On Monday, Nov. 12, I published an article about 3D Systems Corporation (DDD) that caused an unexpected stir. No one was more surprised than yours truly. I do not contribute many articles to Seeking Alpha and the ones that I have published have not garnered much attention. The day my article went live, I had only 87 followers. Even today, I have less than 200. I do not think this reflects the profile of a market mover, do you?
The only reason that my article ruffled feathers is the drop of DDD's share price the day my article went live. The human mind constantly sees patterns and relationships, cause and effect, if you will, where none exist. Longs are always sensitive to atypical drops in their holdings. Most seem to expect their favorite stock to continue its upward trend unabated, especially during a bull run. When a countertrend move occurs, longs cast their net to find the villain. It always seems to involve some sort of conspiracy. Is it a true bear raid? Could the perpetrators be members of a stock pool similar to the ones that were commonplace in the 1920's (I doubt it; it is illegal now)? Could it be shadowy hedge funds, unscrupulous traders or malicious rumormongers? These are the convenient suspects.
The reality is that, most of time, no one knows. As far as price behavior is concerned, the shorter the time frame, the more random the movement. A big move over a day or several days usually means next to nothing. This is the reason that I focus almost all of my attention on a stock's weekly chart. This mitigates much of the market's short-term noise.
DDD's recent share price movement is entirely consistent with a stock that needs to rest after a run-up. No stock goes straight up on its way to its eventual price peak. On February 23, it broke out of a cup-with-a-handle base, clearing its $21.79 trigger on robust volume. This was a classic bullish breakout per Investors Business Daily (see reference at end of article). Its bull run peaked on August 30 reaching its initial high of $44.80, representing a healthy 106% gain.
From a chartist's viewpoint, several characteristics of DDD's price behavior bear mentioning. First, the downward price movement began during the week of September 7. There were four consecutive down weeks on ever-increasing volume. Institutions and momentum traders were clearly exiting. This is typical. At the time of the first down day, DDD price was extended ~60% above its 10-week EMA. Research (IBD and others- see references at bottom) has shown that the maximum bull run price extension above this commonly used metric is ~50%. It was time for DDD's share price to take a breather. The downward movement began ~1 ½ months before Gray Wolf Research's article appeared and 2 months before mine was published.
Another point to remember is that the market transitioned from "confirmed uptrend" to "correction" per IBD on October 10. Institutional money flow turned decidedly negative. Since 75% of stocks follow the market trend, most follow the indexes down. Very few can swim against the tide.
Even considering the market's current weakness and the share price's well-earned rest, its bullish chart remains intact. Wednesday's last print of $41.41 is still 29% above the 10-week EMA. Its relative strength rating is 98, meaning that it is outperforming 98% of publicly traded shares.
DDD's over-reaction to my article is telling. While the attention is flattering (I hardly consider myself a guru or market mover), any influence my article had on its share price movement is most certainly microscopic. The share price was over-extended, the market transitioned into a correction and the institutional money began its outflow two months before my article appeared. Case closed.
DDD's paranoid behavior, epitomized by its November 19 tightly controlled non-interactive conference call and its heavy-handed attempts to get my article removed from SA, reveals a management team that feels threatened by its own information. All of my observations, perceptions and opinions have been gleaned from DDD's SEC documents, its website and its press releases. It is a self-inflicted conspiracy. I will be diplomatic and call the situation unusual.
Under any other scenario, I would avoid a tit-for-tat dialogue. I regard it as sophomoric because it usually degrades into a circular argument without end. However, this set of circumstances is, indeed, special.
I thought (silly me) that I would be given an opportunity to make a short statement and/or ask questions during the conference call. After all, was I not one of the two reasons the call was held? Despite pressing *1 until my finger ached, I was never afforded the opportunity. Does it not seem curious that only analysts were permitted to ask questions? I guess they put down their pompoms early enough to press *1 before anyone else. And how about the last analyst who, for some reason, is unknown? He did not even ask a question. He just parroted management's rhetoric. Methinks he might be getting a paycheck every two weeks from the finance department.
So, considering management's aversion to speaking directly with me about the issues I raised in my article, I have no other reasonable alternative than to publish a follow on piece. I will readdress some of the issues I raised in my first article and respond to the information management presented in the November 19 conference call including the supplemental slides.
The first issue is how DDD accounts for the revenue in its acquisitions. As you know, my opinion is that its method overstates its actual core business growth rate. Here is the information that Mr. Gregoire presented on Monday (slide #15) regarding its organic growth calculation methodology:
Click to enlarge images.
The top half shows how DDD's scheme works. It is very easy to see how acquired revenue transitions to organic one year after the acquisition date and how it affects its growth numbers. The bottom half is my contribution. The core business is actually growing at a constant 20%/year after backing out all of the acquisitions' revenue. This clearly shows the boosting effect of the acquired revenues. This is my point. This has been my point from the beginning.
