PROTO LABS INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our unaudited consolidated
financial statements and related notes appearing elsewhere in this Quarterly
Report on Form 10-Q and our Annual Report on Form 10-K for the year ended
December 31, 2021.



Forward-Looking Statements



Statements contained in this report regarding matters that are not historical or
current facts are "forward-looking statements" within the meaning of The Private
Securities Litigation Reform Act of 1995. In some cases, you can identify
forward-looking statements by the following words: "may," "will," "could,"
"would," "should," "expect," "intend," "plan," "anticipate," "believe,"
"estimate," "predict," "project," "potential," "continue," "ongoing" or the
negative of these terms or other comparable terminology, although not all
forward-looking statements contain these words. These statements involve known
and unknown risks, uncertainties and other factors that may cause our results to
be materially different than those expressed or implied in such statements.
Certain of these risk factors and others are described in Item 1A. "Risk
Factors" of this Form 10-Q, as well as our most recent Annual Report on Form
10-K as filed with the Securities and Exchange Commission (SEC). Other unknown
or unpredictable factors also could have material adverse effects on our future
results. We cannot guarantee future results, levels of activity, performance or
achievements. Accordingly, you should not place undue reliance on these
forward-looking statements. Finally, we expressly disclaim any intent or
obligation to update any forward-looking statements to reflect subsequent events
or circumstances.



Overview



We are one of the world's largest and fastest digital manufacturers of custom
prototypes and on-demand production parts. Our mission is to empower companies
to bring new ideas to market by offering the fastest and most comprehensive
digital manufacturing service in the world. Our automated quoting and
manufacturing systems allow us to produce commercial-grade plastic, metal, and
liquid silicone rubber parts in as fast as one day. We manufacture prototype and
low volume production parts for companies worldwide, who are under increasing
pressure to bring their finished products to market faster than their
competition. We utilize injection molding, computer numerical control (CNC)
machining, 3D printing and sheet metal fabrication to manufacture custom parts
for our customers. For most of our offerings, our proprietary technology
eliminates most of the time-consuming and expensive skilled labor conventionally
required to quote and manufacture parts. Our customers conduct nearly all of
their business with us over the Internet. We target our products to the millions
of product developers and engineers who use three-dimensional computer-aided
design (3D CAD) software to design products across a diverse range of
end-markets. In addition, we serve procurement and supply chain professionals
seeking to manufacture custom parts on-demand. Through the acquisition of Hubs
(formerly 3D Hubs, Inc.) (Hubs) in 2021, we are able to provide our customers
access to a global network of premium manufacturing partners who reside across
North America, Europe and Asia, complementing our in-house manufacturing. We
believe our use of advanced technology enables us to offer significant
advantages at competitive prices to many customers and is the primary reason we
have become a leading supplier of custom parts.



On May 27, 2022, our board of directors approved a plan for the closure of our
manufacturing facility in Japan and announced an intention to cease operations
in the region. Affected employees in Japan will receive severance and other
transition assistance that meet or exceed local requirements. We expect to
substantially complete the closure plan within the next year. Our decision to
close the Japan business resulted in $5.2 million in operating expenses during
the three and six months ended June 30, 2022. Operating expenses included $2.2
million of employee severance, $1.2 million related to the write-down of fixed
assets, $0.9 million of facility-related charges, $0.6 million in goodwill
impairment charges and $0.3 million in other closure related charges for the
three and six months ended June 30, 2022.



Our primary manufacturing product lines currently include Injection Molding, CNC
Machining, 3D Printing and Sheet Metal. We continually seek to expand the range
of sizes and geometric complexity of the parts we can make with these processes,
to extend the variety of materials we are able to support, and to identify
additional manufacturing processes to which we can apply our technology in order
to better serve the evolving preferences and needs of product developers and
engineers. In 2021, we augmented our internal manufacturing operations through
our acquisition of Hubs to expand the envelope of custom parts we can provide to
our customers through a network of premium manufacturing partners in each of our
product lines.



