# Proto Labs Inc (PRLB) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Proto Labs Inc's 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1443669/000143774923003930/prlb20221231_10k.htm
Accession: 0001437749-23-003930
Filing date: 2023-02-21
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/PRLB/
All MD&A years: /company/PRLB/mda/
Previous year: /company/PRLB/mda/fy2021/ (FY 2021)
Next year: /company/PRLB/mda/fy2023/ (FY 2023)

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward- looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

Overview

We are one of the world’s largest and fastest digital manufacturers of custom prototypes and on-demand production parts. We manufacture prototypes and low-volume production parts for companies worldwide that 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. Our proprietary technology eliminates most of the time-consuming and expensive skilled labor conventionally required to quote and manufacture parts. In January 2021, we acquired Hubs, a leading online manufacturing platform based in Amsterdam, Netherlands, that provides customers with on-demand access to a global network of premium manufacturing partners. This acquisition creates an extremely comprehensive digital manufacturing offer, offering the broadest set of manufacturing services with the help of a global network of premium manufacturing partners. Our customers conduct nearly all of their business with us over the Internet. We target our products at 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.

We have experienced significant growth since our inception. Since we first introduced our Injection Molding product line in 1999, we have steadily expanded the size and geometric complexity of the injection-molded parts we are able to manufacture, and we continue to extend the diversity of materials we are able to support. Similarly, since first introducing our CNC Machining product line in 2007, we have expanded the range of part sizes, design geometries and materials we can support. In 2014, we acquired FineLine Prototyping, Inc. (FineLine) to expand the number of process types we offer to include stereolithography (SL), selective laser sintering (SLS) and direct metal laser sintering (DMLS). In 2017, we acquired RAPID to expand the number of process types we offer to include sheet metal fabrication and expand our CNC machining capability. In 2019, we added Carbon DLS to our 3D printing processes, introduced precision color matching on Injection Molding parts and launched production capabilities for metal 3D printing. In 2021, we acquired Hubs to provide customers with on-demand access to a global network of premium manufacturing partners. In 2022, we launched the first iteration of our integrated offer in Europe, which allows us to offer CNC manufacturing for eligible parts through the combination of our internal digital manufacturing and our digital network of manufacturing partners. We also continually seek to enhance other aspects of our technology and manufacturing processes, including our interactive web-based and automated user interface and quoting system. We intend to continue to invest significantly to enhance our technology and manufacturing processes and expand the range of our existing capabilities with the aim of meeting the needs of a broader set of customers. As a result of the factors described above, many of our customers tend to return to Proto Labs to meet their ongoing needs, with approximately 94%, 93% and 93% of our revenue in 2022, 2021 and 2020, respectively, derived from existing customers.

We have established our operations in the United States, Europe and Japan. We believe the United States and Europe are two of the largest geographic markets where product developers and engineers are located. On May 27, 2022, the Company's board of directors approved a plan for the closure of the Company's manufacturing facility in Japan and announced an intention to cease operations in the region. We entered the European market in 2005. We further expanded our operations in the United States through our acquisitions of Fineline in 2014, RAPID in 2017 and Hubs in 2021. Our operations were further expanded in Europe through our acquisitions of Alphaform in 2015 and Hubs in 2021. Our revenue outside of the United States accounted for approximately 21%, 21% and 20% of our consolidated revenue in the years ended December 31, 2022, 2021 and 2020, respectively. We intend to continue to expand our international sales efforts and believe opportunities exist to serve the needs of product developers and engineers in select new geographic regions.

We have grown our total revenue from $445.6 million in 2018 to $488.4 million in 2022. During this period, our operating expenses increased from $149.8 million in 2018 to $313.4 million in 2022, which includes a $118.0 million goodwill impairment charge and $6.9 million in costs related to closure of our Japan business. Our recent growth in revenue has been accompanied by increased cost of revenues and operating expenses. We expect to increase investment in our operations to support anticipated future growth as discussed more fully below.

