Proto Labs - Earnings Call - Q2 2020
July 28, 2020
Transcript
Speaker 0
Greetings and welcome to the Proto Labs Second Quarter twenty twenty Earnings Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Daniel Schumacher, Director of Investor Relations.
Thank you. You may begin.
Speaker 1
Thank you, Michelle, and good morning, everyone. With me today is Vicki Holt, our President and Chief Executive Officer and John Lay, our Chief Financial Officer. This morning before the market opened, Proto Labs issued a press release announcing its financial results for the second quarter ended 06/30/2020. The release is available on the company's website at protolabs.com. In addition, a prepared slide presentation is available online at the web address provided in our press release.
Before we begin, I would like to remind everyone that our discussion 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 ks 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 within the Investor Relations section of our company website for a complete reconciliation of non GAAP to GAAP results. Now I'd like to turn the call over to Vicki Holt, President and Chief Executive Officer of Proto Labs.
Vicki?
Speaker 2
Thanks, Anne. Good morning, everyone, and welcome to our second quarter twenty twenty earnings conference call. Thank you for joining us today. I would like to start by expressing how proud I am of the Proto team and how we've handled the first half of twenty twenty. Like all businesses, we've had to evolve considerably in the first six months of the year.
Proto Labs has rapidly adapted to change guided by our core values of teamwork, trust and achievements. As I mentioned on our first quarter call, our top priority is to keep our employees, communities and customers safe. Our manufacturing and office teams worldwide have done an incredible job of ensuring employee safety while continuing to delight customers with our industry leading digital manufacturing services. Every one of our manufacturing facilities have remained operational throughout the global pandemic. The safety of our employees is extremely important to me, and our essential manufacturing employees are my heroes.
I would like to thank them all for what they do to make Proto Labs a great organization. We have had some confirmed cases of COVID-nineteen, but we believe they occurred outside of our facilities, and we have been able to greatly limit the impact to other employees. Our new cleaning and sanitizing standard operating procedures in all our manufacturing facilities have continued since the beginning of the COVID-nineteen pandemic. In addition to new procedures that minimize employee interaction, our digital manufacturing model offers an advantage in practicing social distancing compared to more manual traditional manufacturing operations. Upon entry into our manufacturing or office facilities, we are conducting rapid temperature screenings via infrared camera technology and have put in place a mandatory mask policy in all of our facilities.
We are following local guidelines in each of our locations and the vast majority of our office employees continue to work remotely. While I'm not surprised, I am very impressed with the agility and creativity with which our employees have adapted to the changes thus far in 2020. A crisis like the COVID-nineteen pandemic provides an opportunity for Proto Labs to demonstrate the value our digital business model can provide. Our purpose is to accelerate innovation from development through commercialization, and we've been able to deliver on that purpose during this crisis. The way we interact with customers has not changed as we are an e commerce technology enabled company.
Through the second quarter, we continued to prioritize orders to equip the medical system to treat patients with COVID-nineteen and provide customers with additional consultative design assistance to get parts designed and manufactured rapidly. Our digital manufacturing model allows us to help our customers rapidly produce parts to respond to COVID-nineteen, including testing, preventing the spread or caring for patients that have contracted the virus. To date, we've manufactured and shipped over 8,000,000 parts be incorporated into products responding to COVID-nineteen at many different medical related customers, resulting in $12,000,000 of revenue recognized in the second quarter. We are grateful and proud to continue to serve our customers and contribute to the fight against this novel virus. Now turning to our financial results in the quarter.
Today, we reported second quarter revenue of $107,000,000 representing a decline of 8.1% over the 2019 and a 7.4% sequential decrease. Our revenue decline is a result of the broad challenges impacting our customer base and also include the $12,000,000 of COVID-nineteen related revenue. On a monthly basis, our second quarter revenue trend played out as follows. As we noted in our Q1 call, April revenue was down approximately 4% year over year. Global industrial manufacturing activity was severely impacted by COVID-nineteen and stay at home orders in April.
Our business was aided by $5,000,000 in revenue from COVID-nineteen related orders in April. May was the softest month in the quarter, with activity picking up slightly in June. The COVID related business continued through May and helped to mitigate the softness we experienced in the rest of the business during the month. To gain additional insights in this uncertain market, we conducted a survey of over 500 customers across a variety of industries in order to learn how customers and supply chains have been impacted by COVID-nineteen. Seventy three percent of respondents indicated they are working remotely.
