Greetings. Welcome to Proto Labs' Second Quarter 2024 Earnings Call. [Operator Instructions] Please note this conference is being recorded. At this time, I'll now turn the conference over to Jason Frankman, Vice President and Corporate Controller. Jason, you may now begin your presentation.

Thank you and welcome, everyone to Proto Labs second quarter 2024 earnings conference call. I'm joined today by Rob Bodor, President and Chief Executive Officer; and Dan Schumacher, Chief Financial Officer. This morning, Proto Labs issued a press release announcing its financial results for the second quarter ended June 30, 2024. The release is available on the Company's website. In addition, a prepared slide presentation is available online at the web address provided in our press release. Our discussion today will include statements relating to future performance and expectations that are or may be considered forward-looking statements and subject to many risks and uncertainties that could cause actual results to differ materially from expectations. Please refer to our earnings press release and recent SEC filings, including our Annual Report on Form 10-K, for information on certain risks that could cause actual outcomes to differ materially and adversely from any forward-looking statements made today. The results and guidance we will discuss include non-GAAP financial measures consistent with our past practice. Please refer to our press release and the accompanying slide presentation at the Investor Relations section of our company website for a complete reconciliation of GAAP to non-GAAP results. Now. I'll turn the call over to Rob Bodor. Rob?

Thanks, Jason. Good morning, everyone and thank you for joining our second quarter earnings call. Despite operating in a challenging macro environment, on a year-over-year basis, Proto Lab's first half 2024 revenue grew 2% and non-GAAP earnings per share grew 25%. In an environment in which manufacturing activity has contracted in the U.S. and Europe, we continue to take share and improve our industry-leading profitability. We've improved the efficiency of our AI-enabled pricing algorithms, increased the automation in our digital factories, and managed our costs with volume. No business is immune from the manufacturing headwinds currently at play in the market, but our resilient model has produced growth and improved profitability. In the second quarter of 2024, we made good progress against our two strategic initiatives, increasing the number of customers using our comprehensive offer and driving higher revenue per customer through larger orders. Our customers continue to recognize, adopt, and benefit from our comprehensive offer fulfilled through both the factory and the network. As we previously discussed, our comprehensive offer enables customers to use Proto Labs as a single source manufacturer throughout the product life cycle, from prototype to production to end of life. We are still in the early stages of customers fully utilizing our combined offer, which presents an incredible long-term growth opportunity and we're focused on driving adoption. In fact, in the last 12 months, the number of customers using the combined offer is up over 50% year-over-year. We're also focused on driving higher revenue per customer through larger orders across services. While large one-time orders decreased slightly compared to the first quarter, second-quarter revenue per customer contact increased 7% year-over-year. There will be fluctuations in larger order quantities quarter-to-quarter as we continue to shift toward more production work, but we strive to increase revenue per…

Thanks, Rob, and good morning, everyone. Our financial results begin on Page 7 of the slide presentation. Second quarter revenue of $125.6 million grew 2.8% year-over-year in constant currencies. Proto Labs network revenue was $24.7 million in the quarter, up 22.7% in constant currencies. Turning to revenue growth by service and constant currencies outlined on Slide 9. Second quarter injection molding revenue was flat year-over-year. Injection molding orders from larger project customers continued to grow, while smaller prototype orders declined. CNC machining grew 6% year-over-year, driven by continued strong growth through Proto Labs network. Second quarter 3D Printing revenue grew 1% year-over-year. Sheet metal revenue was flat year-over-year and up 10% compared to the first quarter. Turning to Slide 10, second quarter non-GAAP gross margin increased 10 basis points sequentially to 45.7%. Proto Labs network non-GAAP gross margin was 32.8%, up from 31.7% in the first quarter, while factory non-GAAP gross margin was unchanged sequentially. Non-GAAP operating expenses were flat compared to the first quarter of 2024 as a decrease in employee-related expenses was offset by an increase in various discretionary costs. As a result, second quarter non-GAAP diluted net income per share was $0.38 at the top end of our expectations and down $0.02 compared to the first quarter of 2024. The sequential decline was due to lower volume, partially offset by a slight improvement in gross margin. As Rob mentioned earlier, our first half 2024 adjusted EPS, increased 25% over the first half of 2023. Our industry-leading profitability continues to improve year-over-year, driven by increases in both factory and network gross margins. Total Proto Labs non-GAAP gross margin in the first half of 2024 was 45.6%, up 190 basis points year-over-year. Transitioning to cash flow and balance sheet highlights on Slide 11. Cash flow from operations was $14.4…