In addition, we believe that a number of trends affecting our industry have affected our results of operations and may continue to do so. For example, we believe that many of our target product developer and engineer customers are facing three mega trends, which are disrupting long-term product growth models. We believe our customers are facing increased pressure to shorten product life-cycles, to embed products with connectivity driven by the internet of things technology, and to deliver products that are personalized and customized to unique customer specifications. We believe we continue to be well positioned to benefit from these trends, given our proprietary technology that enables us to automate and integrate the majority of activities involved in procuring custom parts. The COVID-19 pandemic has also impacted the manufacturing environment. For example, the pandemic accelerated the digitization of manufacturing as companies pivoted to a work-from-home and socially-distanced manufacturing plant environment. As a result, the adoption of e-commerce was accelerated, which allows opportunity for us to provide valuable solutions to manufacturers looking to build resiliency in their supply chains through fast, on-demand manufacturers. While our business may be positively affected by these trends, our results may also be favorably or unfavorably impacted by other trends that affect product developer and engineer orders for custom parts in low volumes, including, among others, economic conditions, changes in product developer and engineer preferences or needs, developments in our industry and among our competitors, and developments in our customers' industries. For a more complete discussion of the risks facing our business, see Part I, Item 1A. “Risk Factors” of this Annual Report on Form 10-K.

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Key Financial Measures and Trends

Revenue

Our operations are comprised of two geographic operating segments in the United States and Europe. On May 27, 2022, the Company's board of directors approved a plan for the closure of the Company's manufacturing facility in Japan and announced an intention to cease operations in the region. 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 custom 3D-printed parts. Sheet Metal revenue consists of sales of fabricated sheet metal custom parts and assemblies. Our revenue is generated from a diverse customer base, with no single customer company representing more than 5% of our total revenue in 2022. 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:

[[GREPCENT_TABLE]]
[["","\u2022","expanding the breadth and scope of our products by adding more sizes and materials to our offerings;"],["","\u2022","the introduction of our 3D Printing product line through our acquisition of FineLine in 2014;"],["","\u2022","expanding 3D printing to Europe through our acquisition of Alphaform in October 2015;"],["","\u2022","the introduction of our Sheet Metal product line through our acquisition of RAPID in 2017;"],["","\u2022","continuously improving the usability of our product lines such as our web-centric applications; and"],["","\u2022","providing customers with on-demand access to a global network of premium manufacturing partners through our acquisition of Hubs in January 2021."]]
[[/GREPCENT_TABLE]]

During 2022, we served 56,333 unique product developers and engineers who purchased our products through our web-based customer interface, an increase of 1.8% over the same period in 2021.

During 2021, we served 55,330 unique product developers and engineers who purchased our products through our web-based customer interface, an increase of 26.3% over the same period in 2020. The increase in product developers served was driven primarily by our acquisition of Hubs. Excluding the impact of Hubs, our product developers served increased 5.2% over the same period in 2020.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of raw materials, equipment depreciation, employee compensation including benefits and stock-based compensation, facilities costs and overhead allocations associated with the manufacturing process for molds and custom 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.

Our business model requires that we invest in our capacity well in advance of demand to ensure we can fulfill the expectations for quick delivery of our products to our customers. Therefore, over the last several years, we have made significant investments in additional factory space, equipment and infrastructure across our geographic segments. We expect to continue to grow in future periods, which will result in the need for additional investments in factory space and equipment. We expect that these additional costs for factory and equipment expansion can be absorbed by revenue growth, and allow gross margins by product line to remain relatively consistent over time. Our addition of Hubs in 2021 provides a complementary opportunity to add revenue growth through the use of premium manufacturing partners, without the significant investments required by our legacy business model.

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 consist of marketing and sales, research and development and general and administrative expenses. Personnel-related costs are the most significant 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 nine 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 PL 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, software developed 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 Accounting Standards Codification (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 PL 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.

Goodwill impairment. Goodwill is tested for impairment annually as of the first day of the fourth quarter. An impairment charge for goodwill was recognized for our Europe reporting unit in the fourth quarter of 2022, as it was determined the estimated fair value of the reporting unit, including goodwill, was less than its carrying amount.