Injection Molding



Our Injection Molding product line uses our 3D CAD-to-CNC machining technology
for the automated design and manufacture of molds, which are then used to
produce custom plastic and liquid silicone rubber injection-molded parts and
over-molded and insert-molded injection-molded parts on commercially available
equipment. Our Injection Molding product line works best for on-demand
production, bridge tooling, pilot runs and functional prototyping. Our
affordable molds and quick turnaround times help reduce design risk and limit
overall production costs for product developers and engineers. Because we retain
possession of the molds, customers who need short-run production often come back
to Proto Labs' Injection Molding product line for additional quantities. They do
so to support pilot production for product testing, while their tooling for
high-volume production is being prepared, because they need on-demand
manufacturing due to disruptions in their manufacturing process, because their
product requires limited annual quantity or because they need end-of-life
production support. In 2017, we launched an on-demand manufacturing injection
molding service. This service utilizes our existing processes, but is designed
to fulfill the needs of customers with on-going production needs.



CNC Machining



Our CNC Machining product line uses commercially available CNC machines to offer
milling and turning. CNC milling is a manufacturing process that cuts plastic
and metal blocks into one or more custom parts based on the 3D CAD model
uploaded by the customer. CNC turning is a subtractive manufacturing process
that rotates a metal rod while a cutting tool is used to remove material and
create final parts. Quick-turn CNC machining works best for prototyping, form
and fit testing, jigs and fixtures and functional components for end-use
applications.



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Industrial 3D Printing



Our Industrial 3D Printing product line includes SL, SLS, DMLS, MJF, PolyJet,
Carbon DLS and fused deposition modeling (FDM) processes, which offers customers
a wide-variety of high-quality, precision rapid prototyping and low volume
production. These processes create parts with a high level of accuracy, detail,
strength and durability. Industrial 3D Printing is best suited for functional
prototypes, complex designs and end-use applications.



Sheet Metal



Our Sheet Metal product line includes quick-turn and e-commerce-enabled custom
sheet metal parts, providing customers with prototype and low-volume production
parts. The rapid prototype sheet metal process is most often used when form, fit
and function are all a priority. Our manufacturing process uses customer 3D CAD
models uploaded by the customer to fabricate rapid prototyping sheet metal or
end-use production parts and assemblies.

Key financial metrics and trends

Revenue



Our operations are comprised of three geographic operating segments in the
United States, Europe and Japan. Revenue is derived from our Injection Molding,
CNC Machining, 3D Printing and Sheet Metal product lines. Injection Molding
revenue consists of sales of custom injection molds and injection-molded parts.
CNC Machining revenue consists of sales of CNC-machined custom parts. 3D
Printing revenue consists of sales of 3D-printed parts. Sheet Metal revenue
consists of sales of fabricated sheet metal custom parts. Our historical and
current efforts to increase revenue have been directed at gaining new customers
and selling to our existing customer base by increasing marketing and selling
activities, including:

? expanding the breadth and scope of our products by adding more sizes and

materials to our offers;

? the introduction of our 3D printing product line through our acquisition of

Fine Line in 2014?

? extend 3D printing to Europe by our acquisition of Alphaform in 2015?

? the introduction of our line of sheet metal products through our acquisition of

    Rapid Manufacturing Group, LLC in 2017;

  ? continuously improving the usability of our product lines such as our
    web-centric applications? and

? providing customers with on-demand access to a global network of

    manufacturing partners through our acquisition of Hubs in 2021.




During the three months ended June 30, 2022, we served 24,058 unique product
developers and engineers who purchased our products through our web-based
customer interface, an increase of 3.4% over the same period in 2021. During the
six months ended June 30, 2022, we served 36,878 unique product developers and
engineers who purchased our products through our web-based customer interface,
an increase of 5.2% over the same period in 2021.

Cost of revenue, gross profit and gross margin

Cost of revenue consists primarily of raw materials, equipment depreciation,
employee compensation, benefits, stock-based compensation, facilities costs and
overhead allocations associated with the manufacturing process for molds and
customer parts. We expect our personnel-related costs to increase in order to
retain and attract top talent and remain competitive in the market. Overall, we
expect cost of revenue to increase in absolute dollars.



We define gross profit as our revenue less our cost of revenue, and we define
gross margin as gross profit expressed as a percentage of revenue. Our gross
profit and gross margin are affected by many factors, including our mix of
revenue by product line, pricing, sales volume, manufacturing costs, the costs
associated with increasing production capacity, the mix between domestic and
foreign revenue sources, the mix between revenue produced in our internal
manufacturing operations and outsourced to our external manufacturing partners,
and foreign exchange rates.