Forty three percent have experienced a decrease in demand for their products. Regarding timing and development schedules, fifty eight percent of our customers surveyed have seen delayed development project timing and thirty three percent have seen reductions in project funding. These changes are reflected in our revenue performance and the number of unique product developers served in the second quarter of twenty twenty. I will now transition to second quarter twenty twenty revenue by geography highlighted on Slide five of our earnings presentation. Americas revenue declined 5% compared to the second quarter of twenty nineteen.
Revenue declined significantly in our industrial and consumer end markets in The Americas. Our aerospace customer end market continued its strong performance in 2020 during the second quarter. Automotive also increased year over year. Europe's second quarter revenue declined 20% year over year or 18% in constant currency. Demand was off in all European customer end use markets.
In Japan, revenue declined 21% or 23 in constant currency. Overall, our business declined 8% year over year in constant currency during the second quarter of twenty twenty. Revenue by service for the second quarter is presented on Slide six of our earnings presentation. Injection molding revenue grew 4% compared to the same period in 2019 due to strong demand for COVID-nineteen related components. Excluding COVID-nineteen revenue, year over year injection molding revenue declined 17%.
Three d printing, CNC machining and sheet metal were all down year over year as muted demand was not offset by demand for COVID-nineteen revenue in those services. Turning to earnings. We reported second quarter non GAAP EPS of $0.59 per share, down only $02 sequentially. Our revenue in the second quarter our earnings in the second quarter, excuse me, were down primarily due to lower volume and fixed cost absorption, partially offset by lower variable compensation and discretionary spending. We continue to manage expenses as demand remains soft, including labor and variable manufacturing costs, leadership and Board compensation reductions and tightly controlling discretionary spend.
John will dive deeper into our financial performance during the quarter a little later on the call. Despite the challenging economic environment, we are still focused on investing in and executing on key strategic initiatives to position our business for strong growth in the future. Our To maintain our position as the leader in digital manufacturing, we continue to push ahead on work related to PortoLabs two point zero, including development, documentation, validation, training and testing. As a reminder, PortoLabs two point zero is a systems project we've undertaken to enhance and evolve our systems and processes to support our customers and our strategy for the next decade and beyond.
There are two main components of Portalix 2.01, to enhance our e commerce platform and customer experience and two, to improve the functionality and interconnectivity of the back end systems, which support our operations. Proto Labs two point zero will allow us to come out of this pandemic stronger than we entered. We continue to operate under a plan to go live with the new systems in Europe by the end of twenty twenty, followed by The Americas in 2021. We recognize that there is both external and internal risk to that plan. Externally, travel restrictions and social distancing due to COVID-nineteen pandemic could present challenges and delays in assisting our operations in Europe with work necessary to go live.
Internally, as we continue to test our new systems and prepare for the go live event, unforeseen issues could arise and push back our intended go live date. Our focus is ensuring that the customer experience is favorable in the new system. Although we've been conducting user acceptance testing for months, we are happy to report that we completed our first round of live customer beta testing in early July with two twelve customer participants from 15 countries across Europe. Feedback on the customer facing component of Proto Labs two point zero was extremely positive. Beta participants described the new customer experience as streamlined, intuitive, modern and easier to use than our current system.
As expected, the first beta test of any new software system, our recent test also uncovered areas that need attention prior to launch. Our teams are working diligently to address these areas, complete development, validate and test our systems as we approach our planned go live dates. We will continue to focus on user testing in The U. S. As well as testing the systems, the business processes and our employees' training to ensure we're ready to serve our customers with the rapid and reliable service they expect from Proto Labs.
I am so proud of our teams and their work on Proto Labs two point zero to date. The level of teamwork across all functions and regions, all while transitioning to remote working environment is extremely impressive. Our teams are working hard every day to make Proto Labs a stronger, more successful company with highly differentiated leading edge technology. In summary, the first half of twenty twenty has presented a great deal of challenges to all businesses and ProLev is no exception. We have a solid financial foundation and a healthy balance sheet to weather the uncertain environment.