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.

Changes in fair value of contingent consideration. Our contingent consideration liability is related to our acquisition of Hubs in 2021 and is evaluated quarterly for changes in fair value.

Other Income, Net

Other income, 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 the 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.

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

*Percentage change not meaningful

Stock-based compensation expense included in the statements of comprehensive income data above is as follows:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["(dollars in thousands)","","2022","","","2021","","","2020"],["Stock options and grants","","$","16,103","","","$","17,553","","","$","13,327"],["Employee stock purchase plan","","","1,442","","","","1,542","","","","1,346"],["Total stock-based compensation expense","","$","17,545","","","$","19,095","","","$","14,673"],["Cost of revenue","","$","2,172","","","$","2,595","","","$","2,451"],["Operating expenses:"],["Marketing and sales","","","3,295","","","","3,736","","","","3,121"],["Research and development","","","2,189","","","","2,833","","","","2,440"],["General and administrative","","","9,889","","","","9,931","","","","6,661"],["Total stock-based compensation expense","","$","17,545","","","$","19,095","","","$","14,673"]]
[[/GREPCENT_TABLE]]

Comparison of Years Ended December 31, 2022 and 2021

Revenue

Revenue by reportable segment and the related changes for 2022 and 2021 is summarized as follows:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2022","","","2021","","","Change"],["(dollars in thousands)","","$","","","% of Total Revenue","","","$","","","% of Total Revenue","","","$","","","%"],["Revenue"],["United States","","$","387,399","","","","79.3","%","","$","384,458","","","","78.8","%","","$","2,941","","","","0.8","%"],["Europe","","","92,770","","","","19.0","","","","90,399","","","","18.5","","","","2,371","","","","2.6"],["Japan","","","8,229","","","","1.7","","","","13,241","","","","2.7","","","","(5,012",")","","","(37.9",")"],["Total revenue","","$","488,398","","","","100.0","%","","$","488,098","","","","100.0","%","","$","300","","","","0.1","%"]]
[[/GREPCENT_TABLE]]

Our revenue increased $0.3 million, or 0.1%, for 2022 compared with 2021. By reportable segment, revenue in the United States increased $2.9 million, or 0.8%, for 2022 compared with 2021. Revenue in Europe increased $2.4 million, or 2.6%, for 2022 compared with 2021. Revenue in Japan decreased $5.0 million, or 37.9%, for 2022 compared with 2021. The decrease in Japan revenue was driven by our decision in the second quarter of 2022 to close our Japan operations. International revenue was negatively impacted by $11.6 million during 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.

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During 2022, we served 56,333 unique product developers and engineers, an increase of 1.8% over 2021. Our growth in product developers and engineers served increased at a greater rate than our revenue growth, resulting in a decrease in the average spend per product developer and engineer. The decrease in average spend per product developer and engineer was driven by the impact of foreign currency movements, primarily the weakening of the British Pound and Euro relative to the United States Dollar. 

Revenue by product line and the related changes for 2022 and 2021 is summarized as follows:

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

By product line, our revenue increase was driven by a 12.9% increase in CNC Machining revenue and an 8.6% increase in 3D Printing revenue, which was partially offset by an 11.3% decrease in Injection Molding revenue, a 4.4% decrease in Sheet Metal revenue, and a 53.1% decrease in Other Revenue, in each case for 2022 compared with 2021.

Cost of Revenue, Gross Profit and Gross Margin

Cost of Revenue. Cost of revenue increased $7.5 million, or 2.8%, for 2022 compared to 2021, which was greater than the rate of revenue increase of 0.1% for 2022 compared to 2021. Hubs provided a $7.6 million increase in cost of revenue due to higher revenue volume for the year ended December 31, 2022 when compared to the same period in 2021. The $0.1 million decrease in cost of revenue in our legacy business was driven by personnel and related cost decreases of $5.3 million, which were partially offset by an increase in raw material and product costs of $4.8 million and an increase in equipment and facility related costs of $0.4 million.

