PRLB 10-Q Quarter ended June 30, 2015

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		June 30,				December 31,
		2015				2014
		(Unaudited)
Assets
Current assets
Cash and cash equivalents		$	56,324			$	43,329
Short-term marketable securities			31,190				30,706
Accounts receivable, net of allowance for doubtful accounts of $150 and $198 as of June 30, 2015 and December 31, 2014, respectively			29,493				24,226
Inventory			6,828				6,194
Prepaid expenses and other current assets			3,935				3,406
Income taxes receivable			2,931				-
Deferred tax assets			464				483
Total current assets			131,165				108,344
Property and equipment, net			100,921				91,626
Goodwill			28,916				28,916
Other intangible assets, net			3,710				4,083
Long-term marketable securities			54,482				54,318
Other long-term assets			197				227
Total assets		$	319,391			$	287,514
Liabilities and shareholders' equity
Current liabilities
Accounts payable		$	11,334			$	7,882
Accrued compensation			8,264				6,067
Accrued liabilities and other			1,779				2,718
Income taxes payable			-				1,953
Current portion of long-term debt obligations			71				139
Total current liabilities			21,448				18,759
Long-term deferred tax liabilities			2,423				1,846
Long-term debt obligations			-				10
Other long-term liabilities			1,533				1,360
Total liabilities			25,404				21,975
Shareholders' equity
Preferred stock, $0.001 par value, authorized 10,000,000 shares; issued and outstanding 0 shares as of each of June 30, 2015 and December 31, 2014			-				-
Common stock, $0.001 par value, authorized 150,000,000 shares; issued and outstanding 25,953,735 and 25,838,110 shares as of June 30, 2015 and December 31, 2014, respectively			26				26
Additional paid-in capital			187,070				180,960
Retained earnings			109,621				87,482
Accumulated other comprehensive loss			(2,730	)			(2,929	)
Total shareholders' equity			293,987				265,539
Total liabilities and shareholders' equity		$	319,391			$	287,514

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		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2015				2014				2015				2014
Statements of Operations:
Revenue		$	63,969			$	52,866			$	122,505			$	98,940
Cost of revenue			26,419				20,183				49,701				37,233
Gross profit			37,550				32,683				72,804				61,707
Operating expenses
Marketing and sales			9,502				7,261				18,356				13,678
Research and development			4,397				3,914				8,711				7,370
General and administrative			6,304				5,534				12,549				10,237
Total operating expenses			20,203				16,709				39,616				31,285
Income from operations			17,347				15,974				33,188				30,422
Other income (expense), net			(36	)			(66	)			(493	)			37
Income before income taxes			17,311				15,908				32,695				30,459
Provision for income taxes			5,625				4,952				10,556				9,401
Net income		$	11,686			$	10,956			$	22,139			$	21,058
Net income per share:
Basic		$	0.45			$	0.43			$	0.86			$	0.82
Diluted		$	0.44			$	0.42			$	0.84			$	0.81
Shares used to compute net income per share:
Basic			25,921,111				25,620,005				25,885,888				25,597,055
Diluted			26,277,503				26,146,848				26,245,135				26,132,265
Comprehensive Income (net of tax)
Comprehensive income		$	12,960			$	11,488			$	22,338			$	21,762

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		Six Months Ended
		June 30,
		2015				2014
Operating activities
Net income		$	22,139			$	21,058
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			6,940				4,683
Stock-based compensation expense			2,909				2,248
Deferred taxes			620				107
Excess tax benefit from stock-based compensation			(989	)			(1,623	)
Amortization of held-to-maturity securities			632				854
Changes in operating assets and liabilities:
Accounts receivable			(5,219	)			(5,742	)
Inventories			(663	)			(306	)
Prepaid expenses and other			(469	)			(372	)
Income taxes			(3,687	)			2,431
Accounts payable			3,377				5,143
Accrued liabilities and other			2,243				(2,464	)
Net cash provided by operating activities			27,833				26,017
Investing activities
Purchases of property and equipment			(15,717	)			(31,625	)
Acquisitions, net of cash acquired			-				(33,864	)
Purchases of marketable securities			(25,389	)			(38,463	)
Proceeds from sales and maturities of marketable securities			24,109				55,441
Net cash used in investing activities			(16,997	)			(48,511	)
Financing activities
Payments on debt			(77	)			(954	)
Acquisition-related contingent consideration			(1,000	)			(400	)
Proceeds from exercises of stock options and other			2,207				1,806
Excess tax benefit from stock-based compensation			989				1,623
Net cash provided by financing activities			2,119				2,075
Effect of exchange rate changes on cash and cash equivalents			40				234
Net increase (decrease) in cash and cash equivalents			12,995				(20,185	)
Cash and cash equivalents, beginning of period			43,329				43,039
Cash and cash equivalents, end of period		$	56,324			$	22,854

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Note 1 – Basis of Presentation

The unaudited interim Consolidated Financial Statements of Proto Labs, Inc. (Proto Labs, the Company, we, us or our) have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These statements are unaudited but, in the opinion of management, reflect all adjustments necessary for a fair presentation of the Company’s statement of financial position, results of operations and cash flows for the periods presented. Except as otherwise disclosed herein, these adjustments consist of normal, recurring items. Operating results for interim periods are not necessarily indicative of results that may be expected for the fiscal year as a whole.