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Operating Expenses

Operating expenses include marketing and sales, research and development, and general and administrative expenses. Personnel costs are the largest component in each of these categories.

The launch of our Protolabs 2.0 project, an internal business systems initiative
impacting both external customer-facing and internal back-end systems, in the
United States in the first quarter of 2021, and our acquisition of Hubs in
January 2021, led to higher operating expenses in the first six months of 2021.
Our business strategy is to continue to be a leading online and
technology-enabled manufacturer of quick-turn, on-demand injection-molded,
CNC-machined, 3D-printed and sheet metal custom parts for prototyping and
low-volume production. In order to achieve our goals, we anticipate continued
substantial investments in technology and personnel, resulting in increased
operating expenses in the future.



Marketing and sales. Marketing and sales expense consists primarily of employee
compensation, benefits, commissions, stock-based compensation, marketing
programs such as electronic, print and pay-per-click advertising, trade shows
and other related overhead, which includes an allocation of information
technology expense including amortization of Protolabs 2.0 software assets. We
expect sales and marketing expense to increase in the future as we increase the
number of marketing and sales professionals and marketing programs targeted to
increase our customer base and grow revenue.



Research and development. Research and development expense consists primarily of
personnel and outside service costs related to the development of new processes
and product lines, enhancement of existing product lines, development of
software for internal use, maintenance of internally developed software, quality
assurance and testing. Costs for internal use software are evaluated by project
and capitalized where appropriate under ASC 350-40, Intangibles - Goodwill and
Other, Internal-Use Software. We expect research and development expense to
increase in the future as we seek to enhance our e-commerce interface
technology, internal software and supporting business systems, and continue to
expand our product lines.



General and administrative. General and administrative expense consists
primarily of employee compensation, benefits, stock-based compensation,
professional service fees related to accounting, tax and legal, and other
related overhead, which includes an allocation of information technology expense
including amortization of Protolabs 2.0 software assets. We expect general and
administrative expense to increase in the future as we continue to grow and
expand as a global organization.



Closure of Japan business. Closure of Japan business expense is driven by our
decision to close the Japan manufacturing facility and exit the Japan
market. The expenses consist primarily of operating expense, including employee
severance, write-down of fixed assets, facility-related charges and goodwill
impairment charges.



Other Income (Loss), net



Other income (loss), net primarily consists of foreign currency-related gains
and losses and interest income on cash balances and investments. Our foreign
currency-related gains and losses will vary depending upon movements in
underlying exchange rates. Our interest income will vary each reporting period
depending on our average cash balances during the period, composition of our
marketable security portfolio and the current level of interest rates.



Provision for Income Taxes



Provision for income taxes is comprised of federal, state, local and foreign
taxes based on pre-tax income. Overall, our effective tax rate for 2022 and
beyond may differ from historical effective tax rates due to increases in losses
in foreign operations that are not eligible for tax benefits on account of
valuation allowances, as well as any future tax law changes that may impact our
effective tax rate.



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Results of Operations



The following table summarizes our results of operations and the related changes
for the periods indicated. The results below are not necessarily indicative of
the results for future periods.



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                                  Three Months Ended June 30,              Change                 Six Months Ended June 30,                 Change
(dollars in thousands)             2022                2021              $         %              2022                 2021               $         %
Revenue                      $ 126,902   100.0   $ 123,048   100.0   $   3,854      3.1      $ 251,070   100.0   $ 239,174   100.0     $11,896       5.0
Cost of revenue                 69,480    54.8      66,423    54.0       3,057      4.6        137,844    54.9     127,219    53.2      10,625       8.4
Gross profit                    57,422    45.2      56,625    46.0         797      1.4        113,226    45.1     111,955    46.8       1,271       1.1
Operating expenses:
Marketing and sales             21,055    16.6      21,044    17.1          11      0.1         41,641    16.6      40,524    16.9       1,117       2.8
Research and development         9,450     7.4      11,060     9.0      (1,610 )  (14.6 )       20,007     8.0      23,241     9.7      (3,234 )  (13.9)
General and administrative      16,522    13.0      16,180    13.1         342      2.1         33,293    13.2      35,588    14.9      (2,295 )   (6.4)
Closure of Japan business        5,194     4.1           -       -       5,194    100.0          5,194     2.1           -       -       5,194     100.0
Changes in fair value of
contingent consideration             -    (0.0 )    (7,763 )  (6.3 )     7,763   (100.0 )        -           -      (7,763 ) (3.2)       7,763   (100.0)