Gross Profit and Gross Margin. Gross profit decreased from $222.7 million in 2021 to $215.5 million in 2022. Gross margin decreased from 45.6% of revenue in 2021 to 44.1% of revenue in 2022 primarily due to a decrease in Injection Molding revenue.

Operating Expenses

Marketing and Sales. Marketing and sales expense increased $0.6 million, or 0.7%, for 2022 compared to 2021. Hubs provided a $2.6 million increase in marketing and sales expense during 2022. In our legacy business, a decrease of $2.4 million in personnel and related cost decreases was partially offset by a $0.4 million increase in marketing and sales expenses.

Research and Development. Our research and development expense decreased $6.0 million, or 13.6%, for 2022 compared to 2021 primarily due to legacy personnel and related cost decreases of $6.6 million driven by personnel and contractor resources dedicated to the launch of our PL 2.0 system in 2021 and decreases in other operating costs of $0.7 million, which were partially offset by a $0.3 million increase in professional services. Hubs provided increases of $1.0 million in research and development expense.

General and Administrative. Our general and administrative expense decreased $0.9 million, or 1.3%, for 2022 compared to 2021 primarily due to a decrease of $2.4 million in administrative costs, a decrease of $2.2 million in professional service costs, a decrease of $0.8 million in personnel and related costs, and a decrease of $0.3 million in stock-based compensation cost, which were partially offset by an increase in research and development costs of $4.8 million provided by Hubs.

Goodwill impairment. A goodwill impairment charge of $118.0 million was recognized in the fourth quarter of 2022, as it was determined the estimated fair value of our Europe reporting unit, including goodwill, was less than its carrying amount.

Closure of Japan business. Our decision to close our Japan business resulted in $6.9 million in operating expenses during 2022. Operating expenses included $2.3 million of employee severance, $2.4 million related to the write-down of fixed assets, $0.9 million of facility-related charges, $0.6 million in goodwill impairment charges, $0.7 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 during 2022. The fair value of contingent consideration associated with the acquisition of Hubs decreased $12.5 million during 2021.

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Income (Loss) from Operations

Income from operations decreased $138.3 million, or 342.9%, for 2022 compared with 2021. By reportable segment, income from operations for the United States decreased $4.8 million. Income from operations for Europe decreased $131.1 million for 2022 compared with 2021, which was primarily driven by a $118.0 goodwill impairment charge. Loss from operations included in Corporate Unallocated and Japan decreased $2.4 million for 2022 compared with 2021. The loss from operations is primarily driven by the Europe goodwill impairment charge.

Other (Expense) Income, Net and Provision for Income Taxes

Other (Expense) Income, Net. We recognized other income, net of $0.1 million in 2022, an increase of $0.3 million compared to other expense, net of $0.2 million for 2021. Other income, net for 2022 primarily consisted of $1.0 million in interest income, which was partially offset by a $0.9 million loss on foreign currency and other losses. Other income, net for 2021 primarily consisted of a $0.9 million loss on foreign currency, which is partially offset by a $0.2 million in interest income and $0.5 million in other income.

Provision for Income Taxes. Our income tax provision decreased by $1.2 million for 2022 compared to 2021. The decrease in the provision is primarily due to lower taxable income and the lower effective tax rate. Our effective tax rate of (5.7)% for 2022 decreased 22.7% compared to 17.0% for the same period in 2021 primarily due to the tax rate impact of the goodwill impairment and a benefit from the decrease in the tax liability for uncertain tax positions. These benefits were partially offset by an increase in the valuation allowances on losses from foreign operations.

Comparison of Years Ended December 31, 2021 and 2020

For a comparison of our results of operations for fiscal years ended December 31, 2021 and December 31, 2020, see "Part II, Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 18, 2022.