On April 23, 2014, the Company completed the acquisition of FineLine Prototyping, Inc. (FineLine). The operations of FineLine have been integrated into the operations of the Company and operating results beginning April 23, 2014 are included in the consolidated results under the Fineline product line.

The preparation of the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures at the date of the financial statements and during the reporting period. Actual results could materially differ from these estimates. For further information, refer to the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 as filed with the Securities and Exchange Commission (SEC) on February 27, 2015.

The accompanying Consolidated Balance Sheet as of December 31, 2014 was derived from the audited Consolidated Financial Statements but does not include all disclosures required by U.S. GAAP for a full set of financial statements. This Form 10-Q should be read in conjunction with the Company’s Consolidated Financial Statements and Notes included in the Annual Report on Form 10-K filed on February 27, 2015 as referenced above.

Note 2 – Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. This ASU is a comprehensive new revenue recognition model that requires a company to recognize revenue from the transfer of goods or services to customers in an amount that reflects the consideration that the entity expects to receive in exchange for those goods or services. The Company is required to adopt the new pronouncement using one of two retrospective application methods.

On July 9, 2015, the FASB voted to approve a one-year deferral of the effective date of ASU 2014-09 by one year to December 15, 2017 for annual reporting periods beginning after that date. The Company is evaluating the application method and the impact of this new standard on our financial statements, but does not expect the impact to be material.

Note 3 – Net Income per Common Share

Basic net income per share is computed based on the weighted-average number of common shares outstanding. Diluted net income per share is computed based on the weighted-average number of common shares outstanding, increased by the number of additional shares that would have been outstanding had potentially dilutive common shares been issued and reduced by the number of shares the Company could have repurchased from the proceeds from issuance of the potentially dilutive shares. Potentially dilutive shares of common stock include stock options, restricted stock units and restricted stock awards granted under stock-based compensation plans and shares committed to be purchased under the employee stock purchase plan.

The table below sets forth the computation of basic and diluted net income per share:

Note 4 – Goodwill and Other Intangible Assets

The changes in the carrying amount of Goodwill during the six months ended June 30, 2015 were as follows:

Intangible assets other than Goodwill at June 30, 2015 and December 31, 2014 were as follows:

Amortization expense for intangible assets for the three and six months ended June 30, 2015 was $0.2 million and $0.4 million, respectively. Amortization expense for intangible assets, which were acquired in the purchase of FineLine in April 2014, was $0.1 million for each of the three and six months ended June 30, 2014.

Estimated aggregated amortization expense based on the current carrying value of the amortizable intangible assets is as follows:

Note 5 – Fair Value Measurements

ASC 820, Fair Value Measuremen t (ASC 820), defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires classification based on observable and unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:

Level 1 —Quoted prices in active markets for identical assets or liabilities.

Level 2 —Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 —Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company’s cash consists of bank deposits. The Company’s cash equivalents measured at fair value consist of money market mutual funds. The Company determines the fair value of these investments using Level 1 inputs.

A summary of financial assets as of June 30 , 2015 and December 31, 2014 measured at fair value on a recurring basis follows:

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Note 6 – Marketable Securities

The Company invests in short-term and long-term agency, municipal, corporate, commercial paper and other debt securities. The securities are categorized as held-to-maturity and are recorded at amortized cost. Categorization as held-to-maturity is based on the Company’s ability and intent to hold these securities to maturity. Information regarding the Company’s short-term and long-term marketable securities as of June 30, 2015 and December 31, 2014 is as follows:

Fair values for the corporate debt securities are primarily determined based on quoted market prices (Level 1). Fair values for the U.S. municipal securities, U.S. government agency securities, certificates of deposit and commercial paper are primarily determined using dealer quotes or quoted market prices for similar securities (Level 2).

The Company tests for other-than-temporary losses on a quarterly basis and has considered the unrealized losses indicated above, which are the result of changes in interest rates, to be temporary in nature. In reaching this conclusion, the Company considered the credit quality of the issuers of the debt securities as well as the Company's intent to hold the investments to maturity and recover the full principal.

Classification of marketable securities as current or non-current is based upon the security’s maturity date as of the date of these financial statements.

The June 30, 2015 balance of held-to-maturity debt securities by contractual maturity is shown in the following table at amortized cost. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

Note 7 – Inventory

Inventory consists primarily of raw materials, which are recorded at the lower of cost or market using the average-cost method, which approximates first-in, first-out (FIFO) cost. The Company periodically reviews its inventory for slow-moving, damaged and discontinued items and provides allowances to reduce such items identified to their recoverable amounts.