Total operating expenses 52,221 41.1 40,521 32.9 11,700 28.9 100,135 39.9 91,590 38.3 8,545

9.3

Income from operations           5,201     4.1      16,104    13.1     (10,903 )  (67.7 )       13,091     5.2      20,365     8.5      (7,274 )  (35.7)
Other income (loss), net             1     0.0         137     0.1        (136 )  (99.3 )        (299)    (0.1 )      (176 ) (0.1)        (123 )    69.9
Income before income taxes       5,202     4.1      16,241    13.2     (11,039 )  (68.0 )       12,792     5.1      20,189     8.4      (7,397 )  (36.6)
Provision for income taxes       2,645     2.1       3,326     2.7        (681 )  (20.5 )        5,140     2.1       3,562     1.5       1,578      44.3
Net income                   $   2,557     2.0 % $  12,915    10.5 % $ (10,358 )  (80.2 )%     $ 7,652     3.0 % $  16,627    7.0%     $(8,975 ) (54.0)%

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Stock-based compensation expense included in the income statement data above for the three and six months ended June 30, 2022 and 2021 were as follows:

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                                           Three Months Ended June 30,           Six Months Ended June 30,
(dollars in thousands)                      2022                2021              2022               2021
Stock options, restricted stock and
performance stock                       $       3,668       $       4,563     $      7,674       $       9,854
Employee stock purchase plan                      363                 378              754                 707
Total stock-based compensation
expense                                 $       4,031       $       4,941     $      8,428       $      10,561

Cost of revenue                         $         528       $         668     $      1,115       $       1,303
Operating expenses:
Marketing and sales                               813                 929            1,550               1,782
Research and development                          471                 744            1,100               1,368
General and administrative                      2,219               2,600            4,663               6,108
Total stock-based compensation
expense                                 $       4,031       $       4,941     $      8,428       $      10,561

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Comparison of the three months ended June 30, 2022 and 2021

Revenue

Revenue by Reportable Segment and Related Changes for the Three Months Ended June 30, 2022 and 2021 were as follows:

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                                           Three Months Ended June 30,
                                        2022                         2021                      Change
                                            % of Total                   % of Total
(dollars in thousands)            $          Revenue           $          Revenue          $            %
Revenue
United States                 $ 100,655           79.3 %   $  95,344           77.5 %   $  5,311          5.6 %
Europe                           23,391           18.4        24,655           20.0       (1,264 )       (5.1 )
Japan                             2,856            2.3         3,049            2.5         (193 )       (6.3 )
Total revenue                 $ 126,902          100.0 %   $ 123,048          100.0 %   $  3,854          3.1 %

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Our revenue increased $3.9 million, or 3.1%, for the three months ended June 30,
2022 compared to the same period in 2021. By reportable segment, revenue in the
United States increased $5.3 million, or 5.6%, for the three months ended June
30, 2022 compared to the same period in 2021. Revenue in Europe decreased
$1.3 million, or 5.1%, and revenue in Japan decreased $0.2 million, or 6.3%, in
each case for the three months ended June 30, 2022 compared to the same period
in 2021. Our acquisition of Hubs provided revenue of $5.9 million and
$4.6 million in the United States and $5.4 million and $4.3 million in Europe
for each of the three months ended June 30, 2022 and 2021,
respectively. International revenue was negatively impacted by $2.7 million
during the three months ended June 30, 2022 compared to the same period in 2021
as a result of foreign currency movements, primarily the weakening of the
British Pound and Euro relative to the United States Dollar.



During the three months ended June 30, 2022, we served 24,058 unique product
developers and engineers, an increase of 3.4% over the same period in 2021. Our
growth in product developers and engineers served increased at a rate consistent
with our revenue growth.