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Liquidity and Capital Resources

Cash Flows

The following table summarizes our cash flows for the years ended December 31, 2022, 2021 and 2020:

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[[/GREPCENT_TABLE]]

Sources of Liquidity

We finance our operations and capital expenditures through cash flow from operations. We had cash and cash equivalents of $56.6 million as of December 31, 2022, a decrease of $9.4 million from December 31, 2021. The decrease in our cash was primarily due to cash used in investing activities for net purchases of, and proceeds from sales of, marketable securities of $25.5 million, purchases of property, equipment and other capital assets of $17.6 million, and cash used in financing activities for repurchases of common stock of $29.7 million, which were partially offset by cash generated through operations of $62.1 million. We had cash and cash equivalents of $65.9 million as of December 31, 2021, a decrease of $61.7 million from December 31, 2020. The decrease in our cash was primarily due to cash used in investing activities for our acquisition of Hubs of $127.4 million, purchases of property, equipment and other capital assets of $34.2 million, and cash used in financing activities for repurchases of common stock of $23.3 million, which were partially offset by net proceeds from investments in marketable securities of $67.0 million and cash generated through operations of $55.2 million. 

As of December 31, 2022, the amount of cash and cash equivalents held by foreign subsidiaries was $19.6 million. Our intent is to continue to permanently reinvest these funds outside the U.S. and our current plans do not demonstrate a need to repatriate them to fund our domestic operations. We believe that our existing cash and cash equivalents together with cash generated from operations will be sufficient to meet our working capital expenditure requirements for at least the next 12 months.

Cash Flows from Operating Activities

Cash flow from operating activities of $62.1 million during 2022 primarily consisted of net loss of $103.4 million, adjusted for certain non-cash items, including depreciation and amortization of $39.4 million, stock-based compensation expense of $17.6 million, loss on goodwill impairment of $118.0 million and impairments related to closure of Japan business of $2.8 million, which were partially offset by changes in deferred taxes of $9.5 million and changes in operating assets and liabilities and other items totaling $2.8 million. The cash flow from operating activities during 2022 compared to 2021 increased $6.8 million primarily due to changes in operating assets and liabilities and other items of $22.0 million, loss on impairment of goodwill of $118.0 million, changes in fair value of contingent consideration of $13.3 million and impairments related to closure of Japan business of $2.8 million, which were partially offset by decreases in net income of $136.8 million, decreases in deferred taxes of $9.8 million, decreases in depreciation and amortization of $1.1 million and decreases in stock-based compensation of $1.6 million.

Cash flow from operating activities of $55.2 million during 2021 primarily consisted of net income of $33.4 million, adjusted for certain non-cash items, including depreciation and amortization of $40.5 million and stock-based compensation expense of $19.1 million, which were partially offset by a decrease in the fair value of contingent consideration of $13.3 million and changes in operating assets and liabilities and other items totaling $24.5 million. The cash flow from operating activities during 2021 compared to 2020 decreased $51.7 million primarily due to decreases in net income of $17.5 million, increases in accounts receivable of $20.1 million driven by timing of cash receipts, a decrease in the fair value of contingent consideration of $13.3 million, decreases in deferred taxes of $7.2 million, and decreases of $6.0 million in other items, which were partially offset by increases in depreciation and amortization of $7.9 million and increases in stock-based compensation of $4.4 million.

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Cash Flows from Investing Activities

Cash used in investing activities was $43.1 million for the year ended December 31, 2022, consisting of $17.6 million for the net purchases of property, equipment and other capital assets and $25.5 million of net purchases of marketable securities.

Cash used in investing activities was $94.7 million for the year ended December 31, 2021, consisting of $127.4 million in cash used for acquisitions, net of cash acquired and $34.2 million for the purchases of property, equipment and other capital assets, which were partially offset by $67.0 million of net proceeds from investments in marketable securities.

Cash Flows from Financing Activities

Cash used in financing activities was $27.9 million for the year ended December 31, 2022, consisting of $29.7 million in repurchases of common stock, $1.7 million in shares withheld for tax obligations associated with equity transactions, and $0.5 million for repayments of finance lease obligations, which were partially offset by $4.0 million in proceeds from issuance of common stock from equity plans.