[Operator Instructions] And our first question will be coming from the line of Brian Drab with William Blair. Please proceed with your questions.

Good morning. Thanks for taking my questions. I guess I just was hoping we could start with the reorg and I'm not sure I caught all of it the first time through. So I was wondering, Rob, if you could just elaborate on what you're doing and what the impetus is for it and how it accelerates growth? And then, like a follow-up also is what -- it sounds like the team is slightly smaller now, and what is the potential impact in the medium term on margins or cost take-outs?

Yes, sure. Thanks for the question, Brian. So the purpose of the reorganization is to really focus us around serving our customer even better than we have been and more holistically and it does that in several ways. So, one, we're moving from regionally organized, where we had all our P&Ls were regional in the U.S. and in Europe, and we had general managers, right, who were overseeing that. And that came from our old model of really fulfilling in the regions, where we were going to market from the factory business. We're now moving to a global operations organization, right, where, whether it's factory or network, we've got one unified organization whose job it is to bring our broad comprehensive offer to every customer in a unified way, so that we can really ensure that we're giving our customers the best experience and full exposure to our full capabilities from an operation standpoint and that we can then find opportunities to drive productivity in that. From a go to market standpoint, now we've got revenue and customer-facing teams in each region, focusing on driving customer demand in a unified way with they'll be having single unified incentive plans, and really just focusing on bringing that offering to our customers even more effectively than we had been. So that's the rationale for the reorganization, and we're very excited about it here internally. You asked about my...

Yes, I asked about the cost, but before we get, just maybe an example of a customer, you know, benefiting from this reorg would be helpful, just how this would benefit Proto Labs and the customer, I guess. But I'm just picturing, like, maybe it's a customer in Europe, for example, who is doing a lot of product development activity and running fast with the factory, but then they're moving to production, and then maybe you're going to use the network, and that same team then will provide a more seamless customer experience and suggesting that they move to the network for some higher volume production work that maybe will be done even in Asia or something, but it's all more holistically offered. Is that -- am I on the right track in all there?

You got it exactly right. So it's one unified team. They're seeing the full scope. We remove the need for handoffs, and therefore we can just serve the customer more efficiently with that comprehensive offer.

Brian, what I would also just highlight, you've got a team that has just focused on the customer. They're just focusing on getting the customer what it needs, what it wants, right. And that could be -- in terms of our customers, that could be the fastest speed prototype out of our CNC facility, or that might be somebody who is in production and they need that fulfillment out of the network. And they're not worried about, oh, I need to get so many revenue into one fulfillment option or another. They're just worried about getting the customer what they want. The operations organization is then fulfilling that in the most efficient way possible through our broadest kind of scope of fulfillment options that are available. So it is narrowly focusing our organization on the things that matter to drive success to the customer.

Yes, it makes sense. Okay, thank you. I've got a couple more questions, but maybe I'll just ask one more now. How do you foresee in the next year or so, the trend in your customer count going? Because it has been challenged, right. The customer count is down. I know that your revenue per customer is up nicely because of the network strategy, but do you think that ultimately that you're going to be able to get that total customer count kind of reverse course and start growing again?