In addition, the team has demonstrated the resiliency of our dynamic digital manufacturing business model. We will continue to flex costs where we can to match demand, but we will not sacrifice the long term growth of the company. Our agile and creative employees will be there to help our customers succeed as they begin to come back to work and reaccelerate development projects to meet the needs of their as momentum builds in the recovery. With that, I'd like to turn the call over to John for an in-depth look at our financial performance in the second quarter as well as our outlook for the third quarter.
Speaker 3
Thank you, Vicki. Second quarter financial results begin on Page eight of our presentation. Revenue in the second quarter was $106,600,000 a decrease of $9,400,000 over the same quarter in 2019. Foreign currency represented a $350,000 headwind in the quarter, resulting in revenue decline of 7.8% in constant currencies. We served 17,000 unique product developers in the second quarter.
As a reminder, our unique product developers served metric enumerates individual product developers that purchased parts from us during the corresponding quarter. Consistent with the results of our customer survey, many of our customers have been impacted by COVID-nineteen stay at home orders and business shutdowns. The 18.2% decline in product developers served was greater than our year over year revenue decline due to the relatively large order size of the COVID related orders with $12,000,000 in revenue coming from relatively few individuals. Turning 10 to review the income statement. Our non GAAP cost of revenue decreased $3,000,000 compared to the first quarter, resulting in gross margin of 50.1%.
This reduction was a result efforts of our plant managers to align staffing to the significant variability from week to week across our manufacturing services. The reduction in cost of revenue did not correspond to the revenue decline due to the challenges in adjusting our fixed cost structure, resulting in a 110 basis point sequential decline in gross margin. Continuing with the operating expenses, non GAAP operating expenses totaled $34,600,000 in the second quarter, down $3,700,000 sequentially, reflecting our focus on controlling variable and discretionary costs. We have eliminated essentially all of discretionary spend and are prudently managing costs given the uncertainty with respect to the plan for our services. Aside from these spending reductions, lower incentive compensation expense, lower trade show activity and travel were largest drivers of lower operating expenses.
Non GAAP operating expenses as a percent of revenue in the most recent quarter was 32.5%, down from 33.3% in the first quarter of twenty twenty. Non GAAP sales and marketing was 15.2% of revenue, down from 16.1% in the 2019 and fifteen point three percent in the prior quarter. Sequentially, the $1,400,000 decline in sales and marketing expense was driven by lower variable compensation, travel expense and a reduction in trade show activity. Research and development expense on a non GAAP basis in the second quarter was $8,000,000 down from $8,500,000 in Q1, primarily due to lower incentive compensation. Our R and D expense did increase compared to the prior year as we continue to invest in Proto Labs two point zero, a key priority to drive future business performance.
Non GAAP general and administrative expenses were $10,400,000 in the quarter, down $1,900,000 compared to Q1. As a reminder, first quarter G and A included an additional allowance for ful accounts of approximately $1,000,000 accounting for a portion of the reduction. The remaining sequential decline was driven by lower incentive compensation accruals, executive pay reductions and lower travel and entertainment. GAAP operating income was $14,400,000 or 13.5% of revenue in the second quarter. Adjusted non GAAP operating income was $18,700,000 or 17.6 percent of revenue.
On a GAAP basis, our tax rate was 16.6%, down from 21.9% in the second quarter of twenty nineteen. The year over year decline in our GAAP tax rate was primarily due to an increase in the research and development tax credit as well as an increase in tax benefits associated with equity compensation. On a non GAAP basis, tax rate was 18.1% in the second quarter compared to 22.7% in the same period in 2019, principally due to the higher R and D tax credit. On a GAAP reporting basis, net income totaled $12,600,000 resulting in diluted earnings per share of $0.47 per share. Adjusting for the after tax cost of stock compensation, amortization of intangibles and unrealized foreign currency gains, our non GAAP diluted earnings per share in the quarter was $0.59 representing a $0.12 per share decrease from the prior year and a sequential decrease of $02 per share.
Breaking down the sequential earnings per share change further, lower volume resulted in a zero five dollars per share reduction. This reduction is partially offset by a $03 per share benefit resulting from the lower effective tax rate. Now turning to cash flow on Slide 11. We generated $31,000,000 in cash from operations during the quarter. Even when our revenue growth is not at historic levels, our business continues to produce very strong cash flows due to the digital nature of our quoting and manufacturing platforms.