Cash used in financing activities was $22.2 million for the year ended December 31, 2021, consisting of $23.3 million in repurchases of common stock, $4.2 million in shares withheld for tax obligations associated with equity transactions, and $0.6 million for repayments of finance lease obligations, which were partially offset by $5.9 million in proceeds from issuance of common stock from equity plans.

Operating and Capital Expenditure Requirements

We believe, based on our current operating plan, that our cash balances and cash generated through operations and interest income will be sufficient to meet our anticipated cash requirements through at least the next 12 months. From time to time we may seek to sell equity or convertible debt securities or enter into credit facilities. The sale of equity and convertible debt securities may result in dilution to our shareholders. If we raise additional funds through the issuance of convertible debt securities or enter into credit facilities, these securities and debt holders could have rights senior to those of our common stock, and this debt could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on terms acceptable to us, or at all.

Our future capital requirements will depend on many factors, including the following:

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

Our recent annual capital expenditures have varied between 4% and 11% of annual revenue. We believe future growth capital expenditures, excluding any expenditures for buildings and maintenance capital we might purchase for our operations, are likely to vary between approximately 8% and 12% of annual revenue.

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Contractual Obligations

As of December 31, 2022, our contractual obligations are $21.4 million related to current and long-term operating and finance lease liabilities.

Financing Arrangements

We had no financing arrangements as of December 31, 2022 and 2021.

Inflation

We experience normal inflation and changing prices, primarily on our production materials and labor. In 2022, 2021 and 2020 wage inflation contributed to our lower gross margin. 

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amount of assets, liabilities, revenue, expenses and related disclosures. Critical accounting estimates are those estimates made in accordance with GAAP which involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, goodwill, capitalized software costs, other intangible assets, stock-based compensation, and income taxes. We base our estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Management has discussed the development, selection and disclosure of these estimates with the audit committee of our board of directors. Our actual results may differ significantly from these estimates under different assumptions or conditions.

We believe the following critical accounting policies and estimates affect our more significant judgments used in the preparation of our consolidated financial statements. See the Notes to Consolidated Financial Statements included in Item 8. “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for additional information about these critical accounting policies and estimates, as well as a description of our other accounting policies and estimates.

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Revenue Recognition

We recognize revenue for our internal and outsourced manufacturing operations in accordance with ASC 606, Revenue from Contracts with Customers. We manufacture custom parts to specific customer orders that have no alternative use to us, and we believe there is a legally enforceable right to payment for performance completed to date on internally and outsourced manufactured parts. For manufactured parts that meet these two criteria, we will recognize revenue over time. Revenue is recognized over time using the input method based on time in production as a percentage of total estimated production time to measure progress toward satisfying performance obligations using the estimated total time necessary to complete the parts per the customer's order and an estimate of inventory and production costs incurred to date. The input method requires an analysis of the incurred time in production and an estimate of the total time necessary to complete the total parts per the customer's order. The majority of our CNC machining, 3D printing, and sheet metal contracts have a single performance obligation. The majority of our injection molding contracts have multiple performance obligations including one obligation to produce the mold and a second obligation to produce parts. For injection molding contracts with multiple performance obligations, we allocate revenue to each performance obligation based on its relative standalone selling price. We generally determine standalone selling price based on the price charged to customers.

Goodwill

We recognize goodwill in accordance with ASC 350, Intangibles—Goodwill and Other. Goodwill is the excess of cost of an acquired entity over the amounts assigned to assets acquired and liabilities assumed in a business combination. Goodwill is allocated to our reporting units, which are determined by the discrete financial information available for the component and whether it is regularly reviewed by segment management. Our reporting units are the United States and Europe. Goodwill is not amortized.