The Company’s inventory consists of the following:

Note 8 – Stock-Based Compensation

Under the 2012 Long-Term Incentive Plan (2012 Plan), the Company has the ability to grant stock options, stock appreciation rights (SARs), restricted stock, stock units, other stock-based awards and cash incentive awards. Awards under the 2012 Plan will have a maximum term of ten years from the date of grant. The compensation committee may provide that the vesting or payment of any award will be subject to the attainment of specified performance measures in addition to the satisfaction of any continued service requirements and the compensation committee will determine whether such measures have been achieved. The per share exercise price of stock options and SARs granted under the 2012 Plan generally may not be less than the fair market value of a share of our common stock on the date of the grant.

Employee Stock Purchase Plan

The Company’s 2012 Employee Stock Purchase Plan (ESPP) allows eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions of up to 15 percent of their eligible compensation, subject to plan limitations. The ESPP provides for six-month offering periods ending May 15 and November 15, respectively. At the end of each offering period, employees are able to purchase shares at 85 percent of the lower of the fair market value of the Company’s common stock on the first trading day of the offering period or on the last trading day of the offering period.

Stock-Based Compensation Expense

Stock-based compensation expense was $1.6 million and $1.2 million for the three months ended June 30, 2015 and 2014, respectively, and $2.9 million and $2.2 million for the six months ended June 30, 2015 and 2014, respectively.

Stock Options

A summary of stock option activity during the six months ended June 30, 2015 is as follows:

The outstanding options generally have a term of ten years. For employees, options granted become exercisable ratably over the vesting period, which is generally a five-year period beginning on the first anniversary of the grant date, subject to the employee’s continuing service to the Company. For directors, options generally become exercisable in full on the first anniversary of the grant date.

The weighted-average grant date fair value of options that were granted during the six months ended June 30, 2015 was $32.42.

The following table provides the assumptions used in the Black-Scholes pricing model valuation of options during the six months ended June 30, 2015 and 2014, respectively:

As of June 30, 2015, there was $8.8 million of unrecognized compensation expense related to unvested stock options, which is expected to be recognized over a weighted-average period of 3.3 years .

Restricted Stock

The 2012 Plan provides for the award of restricted stock or restricted stock units. Restricted stock awards are share settled awards and restrictions lapse ratably over the vesting period, which is generally a five-year period, beginning on the first anniversary of the grant date, subject to the employee's continuing service to the Company. For directors, restricted stock awards generally vest in full on the first anniversary of the grant date.

A summary of restricted stock activity during the six months ended June 30, 2015 is as follows:

As of June 30 , 2015, there was $7.9 million of unrecognized compensation expense related to non-vested restricted stock, which is expected to be recognized over a weighted-average period of 4.1 years.

Employee Stock Purchase Plan

The following table presents the assumptions used to estimate the fair value of the ESPP during the six months ended June 30 , 2015 and 2014, respectively:

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Note 9 – Accumulated Other Comprehensive Income (Loss)

Other comprehensive income (loss) is comprised entirely of foreign currency translation adjustments. The following table presents the changes in accumulated other comprehensive income (loss) balances during the three and six months ended June 30 , 2015 and 2014, respectively:

Note 10 – Income Taxes

The Company is subject to income tax in multiple jurisdictions and the use of estimates is required to determine the provision for income taxes. For the three months ended June 30, 2015 and 2014, the Company recorded an income tax provision of $5.6 million and $5.0 million, respectively. For the six months ended June 30, 2015 and 2014, the Company recorded an income tax provision of $10.6 million and $9.4 million, respectively. The income tax provision is based on the estimated annual effective tax rate for the year applied to pre-tax income. The effective income tax rate for the three months ended June 30, 2015 was 32.5 percent compared with 31.1 percent in the same period of the prior year. The effective income tax rate for the six months ended June 30, 2015 was 32.3 percent compared with 30.9 percent in the same period of the prior year.

The effective income tax rate for the three and six months ended June 30, 2015 differs from the U.S. federal statutory rate of 35 percent due primarily to the mix of income earned in domestic and foreign tax jurisdictions and deductions for which the Company qualifies.

The Company had liabilities related to unrecognized tax benefits totaling $1.5 million at June 30 , 2015 and $1.3 million at December 31, 2014, all of which, if recognized, would affect the Company’s effective tax rate. The Company recognizes interest and penalties related to income tax matters in income tax expense, and reports the liability in current or long-term income taxes payable as appropriate.

During the six months ended June 30, 2015, the Company increased its current year uncertain tax positions by $0.2 million. The increase was due to certain tax positions not meeting the more-likely-than-not standard for accounting for uncertain tax positions under the Company’s current facts and circumstances.

Based upon the information available as of June 30, 2015, the Company anticipates the amount of uncertain tax positions will change in the next twelve months; however, the change is not expected to be material.

Note 11 – Revenue and Geographic Information

The Company’s revenue is derived from its Protomold injection molding, Firstcut computer numerical control (CNC) machining and Fineline additive manufacturing (3D printing) product lines. Total revenue by product line is as follows:

Revenue to external customers based on the billing location of the end user customer and long-lived assets by geographic region are as follows:

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