Revenue by product line and associated variations for the three months ended June 30, 2022 and 2021 were as follows:

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                                           Three Months Ended June 30,
                                        2022                         2021                      Change
                                            % of Total                   % of Total
(dollars in thousands)            $          Revenue           $          Revenue          $            %
Revenue
Injection Molding             $  53,355           42.0 %   $  58,168           47.3 %   $ (4,813 )       (8.3 )%
CNC Machining                    48,222           38.0        41,592           33.8        6,630         15.9
3D Printing                      19,963           15.7        18,170           14.8        1,793          9.9
Sheet Metal                       5,160            4.1         4,717            3.8          443          9.4
Other Revenue                       202            0.2           401            0.3         (199 )      (49.6 )
Total revenue                 $ 126,902          100.0 %   $ 123,048          100.0 %   $  3,854          3.1 %

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By product line, our revenue increase was driven by a 15.9% increase in CNC
Machining revenue, a 9.9% increase in 3D Printing revenue, and a 9.4% increase
in Sheet Metal revenue, which was partially offset by an 8.3% decrease in
Injection Molding revenue, and a 49.6% decrease in Other Revenue, in each case
for the three months ended June 30, 2022 compared to the same period in 2021.



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Cost of revenue, gross profit and gross margin

Cost of Revenue. Cost of revenue increased $3.1 million, or 4.6%, for the three
months ended June 30, 2022 compared to the same period in 2021, which was
greater than the rate of revenue increase of 3.1% for the three months
ended June 30, 2022 compared to the same period in 2021. Cost of revenue
increased $2.6 million in our digital manufacturing business, which was driven
by increased volumes and labor shortages resulting in wage inflation, driving
personnel and related cost increases of $0.7 million, an increase in raw
material and product costs of $1.8 million driven by materials cost inflation
and higher logistics costs, and an increase in equipment and facility related
costs of $0.1 million. Hubs provided a $0.5 million increase in cost of revenue
for the three months ended June 30, 2022 when compared to the same period in
2021.



Gross Profit and Gross Margin. Gross profit increased from $56.6 million in the
three months ended June 30, 2021 to $57.4 million in the three months ended June
30, 2022. Gross margin decreased from 46.0% in the three months ended June 30,
2021 to 45.2% in the three months ended June 30, 2022, primarily due to labor
and materials cost inflation as described above and the mix of revenue.

Operating expenses, other income (losses), net and provision for income taxes

Marketing and Sales. Marketing and sales expenses remained consistent during the
three months ended June 30, 2022 compared to the same period in 2021. Personnel
and related cost decreases in our digital manufacturing business of $0.5 million
and marketing program cost decreases in our digital manufacturing business of
$0.1 million were offset by increases in Hubs' marketing and sales expense of
$0.6 million during the three months ended June 30, 2022 when compared to the
same period in 2021.



Research and Development. Our research and development expenses decreased $1.6
million, or 14.6%, during the three months ended June 30, 2022 compared to the
same period in 2021 primarily due to personnel and related cost decreases of
$1.6 million driven by personnel and contractor resources dedicated to the
launch of our Protolabs 2.0 system in the first quarter of 2021.



General and Administrative. Our general and administrative expenses increased
$0.3 million, or 2.1%, during the three months ended June 30, 2022 compared to
the same period in 2021 primarily due to an increase in personnel and related
costs of $0.2 million and an increase of professional services of $0.1 million.



Closure of Japan business. Our decision to close our Japan business resulted in
$5.2 million in operating expenses during the three months ended June 30, 2022.
Operating expenses included $2.2 million of employee severance, $1.2 million
related to the write-down of fixed assets, $0.9 million of facility-related
charges, $0.6 million in goodwill impairment charges and $0.3 million in other
closure related charges. We had no expenses related to the closure of our Japan
business in 2021.

Changes in fair value of contingent consideration. We had no contingent consideration liabilities recorded in 2022. The change in fair value of contingent consideration associated with the acquisition of Hubs was $7.8 million in the three months ended June 30, 2021.

Other income (loss), net. We recognized no other income, net for the three
months ended June 30, 2022, a decrease of $0.1 million compared to other income,
net of $0.1 million for the three months ended June 30, 2021. Other income,
net for the three months ended June 30, 2022 primarily consisted of a $0.3
million loss on foreign currency, which was offset by interest income on
investments and other income. Other income, net for the three months ended June
30, 2021 primarily consisted of a $0.1 million gain on foreign currency and
interest income on investments.