Goodwill is tested for impairment annually as of the first day of the fourth quarter, and is tested for impairment between annual tests if an event occurs or circumstances change that would indicate the carrying amount may be impaired. An impairment charge for goodwill is recognized only when the estimated fair value of a reporting unit, including goodwill, is less than its carrying amount. The quantitative impairment test requires judgment, including the identification of reporting units, the assignment of assets, liabilities and goodwill to reporting units, and the determination of fair value of each reporting unit. The impairment test requires the comparison of the fair value of each reporting unit with its carrying amount, including goodwill. In performing the impairment test, we determined the fair value of its reporting units through the income approach by using discounted cash flow (DCF) analyses. Determining fair value requires us to make judgments about appropriate discount rates, perpetual growth rates and the amount and timing of expected future cash flows. The cash flows employed in the DCF analysis for each reporting unit are based on the reporting unit's budget, long-term business plan and recent operating performance. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting unit and market conditions. Given the inherent uncertainty in determining the assumptions underlying a DCF analysis, actual results may differ from those used in our valuations. In assessing the reasonableness of the determined fair values, we also reconciled the aggregate determined fair value of the Company to the Company's market capitalization, which, at the date of its 2022 impairment test, included a 9 percent control discount. Significant assumptions used in the DCF analysis included forecasted revenue and related revenue growth rate, gross margins rate, operating expenses as a percentage of revenue rate and weighted-average cost of capital. As a result of the analyses, a $118.0 million impairment related to the Europe reporting unit was identified, which represents a write-off of all Europe goodwill.

Capitalized Software Costs

We follow ASC 350-40, Intangibles – Goodwill and Other, Internal-Use Software, in accounting for internally developed software. Costs for internal-use software are evaluated by project and capitalized where appropriate.

Other Intangible Assets

We recognize other intangibles assets in accordance with ASC 350, Intangibles—Goodwill and Other. Other intangible assets include software technology, customer relationships and other intangible assets acquired from independent parties. We used a multi-period excess earnings method under the income approach to measure the software platform when acquired through an acquisition. In 2021, the significant assumptions used to estimate the value of the software platform included forecasted annual revenue growth, gross margin rates, operating expenses as a percentage of sales and the weighted-average cost of capital, which are affected by our business plans and expectations about future market or economic conditions. Other intangible assets with a definite life are amortized over a period ranging from two to 12 years on a straight line basis, and are tested for impairment whenever events or circumstances indicate that the carrying amount of an asset (asset group) may not be recoverable. An impairment loss is recognized when the carrying amount of an asset exceeds the estimated undiscounted cash flows generated by the asset. As of December 31, 2022, no impairment charges for intangible assets have been recognized.

Stock-Based Compensation

We determine our stock-based compensation in accordance with ASC 718, Compensation—Stock Compensation (ASC 718), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and non-employee directors based on the grant date fair value of the award.

Determining the appropriate fair value model and calculating the fair value of stock option grants requires the input of subjective assumptions. We use the Black-Scholes option pricing model to value our stock option awards. Stock-based compensation expense is significant to our consolidated financial statements and is calculated using our best estimates, which involve inherent uncertainties and the application of management’s judgment. Significant estimates include our expected term and stock price volatility. If different estimates and assumptions had been used, our common stock valuations could be significantly different and related stock-based compensation expense may be materially impacted.

The Black-Scholes option pricing model requires inputs such as the risk-free interest rate, expected term, expected volatility and expected dividend yield. We base the risk-free interest rate that we use in the Black-Scholes option pricing model on zero coupon U.S. Treasury instruments with maturities similar to the expected term of the award being valued. The expected term of stock options is estimated from the vesting period of the award and represents the weighted average period that our stock options are expected to be outstanding. We estimated the volatility of our stock price based on the historic volatility of our common stock. We have never paid and do not anticipate paying any cash dividends in the foreseeable future and, therefore, we use an expected dividend yield of zero in the option pricing model. We account for forfeitures as they occur.