Capital spend in the second quarter was $19,900,000 including investments in Broto Labs two point zero, investments in facilities in Europe and equipment, primarily the X Line three d printer to expand our three d printing capabilities. Given our strong cash generation and balance sheet, we continued our opportunistic stock buyback strategy under a 10b5-one plan during the second quarter. We returned capital to shareholders by repurchasing 38,000 shares of our common stock at an average price of $70.81 resulting in a total purchase price of $2,700,000 We have $35,000,000 remaining under our buyback program. We ended the second quarter with a cash and marketable securities balance of $175,000,000 up from $167,000,000 at the end of the first quarter. In addition to our strong cash position, our balance sheet remains free of debt.
Now turning to third quarter guidance. On our last earnings call in late April, we did not provide formal revenue and earnings per share guidance for the second quarter because of the vast global economic uncertainty. Although the global pandemic is still active and macroeconomic conditions remain unpredictable, we believe it is prudent to provide formal third quarter revenue guidance based on what we're seeing in the start of the third quarter and our historical experience to provide additional transparency to shareholders. Our third quarter twenty twenty guidance is summarized on Slide 16. We currently expect third quarter revenue to be in the range of $98,000,000 to $110,000,000 compared to $106,600,000 in the second quarter.
The second quarter included $12,000,000 of COVID-nineteen related orders that we believe are non recurring. This results in a revenue baseline of $95,000,000 as we entered the third quarter. As we progress through the second quarter, May revenue was the trough and we saw a slight improvement in June. July revenue trends have remained fairly consistent with June and we estimate July revenue will be down approximately 11% compared to July 2019. We have increased the range of our revenue guidance given the ongoing uncertainty related to COVID-nineteen and the impact that stay at home orders have had on our unique product developer accounts.
Given the broader range in our revenue guidance and the magnitude of impact on earnings per share at either end of the range, we believe it is more meaningful to provide qualitative information related to the expenses of our business. We will continue to manage our cost structure in response to the revenue levels in each of our services. We expect our non GAAP third quarter gross margin to be between 4951%. We expect to manage our non GAAP operating costs generally in line with or below second quarter levels. Our non GAAP add backs for the quarter will include stock compensation costs of approximately $3,600,000 and amortization of approximately $725,000 We currently estimate our non GAAP tax rate to be approximately 21% to 22% in the third quarter, up from 18.1% in Q2, resulting in a $03 per share headwind.
One further reminder as it pertains to guidance beyond Q3. Upon placing Proto Labs two point zero into service, we will begin amortizing the system, which will result in approximately $1,500,000 of expense per quarter. In addition, we estimate that we will incur an additional 1,500,000.0 to $2,000,000 in expenses each quarter for a couple of quarters related to contractors and other go live related costs. I will now turn the call over to Vicki for some final comments.
Speaker 2
Thank you, John. Before I turn the call over to Michelle for questions, I wanted to comment on Proto Labs' commitment to supporting a diverse workforce and an inclusive culture. At Proto Labs, we do not tolerate racism and have a culture which is focused on respect for all our employees. However, our employees clearly want to continue to improve and make a difference in our communities, so we'll be taking the following actions. We're establishing a diversity and inclusion task force made up passionate employees across the company.
We will focus in three areas: employee education, HR practices around recruitment, development and career advancement, and collaborations and partnerships in our communities to promote diversity and equality. ProtoLess is committing to take action to make sustainable change for our employees and our communities. Going forward, we will continue to provide customers the world class digital manufacturing services they have come to expect from Proto Labs, while maintaining the health and safety of our employees, communities and customers. As an e commerce digital on demand manufacturer, we are very well positioned to help our customers navigate challenges they currently face and future changes in their business. We will continue to respond and adjust our cost structure where we can to manage our business performance in the short term.
But we will continue to drive the business ahead and ensure our position as the digital manufacturing leader continues long into the future. This concludes our formal remarks. Now John and I would be happy to take your questions. Michelle, can you please open up the line for Q and A?
Speaker 0
Thank you. We will now be conducting a question and answer session. Our first question comes from the line of Brian Grab with William Blair. Please proceed with your question.