Provision for Income Taxes. Our effective tax rate of 50.8% for the three months
ended June 30, 2022 increased 30.3% compared to 20.5% for the same period in
2021. The increase in the effective tax rate is primarily due to a decrease in
tax benefits from the vesting of restricted stock and the exercise of stock
options, as well as an increase in losses in jurisdictions, primarily Japan,
that are not eligible for tax benefits due to valuation allowances. Our income
tax provision of $2.6 million for the three months ended June 30, 2022 decreased
$0.7 million compared to our income tax provision of $3.3 million for the three
months ended June 30, 2021.



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Comparison of the six months ended June 30, 2022 and 2021

Revenue

Revenue by reportable segment and related changes for the six months ended June 30, 2022 and 2021 were as follows:

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                                            Six Months Ended June 30,
                                        2022                         2021                      Change
                                            % of Total                   % of Total
(dollars in thousands)            $          Revenue           $          Revenue          $            %
Revenue
United States                 $ 196,151           78.1 %   $ 186,397           77.9 %   $  9,754          5.2 %
Europe                           47,977           19.1        46,104           19.3        1,873          4.1
Japan                             6,942            2.8         6,673            2.8          269          4.0
Total revenue                 $ 251,070          100.0 %   $ 239,174          100.0 %   $ 11,896          5.0 %

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Our revenue increased $11.9 million, or 5.0%, for the six months ended June 30,
2022 compared to the same period in 2021. By reportable segment, revenue in the
United States increased $9.8 million, or 5.2%, for the six months ended June 30,
2022 compared to the same period in 2021. Revenue in Europe increased
$1.9 million, or 4.1%, and revenue in Japan increased $0.3 million, or 4.0%, in
each case for the six months ended June 30, 2022 compared to the same period in
2021. Our acquisition of Hubs provided revenue of $10.6 million and $7.8 million
in the United States and $10.9 million and $6.9 million in Europe for each of
the six months ended June 30, 2022 and 2021, respectively. Hubs revenue in 2021
represents the period from January 22, 2021, the date of acquisition, through
June 30, 2021. International revenue was negatively impacted by $4.3 million
during the six months ended June 30, 2022 compared to the same period in 2021 as
a result of foreign currency movements, primarily the weakening of the British
Pound and Euro relative to the United States Dollar.



During the six months ended June 30, 2022, we served 36,878 unique product
developers and engineers, an increase of 5.2% over the same period in 2021. Our
growth in product developers and engineers served increased at a rate consistent
with our revenue growth.

Turnover by product line and associated variations for the half-year ended June 30, 2022 and 2021 were as follows:

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                                            Six Months Ended June 30,
                                        2022                         2021                      Change
                                            % of Total                   % of Total
(dollars in thousands)            $          Revenue           $          Revenue          $            %
Revenue
Injection Molding             $ 106,753           42.5 %   $ 114,527           47.9 %   $ (7,774 )       (6.8 )%
CNC Machining                    94,320           37.6        78,295           32.7       16,025         20.5
3D Printing                      39,635           15.8        35,405           14.8        4,230         11.9
Sheet Metal                       9,847            3.9         9,936            4.2          (89 )       (0.9 )
Other Revenue                       515            0.2         1,011            0.4         (496 )      (49.1 )
Total revenue                 $ 251,070          100.0 %   $ 239,174          100.0 %   $ 11,896          5.0 %

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By product line, our revenue increase was driven by a 20.5% increase in CNC machining revenue and an 11.9% increase in 3D printing revenue, which was partially offset by a 6.8% decline in injection molding revenues and a 0.9% decline in sheet metal revenues. and a 49.1% decline in other income, in each case for the six months ended June 30, 2022 compared to the same period in 2021.

