PRLB 10-Q Quarter ended June 30, 2021

Note 1 – Basis of Presentation

The unaudited interim Consolidated Financial Statements of Proto Labs, Inc. (Protolabs, 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. In the opinion of management, the accompanying financial statements reflect all adjustments necessary for a fair presentation of the Company’s statements 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.

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, 2020 as filed with the Securities and Exchange Commission (SEC) on February 19, 2021.

The accompanying Consolidated Balance Sheet as of December 31, 2020 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 19, 2021 as referenced above.

Note 2 – Recent Accounting Pronouncements

Recently Adopted Accounting Pronouncements

In December 2019, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2019 - 12, Income Taxes (Topic 740 ): Simplifying the Accounting for Income Taxes (ASU 2019 - 12 ). ASU 2019 - 12 attempts to simplify aspects of accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. ASU 2019 - 12 is effective for public business entities for fiscal years beginning after December 15, 2020, including interim periods within that fiscal year. The Company adopted ASU 2019 - 12 on January 1, 2021 and there was no material impact on the Company’s consolidated financial statements.

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. Performance stock units are excluded from the calculation of dilutive potential common shares until the performance conditions have been satisfied.

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

Note 4 – Business Combinations

On January 22, 2021, the Company acquired all outstanding shares of 3D Hubs, Inc. (“Hubs”), for $ 294.1 million, consisting of $ 127.4 million in cash and 863,995 shares of the Company's common stock valued at $ 166.7 million on the date of close. Up to an additional $ 52.8 million of contingent consideration is payable after closing, subject to the satisfaction of performance-based targets during fiscal year 2021 and fiscal year 2022, consisting of up to $ 25.0 million in cash and up to 143,983 shares of the Company's common stock valued at $ 27.8 million on the date of close.

Hubs is based in Amsterdam, Netherlands and is a leading online manufacturing platform that provides customers with on-demand access to a global network of premium manufacturing partners. The acquisition enhances the Company’s value proposition by expanding the customer offerings, enabling the Company to more holistically serve its customers.

The fair value of the consideration paid for this acquisition has been allocated on a preliminary basis to the assets purchased and liabilities assumed based on their estimated fair values as of the acquisition date, with any excess recorded as goodwill.  The goodwill associated with the acquisition represents both the strategic and growth opportunities by significantly expanding the customer offering with a network of premium manufacturing partners. The goodwill related to the acquisition is not deductible for tax purposes.

The Company recorded a contingent consideration liability of $ 13.6 million as of the acquisition date representing the estimated fair value of the amounts payable to former shareholders, as outlined under the terms of the merger agreement, payable subject to the satisfaction of performance-based targets during fiscal year 2021 and fiscal year 2022, consisting of up to $25.0 million in cash and up to 143,983 shares of the Company's common stock valued at $27.8 million on the date of close. The fair value of the contingent consideration (Level 3 ) is determined using a Monte Carlo pricing model. In the second quarter of 2021, the Company recorded a $ 7.8 million decrease to the estimated fair value of the contingent consideration liabilities, which was included as a decrease in general and administrative expense in the Consolidated Statements of Comprehensive Income. Fluctuations due to foreign currency translation have been recorded in the Consolidated Statements of Shareholders’ Equity.

The results of Hubs since the date of acquisition have been included with Protolabs' results. Pro forma disclosures of the consolidated results of the Company with the full year effects of Hubs, as if the acquisition had occurred on January 1, 2020, are not required and have not been separately presented since the impact to the Company's results of operations was not material.

The acquisition has been accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations . In the second quarter of 2021, the Company recorded adjustments to the preliminary allocation, including a $ 3.9 million decrease to intangible assets, a $ 6.4 million increase to goodwill, a $ 3.3 million increase to contingent consideration, a $ 0.5 million decrease to deferred tax liabilities, and a decrease to cash paid of $ 0.3 million. The adjustments were driven by changes to the preliminary valuation and finalization of the working capital calculation. As of June 30, 2021, the allocation of purchase price to assets and liabilities is preliminary. The purchase price allocation will be finalized in 2021. The preliminary allocation is as follows:

Note 5 – Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill during the six months ended June 30, 2021 were as follows:

Goodwill increased $ 281.8 million during the six months ended June 30, 2021 as a result of our acquisition of Hubs. Goodwill has been allocated to the acquired Hubs entities consisting of goodwill of €106.5 million in Europe and $ 152.2 million in the United States as of the date of the acquisition. The Euro denominated goodwill is translated at the end of each period using the current exchange rates resulting in a foreign currency translation adjustment that is recorded as a component of Other Comprehensive Income.