Yes, we absolutely do. And our focus is on driving that and driving overall growth, right, by improving our revenue per customer. Now, of course, we all understand that this is a very difficult macro environment. And as you talk to our customers who are manufacturers, they're dealing with high interest rates, inflation, uncertainty politically because of elections, uncertainty because of trade policy, et cetera. So many of them are having a difficult time in this period. And I attribute what we're seeing with total customer count reflection of that -- of that kind of macro. So we're driving what we can drive and driving what we can control around serving our customers better about being for them -- being there for them throughout the product lifecycle. I think we have a tremendous opportunity for growth as we go forward. Last year we served 53,000 customers. They came to us for their prototyping. They've told us that they want to use us more broadly across the product life cycle. We are working hard to get them to be adopting that. We saw a 50% growth year-over-year in customers using us in that way. That alone is driving significant leverage and increase in our average revenue per customer. So our focus is on better serving the customers we reorganize to really make us exceptional at doing that, so that we can grow in the long term and that's what we're focused on right now. Thank you.

All right. Okay. Thank you very much.

Thanks, Brian.

Our next questions are from the line of Troy Jensen with Cantor Fitzgerald. Please proceed with your questions.

Hi, gentlemen, congrats on a good Q2 in a tough environment.

Thanks, Troy.

Maybe just a couple questions -- You're very welcome. For Daniel, though, can you talk about what you think gross margins is going to look like kind of the midpoint of the guidance range Q3, then also following up on Brian's question about cost takeouts. Do you think OpEx is going to be up flat or down sequentially on an absolute basis here in September?

Yes. So with the middle of the guidance range, I would expect gross margins to be down slightly quarter-over-quarter. We are still pushing efficiencies, automation through our factory, and continue to working the algorithm on the network side. But, there is going to be some pressure from the volume. So I would see the gross margin down slightly quarter-over-quarter. From an operating expense perspective, I would expect operating expenses to be down slightly quarter-over-quarter as well. I think if you factor those things in, you get to the middle of our guidance range from an EPS perspective. Was there a second part to that question or did I answer it?

Well, there is a follow-up for that, Daniel, and - one of you guys, actually. But just the hubs business, I know on a year-over-year basis it's been growing nicely, but the last four quarters we've been stuck in $23 million to $25 million. I know your biggest competitor out there is growing significantly faster. So can you just talk about share shifts or kind of why hubs isn't growing as fast as maybe some of the others out there?

So I think our focus has been on really serving the customer holistically and driving production with them. And I think we've seen that, that has been quite successful for us. Whether that's in injection molding or in CNC through the network, I believe that long-term we are going to be able to see really strong growth in that as we continue to expose that to our customers. Of course, right now in this environment, there's clearly headwinds for customers in terms of the use cases and their adoption. And so I think that, that's affecting us right. We're not independent of the overall market.

Got you. That's fair. Okay. So good luck here in Q3.

Thanks, Troy.

Our next question is from the line of Jim Ricchiuti with Needham & Company. Please proceed with your questions.

Hi. Thanks. Good morning. So if we think about this reorganization, it appears to be more of a redeployment of resources as opposed to -- as you go through this process, would you anticipate any additional investments having to be made, and how soon do you think you would anticipate seeing the benefits of the reorganization or at least we'll see some of it be able to see the benefits.

Yes. Thanks for the question, Jim. So the purpose of the reorganization again is really revenue-focused, and it is about redeploying our resources in the most effective way, make sure that we are operating seamlessly as one team, as we face the customer, and as we work to fulfill their orders and fully leverage our full global capabilities, right. So that's really what it's about. We believe that longer term, this will set us up to find additional productivity and so forth, but we're focused on growth and serving our customer better and so that's really the key rationale for it. Dan, would you…

Jim, when I look at -- we grew EPS 25% through the first half of the year, but we only grew revenue to 2%, right. And growing in a tough environment is good, but as Rob has stated earlier, we're not satisfied with that level of growth, and realigning and getting the organization focused on the right things for the customer are extremely important to us in order for us to really grow meaningfully, grow through production, growth through improved customer experiences and so this alignment does this. With that growth right over time, we will see a pickup in margins as our growth numbers get larger and larger. The other thing I would tell you is streamlining into a unified operations organization will have a longer-term benefit, and we'll see efficiencies through that streamline over the longer term.