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Cost of revenue, gross profit and gross margin

Cost of Revenue. Cost of revenue increased $10.6 million, or 8.4%, for the six
months ended June 30, 2022 compared to the same period in 2021, which was
greater than the rate of revenue increase of 5.0% for the six months ended June
30, 2022 compared to the same period in 2021. Cost of revenue increased $7.5
million in our digital manufacturing business, which was driven by increased
volumes and labor shortages resulting in wage inflation driving personnel and
related cost increases of $3.2 million, an increase in raw material and product
costs of $3.9 million driven by materials cost inflation and higher logistics
costs, and an increase in equipment and facility related costs of $0.4 million.
Our acquisition of Hubs provided a $3.1 million increase in cost of revenue for
the six months ended June 30, 2022 when compared to the same period in 2021.



Gross Profit and Gross Margin. Gross profit increased from $112.0 million in the
six months ended June 30, 2021 to $113.2 million in the six months ended June
30, 2022. Gross margin decreased from 46.8% in the six months ended June 30,
2021 to 45.1% in the six months ended June 30, 2022, primarily due to labor and
materials cost inflation as described above and the mix of revenue.

Operating expenses, other income (losses), net and provision for income taxes

Marketing and Sales. Marketing and sales expenses increased $1.1 million, or
2.8%, during the six months ended June 30, 2022 compared to the same period
in 2021. Hubs provided a $1.2 million increase in marketing and sales expenses
and our digital manufacturing business provided marketing program cost increases
of $0.2 million during the six months ended June 30, 2022 when compared to the
same period in 2021, which was partially offset by a decrease in our digital
manufacturing business personnel and related costs of $0.3 million.



Research and Development. Our research and development expenses decreased $3.2
million, or 13.9%, during the six months ended June 30, 2022 compared to the
same period in 2021 primarily due to personnel and related cost decreases of
$3.8 million driven by personnel and contractor resources dedicated to the
launch and support of our Protolabs 2.0 system in the first quarter of 2021. The
decrease was partially offset by a $0.6 million increase in Hubs' research and
development expenses during the six months ended June 30, 2022 when compared to
the same period in 2021.



General and Administrative. Our general and administrative expenses decreased
$2.3 million, or 6.4%, during the six months ended June 30, 2022 compared to the
same period in 2021 primarily due to a decrease of $2.3 million in professional
service costs primarily driven by increased transaction costs in 2021 related to
our acquisition of Hubs and a decrease of $1.3 million in stock-based
compensation expense primarily driven by increased stock-based compensation
expense in 2021 related to the retirement of our CEO. In addition, our
acquisition of Hubs provided an increase of $1.3 million in general and
administrative expense during the six months ended June 30, 2022 when compared
to the same period in 2021.



Closure of Japan business. Our decision to close our Japan business resulted in
$5.2 million in operating expenses during the six months ended June 30, 2022.
Operating expenses included $2.2 million of employee severance, $1.2 million
related to the write-down of fixed assets, $0.9 million of facility-related
charges, $0.6 million in goodwill impairment charges and $0.3 million in other
closure related charges. We had no expenses related to the closure of our Japan
business in 2021.

Changes in fair value of contingent consideration. We had no contingent consideration liabilities recorded in 2022. The change in fair value of contingent consideration associated with the acquisition of Hubs was $7.8 million in the six months ended June 30, 2021.

Other Loss, net. We recognized other loss, net of $0.3 million for the six
months ended June 30, 2022, a decrease of $0.1 million compared to other loss,
net of $0.2 million for the six months ended June 30, 2021. Other loss, net for
the six months ended June 30, 2022 primarily consisted of a $0.4 million loss on
foreign currency, which was partially offset by $0.1 million in interest income
on investments and other income. Other loss, net for the six months ended June
30, 2021 primarily consisted of a $0.5 million loss on foreign currency, which
was partially offset by $0.2 million in interest income on investments and $0.1
million in other income.



Provision for Income Taxes. Our effective tax rate of 40.2% for the six months
ended June 30, 2022 increased 22.6% compared to 17.6% for the same period in
2021. The increase in the effective tax rate is primarily due to a decrease in
tax benefits from the vesting of restricted stock and the exercise of stock
options, as well as an increase in losses in jurisdictions, primarily Japan,
that are not eligible for tax benefits due to valuation allowances. Our income
tax provision of $5.1 million for the six months ended June 30, 2022 increased
$1.5 million compared to our income tax provision of $3.6 million for the six
months ended June 30, 2021.