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The fair value of each new employee option awarded was estimated on the date of grant for the periods below using the Black-Scholes option pricing model with the following assumptions:

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[[/GREPCENT_TABLE]]

Our 2012 Employee Stock Purchase Plan (ESPP) allows eligible employees to purchase a variable number of shares of our common stock during each offering period at a discount through payroll deductions of up to 15% of their eligible compensation, subject to plan limitations. The ESPP provides for six-month offering periods with a single purchase period. At the end of each offering period, employees are able to purchase shares at 85% of the lower of the fair market value of our common stock on the first trading day of the offering period or on the last trading day of the offering period. We determine the fair value stock-based compensation related to our ESPP in accordance with ASC 718 using the component measurement approach and the Black-Scholes standard option pricing model.

The fair value of each offering period was estimated using the Black-Scholes option pricing model with the following assumptions:

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[[/GREPCENT_TABLE]]

 There are significant differences among option valuation models, and this may result in a lack of comparability with other companies that use different models, methods and assumptions. If factors change and we employ different assumptions in the application of ASC 718 in future periods, or if we decide to use a different valuation model, such as a lattice model, the stock-based compensation expense that we record in the future under ASC 718 may differ significantly from what we have recorded using the Black-Scholes option pricing model and could materially affect our operating results.

We recognize stock-based compensation expense on a straight-line basis over the requisite service period. We recorded stock-based compensation expense relating to stock options, restricted stock awards, performance stock units and our ESPP of $17.5 million, $19.1 million and $14.7 million during the years ended December 31, 2022, 2021 and 2020, respectively. As of December 31, 2022, we had $3.9 million of unrecognized stock-based compensation costs related to unvested stock options that are expected to be recognized over a weighted average period of 2.6 years. We issued options to purchase 118,434, 57,901 and 60,065 shares of our common stock in 2022, 2021 and 2020, respectively. As of December 31, 2022, we had $21.1 million of unrecognized stock-based compensation costs related to non-vested restricted stock, which is expected to be recognized over a weighted average period of 2.4 years. We issued restricted stock awards of 315,432, 205,996 and 108,179 shares of our common stock in 2022, 2021 and 2020, respectively. As of December 31, 2022, we had $2.5 million of unrecognized stock-based compensation costs related to non-vested performance stock, which is expected to be recognized over a weighted average period of 2.0 years. We issued performance stock awards of 35,697, 15,078 and 19,956 shares of our common stock in 2022, 2021 and 2020, respectively.

In future periods, our stock-based compensation expense is expected to increase due to our existing unrecognized stock-based compensation and the issuance of additional stock-based awards to continue to attract and retain employees and non-employee directors.

Income Taxes

We account for income taxes in accordance with ASC 740, Income Taxes (ASC 740). Under this method, we determine tax assets and liabilities based upon the differences between the financial statement carrying amounts and the tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. The tax consequences of most events recognized in the current year’s financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities and equity, revenues, expenses, gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax basis of assets or liabilities and their reported amounts in the financial statements. Because we assume that the reported amounts of assets and liabilities will be recovered and settled, respectively, a difference between the tax basis of an asset or liability and its reported amount in the balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or the reported amounts of the assets are recovered, giving rise to a deferred tax asset or liability. We establish a valuation allowance for any portion of our deferred tax assets that we believe will not be recognized.

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ASC 740 also clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements. The Company recognizes the effect of income tax positions only if sustaining those positions is more likely than not. The Company records penalties and interest related to unrecognized tax benefits in income taxes in the Company’s Consolidated Statements of Income. Including interest and penalties, we have established a liability for uncertain tax positions of $4.4 million as of December 31, 2022.

The effective tax rate decreased by 22.7% for the year ended December 31, 2022 when compared to 2021 primarily due to the tax rate impact of the goodwill impairment and a benefit from the decrease in the tax liability for uncertain tax positions. These benefits were partially offset by an increase in the valuation allowances on losses from foreign operations. 

Recently adopted accounting pronouncements

We did not recently adopt any accounting pronouncements that had a material impact on our Consolidated Financial Statements.  There are no pending accounting pronouncements that are expected to have a material impact on our Consolidated Financial Statements.

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