Got it. Thank you. The slowing that you called out in June and in July, it seems to be pretty consistent with what we're hearing out there. But I'm wondering if you could provide any additional color. It appears to be in both your major geographic regions, any other color you could provide in terms of the market verticals, where you're seeing some changes?

Yes, so, Jim, we saw a slowing at the beginning of June, and honestly, from the desk I was sitting at, I was like, okay, well, there'll be some pickup before the 4th of July, before people go on holiday, they're going to put their orders in, and that really did not happen. Then after the 4th of July, while we saw increasing order rates after that U.S. holiday, they were not to the increasing level that we've seen in prior years. As we talk to our salespeople about what's going on, I think generally what we're hearing is starting in June, as you talk with a customer about closing a project and so forth, it would go through more approval cycles. There was more delay and trying to get an answer to close an order. And that -- that type of hesitancy continued into July. And so that's the environment in which we're playing in, but we're still focused on solving our customers problems with what we have and driving the growth and capturing as many of the opportunities that are there.

So you asked also about industries, I would say that we're seeing this to be pretty broad-based and affecting most of the industries that we serve. But I would just also add, Jim, that this has been a tough environment for the last two years in the U.S. and in Europe. And I think we've proven that we can outperform in this environment. We grew all of last year, we grew in the first half of this year. We've been executing our discipline around cost management and been able to expand margins in this environment. I think if you look back in our history in strong economies, we outperformed GDP by multiples. So I think we have a very robust business. We are profitable. We are a strong cash generator. We carry no debt. We are focused on serving our customers best as possible in any macroeconomy, and we're driving what we can control, which is to make sure we serve our customer in the best way possible. We will absolutely weather this storm, and when the cycle improves, I expect we will be demonstrating strong growth.

Got it. That's helpful. Best of luck going forward. Thank you.

Thank you.

Thank you.

Our next question is from the line of Greg Palm with Craig-Hallum Capital. Please proceed with your questions.

Yes, good morning. I wanted to just dig into that July comment a little bit more. Dan, it sounded like, you know, it sounded based on your past answer, that maybe orders picked up a little bit in July. But I think what you said was the guidance was based on what you saw in July and assumes an improvement or recovery in August and September. Those don't exactly tie out because I think that would assume that July trends were pretty awful. So can you maybe just tie that out if you can?

Yes. It's not a recovery. What I'm talking about is normal seasonality patterns that we see on a lower base, right? So if you draw that trend across August and September, right. August and September will be lower than what we had last year, which is why the guide is down year-over-year, if that makes sense, Greg.

Okay. I mean, could you give us any sense in terms of like, quantifying the declines in July and what's baked into the guidance or at least sort of ballpark?

No, We just give guide on the overall quarter right and not specifically on what is month-to-month. But I would say in general, the decline in July is consistent with what the middle of the guide is year-over-year.

Okay. And I'm curious, under this new organizational change strategy that you talked about, does it change how you view revenue by service? For instance, sheet metal, which has been declining basically every year since that business was acquired, and even if I look back at 3D Printing, which was historically a pretty good grower, and it's stagnated here the last couple of quarters, I guess what I'm trying to figure out is, how much of this is due to cyclical versus structural reasons? And is there any focus on either de-emphasizing that further walking away from certain processes, just would like to get a little bit more color there?

Yes. Thank you for the question. So in terms of the reorganization, again, this is about how can we serve our customers holistically and how can we be efficiently organized to do that as seamlessly as possible? It does not change the services that we are bringing to market, and we want to continue to be able to bring to market all services to meet the needs of our customers as effectively as possible. Certainly, we have some services that are performing better than others in this macroenvironment, and we are working to drive and improve our overall revenue, and that's really where my focus is.

So I guess, do you think some of the organizational changes could help reaccelerate activity in some of those lower-performing segments, then, is that the hope?

Absolutely, absolutely.

Yes. Okay. All right. I will leave it there. Thanks.

Thanks, Greg.

Thanks, Greg.

Thank you. This will conclude our question and answer session and also conclude today's conference. You may now disconnect your lines at this time. Thank you for your participation.