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Cash and capital resources

Cash Flows

The following table summarizes our cash flows during the six months ended June 30, 2022 and 2021:

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                                                              Six Months Ended June 30,
(dollars in thousands)                                         2022               2021
Net cash provided by operating activities                  $      31,040       $    20,729
Net cash used in investing activities                            (36,516 )        (105,082 )
Net cash used in financing activities                             (4,821 )          (1,856 )
Effect of exchange rates on cash and cash equivalents               (966 )             515
Net decrease in cash and cash equivalents                  $     (11,263 )     $   (85,694 )

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Sources of Liquidity



Historically, we have primarily financed our operations and capital expenditures
through cash flow from operations. We had cash and cash equivalents of $54.7
million as of June 30, 2022, a decrease of $11.3 million from December 31, 2021.
The decrease in our cash was primarily due to cash used in investing activity
for purchases of marketable securities, net, of $30.5 million, purchases of
property, equipment and other capital assets of $6.0 million, and cash used in
financing activities of $4.8 million, which were partially offset by cash
generated through operations of $31.0 million.

Cash flow from operating activities

Cash flows from operating activities were $31.0 million during the six months
ended June 30, 2022 and primarily consisted of net income of $7.7 million,
adjusted for certain non-cash items, including depreciation and amortization of
$20.3 million, stock-based compensation expense of $8.4 million, and impairments
related to the closure of our Japan business of $1.8 million, which were
partially offset by deferred taxes of $5.7 million and changes in operating
assets and liabilities and other items totaling $1.5 million. Cash flows from
operating activities were $20.7 million during the six months ended June 30,
2021 and primarily consisted of net income of $16.6 million, adjusted for
certain non-cash items, including depreciation and amortization of $20.1 million
and stock-based compensation expense of $10.6 million, which were partially
offset by a decrease in the fair value of contingent consideration of $7.8
million and changes in operating assets and liabilities and other items totaling
$18.8 million.



Cash flows from operating activities increased $10.3 million during the six
months ended June 30, 2022 compared to the same period in 2021, primarily due to
changes in operating assets and liabilities totaling $17.7 million, changes
in fair value of contingent consideration of $7.8 million, costs related to the
closure of our Japan business of $1.8 million, and increases of depreciation and
amortization of $0.2 million, which were partially offset by decreases in net
income of $9.0 million, stock-based compensation of $2.1 million and deferred
taxes of $6.1 million.

Cash flow from investing activities

Cash used in investing activities was $36.5 million during the six months ended
June 30, 2022, consisting of $30.5 million for net purchases of marketable
securities and $6.0 million for the purchases of property, equipment and other
capital assets.



Cash used in investing activities was $105.1 million during the six months ended
June 30, 2021, consisting of $127.4 million in cash used for acquisitions, net
of cash acquired and $23.9 million for the purchases of property, equipment and
other capital assets, which were partially offset by $46.2 million for net
proceeds from investments in marketable securities.



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Cash flow from financing activities

Cash used in financing activities was $4.8 million during the six months ended
June 30, 2022, consisting of $5.2 million in repurchases of common stock, $1.6
million in purchases of shares withheld for tax obligations associated with
equity transactions and $0.3 million for repayments of finance lease
obligations, which were partially offset by $2.3 million in proceeds from
exercises of stock options.



Cash used in financing activities was $1.9 million during the six months ended
June 30, 2021, consisting of $4.2 million in purchases of shares withheld for
tax obligations associated with equity transactions, $1.2 million in repurchases
of common stock and $0.3 million for repayments of finance lease obligations,
which were partially offset by $3.8 million in proceeds from the exercise of
stock options.

Off-balance sheet arrangements

Since our inception, we have not engaged in any off-balance sheet arrangements,
including the use of structured finance, special purpose entities or variable
interest entities.

Significant Accounting Policies and Use of Estimates

We have adopted various accounting policies to prepare the Consolidated
Financial Statements in accordance with accounting principles generally accepted
in the United States of America (U.S. GAAP). Our significant accounting policies
are disclosed in Note 2 to the Consolidated Financial Statements included in our
Annual Report on Form 10-K for the year ended December 31, 2021. There were no
material changes to our critical accounting policies during the six months ended
June 30, 2022.

Recent accounting pronouncements

For more information on recent accounting pronouncements, see Note 2 to the consolidated financial statements appearing in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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