This does not mean, though, that DDD's scheme is wrong, underhanded or improper. It merely means that the true growth rate of the base business is overstated due to the inclusion of acquired revenues over time. This is how the mechanism works. There will be a time when this "back out" analysis will no longer be feasible. After another 2 - 4 years, the acquired businesses will have evolved too much to do it. However, today, it can.
Why is this so important, then? If DDD's method is proper, what is the problem? There is no problem. The only reason that I believe it is important to identify the growth rate of its base business is to isolate the impact of its acquisitions. It is an interim step. Let us compare the impact of the different approaches to acquired revenue below:
Since 2008, DDD's CAGR of its reported consolidated revenue is 26.4%. Backing out its disclosed acquired revenues yields a CAGR of 19.2% (annualized FY12). Backing out all of the acquired revenues per my method yields a CAGR of 16.2% (ZCorp/Vidar annualized).
The 16.2% growth rate is greater than the 13.5% growth rate from the spreadsheet in my first article. This is because I assumed a growth rate in the acquired revenues in the first case and flat growth in this case. I believe that this is a fair and conservative assumption.
Whether or not you use 16.2% or 19.2%, the conclusion is the same. Base business revenue is growing at a slower rate than consolidated revenue. Therefore, acquired revenue must be growing at a higher rate. Are the acquisitions themselves growing at a higher rate or is the higher rate a result of adding revenues per its acquired revenue methodology? As a group, there is no way to tell due to lack of disclosure. Out of the thirty transactions since 2009, only three are considered "significant" as far as disclosure is concerned. According to my calculations, revenues for two are declining (Provel, Quickparts) and one is flat (ZCorp/Vidar). According to management, ten acquisitions are immaterial to reported revenues so this leaves eighteen companies that could contribute a higher growth rate. Are revenues from this group growing at a higher rate than the base business? All eighteen are "insignificant" acquisitions yet they must be the source of all the growth. Does this make sense? I have to admit that I am unclear on this. More clarity from management would be helpful.
This brings us to the private transactions issue. Seventeen acquisitions since 2009 are cash and stock deals. Of these, fifteen involve shares from undisclosed sources. Who provided the shares? No clarifying information can be found in the 10-K. To refresh our memory, here is the information from the 2011 10-K, page 43 (bold type mine):
Cash flow from financing activities
Net cash provided by financing activities increased to $210.0 million in 2011 from $1.0 million in 2010. Net cash provided by financing activities in 2009 was $0.3 million. The increase in 2011 primarily resulted from the previously discussed net proceeds of the common stock issuance and net proceeds of the convertible notes issuance and from $2.8 million of stock-based compensation proceeds.
The cash provided by financing activities in 2010 resulted primarily from higher stock option exercise activity.
This clearly states that employee stock ownership schemes contributed to the financing activities of the company in 2010 and 2011. "Cash flow from financing activities" is the section of the 10-K where the company discloses the sources of capital that it used in its investment activities for the fiscal year, is it not? What was the role of the stock-based compensation proceeds and stock option exercise activity in DDD's investments in these two years?
Mr. Gregoire stated in the conference call that the company fully discloses all issuances of acquisition-related stock and all option exercise activity. This information is in the Stockholder's Equity section on page F-6 in the 2011 10-K. I agree that the total amounts of the line items appear in the spreadsheet.
Mr. Gregoire, however, does an effective job of side-stepping the question. What was the role of the $2.8M in stock-based compensation proceeds and the stock option exercise activity in FY2010 and FY2011? He offers no answer. The line items in the Equity section are generic. There is no detailed information pertaining to specific financing activities involving employee shares anywhere in the 10-K. He also declares that stock-based compensation and option proceeds are separate from acquisitions (slide 36). Normally, yes. This is not what the above information says, though. It clearly states that employees' stock and option exercising had roles in its financing activities. What was the nature of the roles? This needs explaining.
Before I focus on the slides in the conference call, I want to address the over-riding issue that I have with DDD's SEC documents. The issue is obfuscation. It is systematic and pervasive in every 10-Q and 10-K I read. It has made my research effort laborious, time-consuming and frustrating. There is only one reason that a company does this. We all know what that reason is. I will now provide you with one exasperating example.
DDD consummated the Digitalis/Renshape deal on 11/1/11. It paid ~$41M which was a generous 5.9 revenue multiple (41/7 = 5.9) based on the previous year's top line. Naturally, I wanted to know what the revenue figure was for the last two months of 2011. I found this statement on page 31:
Sales of integrated materials represented 52% of total print materials revenue in 2011, compared to 34% in 2010. Excluding the acquired Renshape® print materials revenue, integrated materials were 53% of total print materials revenue.
This is the only reference to Renshape's performance numbers in the entire 10-K. So what is the revenue number? It is impossible to tell is it not? An answer can be derived, though, using algebra. Here is the math:
.52 x $70.6M = $36.7M
$36.7M = .53x
$69.2M = x
$70.6M - 69.2M = $1.4M
Why does DDD not just disclose the revenue number? Why must the reader derive the answer? This kind of egregious obfuscation permeates DDD's SEC documents. It is everywhere.
He Said. They Said. He Said.
This brings us to the final section. As I stated earlier, I find this process rather juvenile. However, since some observers will perceive a non-response as an admission of guilt, I will respond to DDD's responses from the conference call.
1. Slide #23: False allegation: inability to back out acquisitions revenue.
DDD's organic growth rate includes acquisitions' revenues after 12 months. There overstates the growth rate of the base business. I had to piece together my spreadsheet to accomplish what should have been a straightforward process.
Score: House (1) DDD (0)
2. Side #24: Employee stock participation in acquisition financing.
All the questions remain. DDD sidesteps the issue in its response.
Score: House (2) DDD (0)
3. Side #29: Consensus growth numbers. This is one of the silly objections.
The EPS growth estimates are per IBD. Yahoo is certainly not the only source of estimates.
Score: House (3) DDD (0)
4. Slide #29: Acquisition table incomplete.
The list of acquisitions in the 10-K exclude, for some unknown reason, one of the buys from 2009 and three from 2012. Why is this? Why are some acquisitions mysteriously dropped from disclosure in the 10-K? This is the document that I was working with when I wrote my first article.
Score: House (4) DDD (0)
5. Slide #30: Acquired revenue scheme.
I have already addressed this issue. I am right.
Score: House (5) DDD (0)
6. Slide #30: ZCorp/Vidar revenue treatment.
I have already addressed this issue. I am right.
Score: House (6) DDD (0)
7. Slide #31: FY'12 revenues typed $251.2M instead of $252.1M; growth rate 56% instead of 57%; revenues ex ZCorp/Vidar $210.9M instead of $211.9M.
Reality: False. We are getting silly again.
DDD has me by the short hairs on this one. My figures are wrong. Theirs are right.
Score: House (6) DDD (1)
8. Slide #31: Inability to determine actual organic growth rate.
I have already addressed this issue. I am right.
Score: House (7) DDD (1)
9. Slide #32: Lack of informative disclosures.
This is not a GAAP/non-GAAP issue. It is a clarity of disclosure issue.
Score: House (8) DDD (1)
10. Slide #32: Calculation of Quickparts & Provel revenue numbers.
Reality: It is confusing to figure out how to do this. Why are the revenue numbers not disclosed? Why do I have to calculate the numbers? I do not believe that my misperception is my fault, but I will give this one to DDD anyway to make it feel good.
Score: House (8) DDD (2)
11. Slide #33: Missing acquisition from 2009.
The Desktop Factory acquisition is missing from the 2011 10-K. Why is this? Why are other acquisitions missing? The reader should not have to chase down this information when most of the buys are listed in the 10-K. The reader assumes, naturally, that the list is complete.
Score: House (9) DDD (2)
12. Slide #34: This is not really an objection. I do not know why it is there.
Reality: It should not be there.
Score: House (9) DDD (2)
13. Slide #35: Employee stock participation in acquisition activity.
Reality: I have already addressed this issue. Significant questions remain.
Score: House (10) DDD (2)
14. Slide #37: Clarity of revenue numbers.
I have already addressed this issue. I am right.
Score: House (11) DDD (2)
15. Slide #37: Intangibles write down.
Reality: I will give DDD this one despite the lack of disclosure of the components of acquired intangible assets.
Score: House (11) DDD (3)
16. Slide #38/39: Market forces, printer market and price/mix line item.
Differing opinions on market characteristics are just that: differing opinions. Management has yet to explain the large increase of the price/mix line item. It is now $84.5M. What is the reason for the large increase?
Score: House (12) DDD (3)
17. Slide #40: Cube opinion. We are getting silly again.
Reality: DDD's response does not sound like it understands the context of my comment. They need to reread it.
Score: House (13) DDD (3)
So what do we make of the final score? I gave DDD two of its three wins and the one win where it is clearly right involves a minor keystroke error. Does this not tell you something?
My perceptions, observations and opinions that I have expressed herein and in my first article remain intact. My points are clear, concise and supported by examples. My questions to management remain unanswered. My position stands tall.
In closing, I have a proposal for DDD management. Let us schedule another conference call. This time, however, I will be the only person permitted to ask questions. All other participants will be in a "listen only" mode. This will be a superb opportunity for DDD to discredit me once and for all.
But won't this be an unnecessary expense? Maybe. I propose an alternative. I will call Mr. Reichental directly in Rock Hill. He and his management team can put me on speaker as I ask them my questions. The only proviso I have is that I may publish an article detailing our discussion. The cost will be minimal. What do you say?