to audit, they want to be able to see the whole trail, they want to understand our security practices. We have customers for whom we have to guarantee understanding of what the security is for the building, what the entry and exit controls are, and the IT security and a number of things. Those audits can become very, very comprehensive, and so we definitely do see that as a benefit for our production customers who are looking for that kind of security, that we can provide that end-to-end. Our digital thread that runs throughout our production from, quote, all the way through the plant floor to shipping and that full traceability that we’re able to provide them, that’s quite unique, and in fact we have comments from auditors all the time that that provides them a great deal of comfort and that’s a system that they’ve really never seen before.

Okay, and then a question also, Rob, with respect to design complexity. I can definitely understand the use cases for the Hub service, where it might be a very large quantity of parts, perhaps, not with a great deal of design complexity, where the lead time isn’t that critical, but with respect to your core services, I can definitely see that being preferred by customers. Is that the right way to think about part of the distinction between your core services versus Hubs’?

I think Hubs brings two dimensions of additional capability. One is the higher quantities and longer lead times, lower pricing, so it extends in that context very much our production capabilities, right, into a broader range of needs for our customers. But the second is added party complexity or specialization, right, because through the network, we’ve got these premium manufacturing partners who have specializations and capabilities that might be beyond our core offering and so can therefore complement, so that might be very tight tolerances or it might be some kind of specialty machining, for example, or certain secondary operations or those kinds of capabilities that we don’t currently have in-house, the network can help complement and we can provide to our customers.

Okay, great. Then finally, I know that there’s been some recent initiatives within the company to target some of the growing EV manufacturers’ prototyping needs. Has that been a sector that’s been contributing to the performance in the last couple quarters?

What I would say, Ben, is in multiple industries in which innovation is at the forefront, people are using us, and EV and automotive is just one. But we see that in many different industries and spaces that as they’re innovating, they’re coming to us because of how fast we are.

Okay, thanks. That’s very helpful.

Thank you.

Thank you. At this time, we have reached the end of the question and answer session. I’ll now turn the call over to Rob Bodor for closing remarks.

Thank you for joining us on our fourth quarter and full year 2021 conference call. I want to thank the 2,700 Proto Labs and Hubs employees across the world for their continued efforts and enthusiasm as we enter 2022. Lastly, thanks to our customers and shareholders for their continued support. We look forward to updating you on our performance next quarter. Have a great day.

This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.