Speaker 4
Hi, good morning. Thanks for taking my questions.
Speaker 2
Good morning, Brian. Good morning, Brian.
Speaker 4
Hey, so you mentioned very clearly that May was the softest month. Can you just talk through what the customer activity has looked like as we've moved through the months here and into July? Have June and July have you seen continued improvement in those months?
Speaker 3
So mainly it's the trough. It picked up some in June and July has stayed pretty consistent with June activity. I think I mentioned in my comments that we're looking still as an estimate for July as we finish out the week, but somewhere in that 11% range down 10% to 12%, something like that.
Speaker 4
Okay. Thanks. And then how have I'm looking at the different service lines and how have the different service lines been trending? And maybe you could comment on why it looks like injection molding is holding up quite a bit better than CNC in this environment, even if you exclude or actually specifically if you exclude the COVID related orders?
Speaker 2
Yes. Yes, injection molding, as you know, is our most differentiated service. And in this time of supply chain disruptions and need for speed in areas like COVID-nineteen, we really provide significant customer value. So I think you could I think that's probably a good reason why it's holding up a little bit better. Again, it's up when you include COVID.
If you exclude COVID, injection molding is down 17%. So it's still significantly impacted by the economic situation that we're dealing with.
Speaker 4
Okay. Yes, understood. And I'll just ask one more for now. I guess, can you talk about what you're expecting for gross margin? I think you mentioned I've got a couple of conference calls going simultaneously here, what's the expectation for gross margin for the balance of the year?
And where do you see that in an environment where things have become a little bit more normal? What do you think you can do with gross margin 2021? And then also how does Proto Labs two point zero play into that and potentially help gross margin?
Speaker 3
Yes. So a lot in that question. I think as we've talked about volume significantly impacts our gross margin and our ability to flex. Higher volumes, we can drive improvement in the gross margin. I think for the third quarter, we provided guidance in the range of 49,000,000 to 51,000,000 which is essentially bookends where we finished here in the second quarter.
Again, volume is going to be a big driver of where that goes in the fourth quarter and into 2021. And I think we'll just have to continue to watch where that plays out. But as we return to growth, that's when we'll see improvements in the gross margin over the long term.
Speaker 4
John, have you said on the call yet where or how big an impact AlphaForm and Rapid each had on gross margin? Can you give us those numbers again if you haven't?
Speaker 3
Yes. So New Hampshire is about two thirty basis points of an impact on the quarter. And then three d printing in Europe was about 130 basis points.
Speaker 4
Okay. And where are those gross margins, the absolute gross margins now in those businesses roughly?
Speaker 3
They are currently sitting the Europe three d is just below 10% and the Rapid business is in the mid-20s.
Speaker 4
Okay. Thanks very much.
Speaker 0
Thank you. Our next question comes from the line of Greg Palm with Craig Hallum Capital Group. Please proceed with your question.
Speaker 5
Yes, thanks. I guess just starting off since you didn't provide guidance last quarter, I'm curious how did the quarter compare to your own internal expectations? And I guess outside of healthcare and the COVID related revenue, any end markets that surprised significantly either to the upside or downside?
Speaker 2
Yes. It played out about as we expected it to when we were when we gave the guidance. We gave a lot of color, as you recall, around April. May was a little softer than what we thought, but it rebounded a little bit in June. In terms of end markets, yes, not a lot different.
Aerospace has been very strong for us. As you know, we play not in the commercial aircraft part of aerospace, but more in the satellite communication space side of aerospace. And that's been really strong for us all year. The other maybe a little bit of price, auto was up slightly here in North America. That might be a surprise, but not significant.
So yes, I don't think anything else really surprised us. I guess Europe has been very slow to recover. You think with some of the opening up happening in Europe, we'd see some faster recovery there. Some of our speculation is a lot of the economies in Europe are very export oriented in the manufacturing space. And again, we play in the industrial manufacturing space.
So with the weaker export economies, that could be impacting Europe even though they're opening up a little bit.