Intangible assets other than goodwill at June 30, 2021 and December 31, 2020 were as follows:

Intangible assets increased $ 30.8 million during the six months ended June 30, 2021 as a result of our acquisition of Hubs. Intangible assets have been allocated to the acquired Hubs entities consisting of intangible assets of €11.6 million in Europe and $ 16.6 million in the United States as of the date of the acquisition. The Euro denominated intangible assets are translated at the end of each period using the current exchange rates resulting in a foreign currency translation adjustment that is recorded as a component of Other Comprehensive Income. Foreign currency losses related to intangible assets were $ 0.4 million as of June 30, 2021. There was no foreign currency translation impact as of December 31, 2020. Amortization expense for intangible assets was $ 1.5 million and $ 0.8 million for the three months ended June 30, 2021 and 2020 , respectively, and $ 3.0 million and $ 1.5 million for the six months ended June 30, 2021 and 2020, respectively.

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

Note 6 – Fair Value Measurements

Accounting Standards Codification, 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 that 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 assets and liabilities that are required to be measured or disclosed at fair value on a recurring basis include cash and cash equivalents, marketable securities and contingent consideration. 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. The Company's marketable securities consist of short-term and long-term agency, municipal, corporate and other debt securities. Fair value for the corporate debt securities is 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 U.S. treasury securities are primarily determined using dealer quotes or quoted market prices for similar securities (Level 2 ). The Company's contingent consideration is the current fair value estimate of amounts owed to the former shareholders of Hubs and is determined using the Monte Carlo pricing model (Level 3 ).

The following table summarizes financial assets as of June 30, 2021 and December 31, 2020 measured at fair value on a recurring basis:

In the first quarter of 2021, the Company sold held-to-maturity securities in order to partially fund the acquisition of Hubs. As a result of the sale, all remaining marketable securities were reclassified to available-for-sale securities and reported at fair value.

The Company recorded a contingent consideration liability at the acquisition date of Hubs representing the amounts payable to former shareholders, as outlined under the terms of the merger agreement, payable subject to the satisfaction of performance-based targets during fiscal year 2021 and fiscal year 2022, consisting of up to $ 25.0 million in cash and up to 143,983 shares of the Company's common stock valued at $ 27.8 million on the date of close. The fair value of the contingent consideration (Level 3 ) is determined using a Monte Carlo pricing model. Subsequent changes in the fair value of the contingent consideration liabilities have been recorded in the Consolidated Statements of Comprehensive Income. Fluctuations due to foreign currency translation have been recorded in the Consolidated Statements of Shareholders’ Equity.

Note 7 – Marketable Securities

The Company invests in short-term and long-term agency, municipal, corporate and other debt securities. As of June 30, 2021 the securities are categorized as available-for-sale and are recorded at fair value. As of December 31, 2020, the securities were categorized as held-to-maturity and were recorded at amortized cost, net of an allowance for credit losses. The change in categorization was a result of the sale of securities in the first quarter of 2021 in order to partially fund the acquisition of Hubs and did not have a material impact on our financial statements. The following table summarizes information regarding the Company’s short-term and long-term marketable securities as of June 30, 2021 and December 31, 2020 :

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 U.S. treasury securities are primarily determined using dealer quotes or quoted market prices for similar securities (Level 2 ).

During the first quarter of 2020, the Company adopted the FASB ASU 2016 - 13, Financial Instruments – Credit Losses. The Company calculated the expected credit loss for each security in its portfolio using the probability-of-default method. The Company concluded the adoption of the guidance had no material impact on its consolidated financial statements.

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, 2021 balance of available-for-sale debt securities by contractual maturity is shown in the following table at fair value. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties.

Note 8 – Inventory

Inventory consists primarily of raw materials, which are recorded at the lower of cost or market using the standard 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 consisted of the following as of the dates indicated: