Tickers mentioned in this show: PRLB

Tidal River Investments positions the day after the first show airing:

Long: NFLX, ETSY, SPY, TDOC, U, Z, ZG, WK, ATVI, AVGO, JPM, PRLB

Show Notes: Collected PRLB data spreadsheet

2Q2021 Earnings Call transcript

Photography from Tidal River Investments can be purchased at tidalriverinvestments.com

Script

Welcome to Fluctuating Tides, the Podcast, Episode 10. I’m your host, SomeCodingGuy, and let’s get right to it!

This week I’m going to be covering Proto Labs, Inc. ticker PRLB, a “digital manufacturer” that has automated the process of rapidly building small volumes of real world hardware from uploaded design files through the web, cutting prototyping lead times with facilities in the US, Europe, and Japan. Proto Labs has recently fallen out of favor with Wall Street for reasons we’ll get to later, leaving us with an interesting entry point if we like the stock.

For this week’s knowledge segment, and to better understand this stock, I want to talk about two items that frequently show up on financial statements, namely receivables and payables, that help us understand how companies handle cash day to day.

Receivables, or “accounts receivable”, is just money owed to the company that hasn’t been settled yet. For the company, it’s that in-between state from the moment when you’re billed for a product, but the money hasn’t shown up yet. There’s a variety of reasons for that gap, but mostly it’s due to delays such as how long it takes credit cards to settle up, or how long before your finance department sends the check, or because the company extended you payment terms like, “sure, just pay your bill within 30 days”. Since we’re waiting for the money to be “received”, we call it a “receivable”.

Payables, or “accounts payable”, is basically the reverse of that, or the other side of the transaction. That’s money that my company owes to someone else, but I haven’t paid it yet. So in the last example, when I’ve ordered those products from you, but I haven’t paid my bill yet, the bill is called a “payable”, since I still have to pay it.

To take a simpler example, let’s go to a restaurant. We order some nice food, perhaps the house specialty. Restaurants, unlike fast food, don’t usually demand cash the moment I order the food, so the moment I order the food, I’ve created a payable, and the restaurant has a new receivable, on the assumption that both of us are going to make good on the deal. If everything goes according to plan, the restaurant prepares my meal, the waiter serves it, I enjoy it, and I settle up the bill by paying the restaurant at the end of the meal. This changes the restaurant’s receivable to a completed sale, and my payable to the restaurant is zeroed out.

Now what happens if I eat the food and then leave without paying? Accounting leaves a few options at this point depending on whether the restaurant thinks they’re going to settle the bill with me. The restaurant could move the receivable to a “doubtful account” if they think that debt is never going to be paid, or they could extend me some billing terms and say, “ah, just pay it back next time you’re here”, or they could call the cops, but that’s more of a legal matter than an accounting one. When it finally settles or it takes to long, the balance moves out of receivables one way or the other, much the same as it’ll move out my payables. If you like eating at restaurants, you probably don’t want to incur any long term payables, but hey, that’s your call!

Now in investing, I like to always at least glance at the receivables and payables lines. Payables usually gives us a hint at how the company is managing its vendors, what sort of terms are being extended, and how quickly they’re racking up a bill. We can compare payables to short term cash to get an idea how tight the cash is going to be in a given period, along with the other short term debts that may be owed.

Receivables, on the other hand, give us a rough idea of the company’s exposure to payments. With normal business, and because money settlement doesn’t happen in an instant, receivables will grow roughly in line with sales, which is another indicator that business is growing. But the ratio matters - if receivables are growing way too fast, investors have to ask, “why?” If you’d been looking at the balance sheets of companies right before the telecom collapse in 2003, you would have seen massive backup on receivables, as companies were so desperate to make sales that they were stuffing their clients with product and no immediate requirements to pay for the equipment, so even without close inspection, you definitely want to watch out if either of these lines jump too much, because there may be real trouble brewing.

So with our new knowledge, let’s take a closer look at Proto Labs.

Management has guided to a 47% gross margin, not far off the 46% in the most recent filing and very respectable for the manufacturing industry. They’ve automated the intake of parts orders with their push of ProtoLabs 2.0 web ordering at the end of last year, and acquired the 3D Hubs company in Amsterdam at the end of last year for a total deal of about $350m split between cash and stock which they’re continuing to integrate into their operations. Acquisitions are a little tricky as I mentioned in previous episodes, but for now, it suffices to say the integration and buildout needs will continue drawing cash until this is completed, but the business has been continuing strong even in the midst of the COVID pandemic.

Of the $123m in sales in the most recent filing, the US represents about 3-quarters, with europe about 1/5th and Japan the remainder, with healthy growth in revenue. The company is virtually debt free, and both adding additional manufacturing machinery while keeping an eye on optimizing costs to keep the all low-touch web based ordering / quoting / and customer relations. The most recent quarter added a thousand new unique product developers to make 23,250 users, and improved automation to reach the next thousand, the pipeline is staying busy even with COVID.

But what about the receivables?

Receivables jumped a lot in the last quarter, up to 83m from 75m, which bears keeping an eye on. Despite the company being debt free, there’s only about $60m cash and securities for the short term, but that’s probably low due to the continued build out expenses from the recent acquisition. When figuring the money available to pay debts like payables vs. cash on hand, I usually back out items like Property and Equipment, since you usually don’t want to sell your house to pay a bill, and Goodwill, since it’s really more of an acquisition related fiction if you can’t or don’t want to turn around and sell your acquisitions and IP as soon as you get them. Management also usually tells you if that’s the plan, and I didn’t see anything about it, so I remove those when figuring out how they’re going to pay their bills. Either way, we’ll cover Goodwill in more detail in a future show.

Aside from the cash and short term securities mentioned before, the company also has a line of credit available from Wells Fargo, and they own a number of their facilities, which they could probably mortgage if they absolutely had to, so there’s sufficient cash to cover short term payables. Given current interest rates and their revenues, they could also probably tap the low interest debt markets if cash was really constraining operations, especially given the virtually debt free balance sheet.

Mangement did comment on the most recent earnings call that most of the receivables were related to unfortunate timing of when orders came in versus when the quarter ended, so other than checking back in the future, nothing to worry about with dinner for now!

So what happened? Wall Street beat up stocks that it thought were all related to 3d printing, but 3d printing is actually only $18m out of the $123m in revenue, with nearly $100m coming from Injection molding and CNC machining. I think they’re unfairly getting called a 3d printing company despite really being a simple-to-work-with on-shore manufacturer, and a steady stream of increasing designers and engineers using their service will likely continue to match existing growth in sales despite COVID and other concerns. As the US and China continue having trade issues, ProtoLabs likely only stands to increase market share in the future as the easy local option, aside from the advantages they have around a fully digital ordering chain.

Given all this, Tidal River is going to take a position in Proto Labs this week.

If you like the podcast and want to see more content like this get created, feel free to subscribe on your favorite podcast app, or buy a photo from tidalriverinvestments.com - money earned on the photos gets deposited in the investment account. As always, Tidal River Investments and I are not financial advisors, market analysts, or otherwise in any way offering advice for or against any of the securities discussed - meet with a financial advisor for that information. Stocks and funds may not be good investments for you, depending on your financial situation.

We’re here for learning, not advice, and I wish you the best on your financial journey, and remember, tides fluctuate!