Speaker 3
Yes. Greg, I think maybe as I look back, remember our call was at the April. We had a lot of uncertainty at that point in time. I think as we continue to progress through the quarter, it ended up maybe a little bit better than where we were or where we were expecting, but we had a pretty wide range just because we didn't really know. I think one area that we did outperform was and I mentioned in the call, the ability for our plan managers to really dial in and match the cost structure to what the revenue was coming in for the next week, really helped our gross margin in these uncertain times.
And as you think about it, across the individual plants, our injection molding plants were really busy because of COVID orders. So they were trying to flex up. Well, a lot of our other plants were trying to flex down and our plant managers just did a great job of managing those costs.
Speaker 5
Yes. Okay, makes sense. I guess as it relates more to the cost structure, I mean, it seems like there are a number of trends coming out of this pandemic that could really accelerate growth and adoption of your services. I mean, I'm thinking reshoring, on demand, digital, I mean, sort of the list goes on. I mean, I guess, would have thought you may have started to ramp up spending here, whether that's Q3 or second half, whether that's sales or marketing, just trying to take advantage of everything going on.
But it seems like you're keeping a really, really tight lid in the near term. So how do I reconcile that to your comments, Vicki, about not sacrificing long term growth potential? Don't know. Maybe it's just more discretionary spending, but it seems like we're in an environment where we want to take advantage of it, sort of a land grab opportunity here.
Speaker 2
Yes. We are doing quite a bit of shifting to make sure that we are taking advantage of the situation. So particularly in marketing, we've been shifting to a much more digital appearance in marketing and also taking advantage of our leadership to thought leadership in the area of supply chain disruption as well as e commerce. So we've had some great opportunities to showcase the company across a number of different venues, but in a very digital way. And that's one of advantages that we have.
We can pivot digitally very easily since we are such a digital company. So and those are some lower cost approaches to marketing as compared to trade shows, which can be quite expensive. So I think we pivot and are investing appropriately in growth. We want to make sure that we are managing our costs in this uncertain environment and not being I don't wanna say, frivolous in the spend at a point in time when many of our customers, as I mentioned in the survey results that we got, are really remote working remotely and their projects have been delayed or often reduced funding. So let's spend where it makes sense in order to get the revenue growth.
Speaker 5
Okay. John, just to be clear, as it relates to Proto Labs two point zero, can you just repeat what you said about does the additional amortization and expense, does that occur when Europe goes live? Or is that half of that when Europe goes live and half is The Americas? Maybe you can just go over that one more time, please.
Speaker 3
Yes. Actually, when we place the asset into service, we will start amortizing it because it is it's one system built for the entire company. So once we place it into the service, the monthly expense will be roughly $500,000 a month. And then because of that, when we place them in service, we still will have some of the contractors that cost flips from capitalized expense or capitalized cost to expense as we continue to go live and work through that process.
Speaker 5
And you said Q4 was go live, correct?
Speaker 3
Yes. That's our
Speaker 0
next question comes from the line of Jim Ricchiuti with Needham and Company.
Speaker 6
Yes, Mike Cikos here on the line for Jim Ricchiuti. Just a couple of quick questions here. The first, I wanted to make sure that I understood correctly, but the COVID-nineteen related revenue, the $12,000,000 that you guys called out, that is entirely flowing into that injection molding service line? Then the second item sorry, go ahead.
Speaker 3
No, it's not entirely in injection molding, but the vast majority of it is. Think like 90% plus is phones are injection molding. Yes. Yes, it's about Okay.
Speaker 6
And I guess coming back to the OpEx discipline that you guys were able to show, curious, could you help parse out how much of that is tied to the incentive comp versus discretionary spending? And then if I'm thinking about the guidance and commentary, if we're looking to Q3, where is the additional benefit or cost control coming from if we're thinking about OpEx being either stable to down sequentially?
Speaker 3
Yes. So the incentive comp was about 1,000,000 point dollars or so of that cost reduction. I think as we look to Q3, we said flat to down in the operating expenses. I think it's just continuing to look at the areas of where we're spending and looking at opportunities related to that. So again, the COVID kind of hit us in March and we were developing plans.
The cost reductions as we've been managing costs, we've been kind of picking up momentum as we've gone through the year. So that momentum, I think, will carry on through the end of the second quarter into the third quarter. So I think a good chunk of it will be run rate. And I think we had some expenses in Q2, even related to safety of our employees, making sure that we've got masks and protective equipment and things like that that flowed through that. We've got most of that stuff on hand now and we'll be incurring some of that expense.
Speaker 6
Okay. And if I'm thinking about the recovery that you guys are seeing now in June, similar activity in July versus where we were in May being the trough. Just curious, what are the some of the end markets, the service lines where you're seeing some of the, I guess, better improvement versus some of the markets that are tending to lag right now?
Speaker 2
So when we say improvement, so June was a little bit better than the trough in May and July is pretty consistent with June, maybe a tad better. So we continue to see strength in aerospace segments, but the rest of the segments are pretty evenly split in terms of where recovery is coming. Maybe a little bit better with computer electronics than we're seeing in general from automotive. So it's still it's pretty broad brushed. Manufacturing industrial segments remain weak.
So industrial machinery and equipment remain pretty weak. So it's very gradual. It's not a V by any stretch of the imagination.
Speaker 6
Okay, understood. And then just final housekeeping item here. I know you guys are talking about that, call it $1,500,000 a quarter in amortization once Proto Labs two point zero goes live. And then there was also the contractor costs and other go live costs of about 1,500,000 to $2,000,000 a quarter. Just wanted to make sure I understood that correctly.
So the contracts are in go live costs for 1,500,000.0 to $2,000,000 How should we be thinking about it? Is that going to be multiple quarters that's going out?
Speaker 3
Think about two quarters is how we're currently planning that. And that gives a little bit of uncertainty around that, but I would think of that as a onetime cost for a couple of quarters after we go live, whereas the amortization And obviously will be
Speaker 6
those will obviously turn on alongside the amortization then. So we should expect, I guess, two of those in aggregate for those first two quarters then?
Speaker 3
Yes. Unfortunately, that's the way it will work, right? Some of those contractors that are here helping us develop that system. When we go live, we seek capitalization so that cost turns from a capitalized item to an expense at the same time when we start amortizing the system.
Speaker 6
Sure. All right. Appreciate the color guys. Thank you very much.
Speaker 0
Thank you. Our next question comes from the line of Andrew DeGasperi with Berenberg. Please proceed with your question.
Speaker 7
Good morning. Just a few questions from me as well. First, just a quick one, a follow-up to Mike. You mentioned the commercial aerospace was strong. I mean, can you give us maybe an idea of how did it skew like the defense versus commercial aerospace?
Speaker 2
I'm sorry?
Speaker 3
Defense versus commercial.
Speaker 2
Yes. It is definitely more on the defense side as well as the what I would call space and telecommunications side of aerospace. We are not really big on commercial aircraft side.
Speaker 7
Got it. And just maybe some high level questions in terms of I think you mentioned in the prepared remarks that 58% of your customers have delayed project timing in terms of the development cycle. Can you maybe let us know if this has to do with some of the physical testing labs being shut during the last few months? Or is there a shift to, call it, more virtualized prototyping? Anything on that would be helpful.
Speaker 2
Yes, think it's a combination of both. So we do a lot with the large industrial testing labs and many of those were shut down for a good part of early part of second quarter, starting to get some reopening of some labs on limited basis. But that's why we did that survey. We really wanted to understand what's happening with our customers and particularly our product developers and how are they being able to do their jobs during this period of time. It's difficult.
Again, we said 73% of them are working remotely and they've seen decrease in demand for the products that they support and their development cycles have been pushed out or seeing reduced funding. 33% have seen reduced funding. It helps us understand a little bit about what's happening with our product developers served. They're just out there with fewer projects today. And that's what we're seeing reflected in the underlying weakness in our revenue.
As they begin to come back to work, which they will, and as they begin to drive innovation, which manufacturers will do in order to recover on the other end of this economic shock that we're seeing, we will see them get back to work and we will see them begin placing orders again. But we're dealing with a structural change in how they're working right now.
Speaker 7
That's helpful. One more for me is in terms of on competition, can you maybe update us how are your legacy competitors like the machining places doing today? And then maybe also can you let us know if there are any emerging competitors on the from a service bureau perspective?
Speaker 2
Yes. So I really don't know how they're doing, to be honest with you. I would think that they're seeing, especially on the CNC machine, the same kind of reduction in demand that we're seeing, which given some of their financial structures might be more difficult for them. We do see we do quite a bit of secret shopper. We're following what's happening with pricing in those end markets.
We've seen some softening in some of that pricing as some of those smaller mom and pops who are working more on just making sure they're covering their cash needs might be picking up some business at price points that are lower than they might have historically picked up. So we respond to those as we hear them and do so prudently, but we are seeing some competition there. Haven't seen any new service bureaus emerge. And the only other kind of emerging competitors are the ones we've spoken about before, which are more in the broker kind of model with e commerce.
Speaker 7
Got it. Thank you very much.
Speaker 2
Thanks.
Speaker 0
Thank you. Our next question comes from the line of Ben Rose with Battle Road Research. Please proceed with your question.
Speaker 8
Yes, good morning, Vicki and John. A few questions for me. Firstly, on the medical in the medical device area, could you speak to how the business is performing ex COVID-nineteen? I know that this is your largest vertical, but maybe just some trends or color on the performance of that segment.
Speaker 2
Yes. So if you take the Medical segment and you pull the COVID business out, it actually declined by fourteen percent.
Speaker 8
Okay. Any general commentary there? Is it just kind of across the board or in certain
Speaker 2
It's basically across the board. I mean a lot of the product developers that we survey in our in the survey that I mentioned, many of them are in the med device space and they're working from home and some of their projects have been either diverted or slowed down in this environment.
Speaker 3
Yes. And if you think about those businesses, any of the elective procedures aren't happening right now. So a lot of those segments that we're doing business with, their business is hurting quite a bit. So they're trying to figure out the path forward and they're managing their costs pretty tightly right now as well.
Speaker 8
Okay. And with regard to your current capacity, both in The U. S. And Europe, perhaps John, you could speak to the level of capacity that you're operating And then either for John or Vicki, do you have is there a formal policy in place with regard to furloughs or addressing specific workers that may not be needed for the complete time over the next quarter or two?
Speaker 3
Yes. So I think from a capacity standpoint, we've got capacity in each of our facilities. And I think if you just go back to some of the historical trends of the revenue we had produced historically. I haven't done the actual calculations because it's the times when we look at it is when we're looking to add the machining capacity. As far as the labor, I think I will reiterate, like the team has done a great job of flexing that labor.
We are built for a certain amount of variability. So we have a flexible staffing model that we can flex up and down. Unfortunately, some of our plants, we have had to do some furloughs and take some actions like that. But we're managing those costs to correspond with the volumes that are coming in and are looking to drive the growth so we can bring those employees back.
Speaker 2
We're taking advantage of government programs in each of the areas in which we work. Germany has got a shared work program. UK has got a furlough program. And in a couple of the states that we have had to take furloughs here in The United States. They have shared work programs as well.
So really working to try to minimize the impact of our employees. We continue to cover health care benefits and they remain on our headcount and hope to bring them back as soon as we can when we see the recovery occur.
Speaker 8
That sounds good. And then finally, at least for now, I'm intrigued by the customer survey that you took. Sounds like a great idea to get a handle on customer thinking at this point for sure. Was curious, were there any questions in the survey that addressed customer expectations heading into the fall, whether they might see a return to normal or a pickup in project activity?
Speaker 2
Yes. Yes, we did not ask that. We were really just focused on what is it that they were doing at this period of time. I'll just say, as we talk to customers, they share the same level of uncertainty that we do. So I think that people our customers are very hesitant also to predict kind of what the next, you know, few months are gonna look like.
I think we're all being very responsive, being very agile and adaptive.
Speaker 7
Mhmm.
Speaker 8
Okay, thank you very much.
Speaker 0
Thank you. We have reached the end of our question and answer session. I'd like to turn the call back over to Mrs. Holt for any closing remarks.
Speaker 2
Thank you. I would like to thank Proto Labs employees for their efforts in the 2020 and through these extremely uncertain times. I also want to thank our customers for their continued support. We are committed to pushing this company forward through the challenges and changes. We will continue to improve our offering, our company culture and our financial performance.
In the near term, we will continue to adapt and grow as an organization. And over the long term, we're committed to driving great shareholder value. We look forward to reporting to you on our progress during our next call. Thank you.
Speaker 0
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.