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Shares of 3D-Systems (DDD) have witnessed quite some volatility during the first days of the new trading week. Shares ended last Friday around $38 per share, or the equivalent of $57 before the 3-for-2 stock split. Shares fell to lows of $31 on Monday on the back of the fourth quarter results, but have recovered to $36 at the moment.

Fourth Quarter Results

3D Systems generated revenues of $101.6 million for its fourth quarter of 2012, up 45.4% on the year. Revenue growth was driven by a 93% increase in printer and other revenues, and 18.8% in organic growth. Revenues fell slightly short of analysts expectations who on average expected that 3D Systems would report revenues of $103.9 million.

The strong revenue growth resulted in a 60% increase in operating profits. Gross margins expanded by 460 basis points to 51.7% on positive operating leverage.

The company reported a 63.6% increase in non-GAAP net income, coming in at $22.6 million for the final quarter. Non-GAAP diluted earnings per share rose by 44% to $0.39 per share. Earnings beat consensus estimates by a penny.

Of interest is that net income grew much slower compared to non-GAAP income. Net income rose 36% to $10.9 million and has partially been inflated as a result of a $1.5 million benefit for income taxes. As a result of the diluted share base, net earnings per share were up only 19% to $0.19 per share.

CEO Avi Reichental commented on the results, "We are very pleased to report outstanding quarterly and annual results on accelerated printers' sales. We believe that 3D Systems Press Release Page 2 our results reflect the potency of our diversified portfolio, productivity of our channels and effectiveness of our strategic growth initiatives."

Outlook

For the full year of 2013, 3D-Systems expects to generate annual revenues of between $440 and $485 million. At the midpoint of this range, this would imply that annual revenues would grow by approximately 31%. The company guides for annual non-GAAP earnings between $1.00 and $1.15 per share.

Note that the guidance for non-GAAP earnings already factors in the split ratio. As such, the guidance implies non-GAAP earnings of $1.50-$1.73 per share, before factoring in the split ratio. The company furthermore notices that its effective tax rate for the year will increase to "normal" 35-38% rates.

The full year revenue forecast for 2013, at the midpoint of the guided range, tops analysts' estimates. On average, analysts expected 3D to guide for full year revenues of $442.2 million. The earnings guidance comes in line with analysts estimates of non-GAAP earnings of $1.05 per share.

Valuation

3D-Systems ended its fiscal 2012 with $155.9 million in cash and equivalents. The company operates with $80.5 million in convertible senior notes for a net cash position of approximately $75 million.

The company generated annual revenues of $353.6 million for the full year of 2012, up 53.5% on the year before. The company reported a net profit of $38.9 million, up 10% on the year before. As a result of shareholder dilution, GAAP earnings per share inched up by just a penny, coming in at $0.71 per share. Non-GAAP earnings came in at $1.25 per share.

Trading around $35 per share, the market values 3D-Systems at $3.0 billion, or its operating assets at little over $2.9 billion. This values shares at 8.2 times 2012's annual revenues and roughly 75 times its GAAP annual earnings.

3D-Systems does not pay a dividend at the moment.

Some Historical Perspective

Shares of 3D-Systems have more than doubled over the past year. Shares rallied from levels around $15 during spring of 2012, to $36 at the moment. Shares did peak around $48 at the start of 2013, but have lost little over a quarter of their value in the meantime. Note that these share price levels are adjusted for the 3-for-2 split ratio.

After years of stagnating revenue growth, or even declining revenues, 3D has grown aggressively over the past two years fueled by an aggressive acquisition strategy. The company has boosted revenues in recent years, but has consolidated earnings growth over the past year. As the share base diluted, as a result of this aggressive acquisition strategy, earnings per share have remained essentially unchanged over the past year.

Poor Received Figures

It is not surprising that shareholders react disappointed to the earnings release on Monday. While earnings came in line with expectations, revenues fell short. Given the hype in the 3D printing industry, the whisper numbers were higher than the reported results.

Shares of 3D dropped as much as 20% in the first minutes of trading on Monday. Many investors and analysts got confused as the earnings forecast for 2013 was not comparable, given the stock split which became effective on the same day as the earnings release. This confusion could have been easily avoided by management and added to Monday's volatility. Shares recouped more than half of those losses in the remainder of the session as analysts worked things out.

Still the prospects do not look great. The full year guidance for 2013 calls for revenue growth of 24 to 37%, which compares to annual revenue growth of 53.5% over the past year. Non-GAAP earnings are expected to grow by a similar 20 to 38%.

Investment Thesis

Despite the recent correction, shares of 3D Systems continue to remain in a "bubble" phase as I see a lot of red flags. One concern is the continued and widening discrepancy between GAAP and non-GAAP earnings. Non-GAAP earnings for the full year of 2012 came in roughly 75% higher than GAAP earnings, as the company continues to treat recurring costs including stock based compensation and acquisition related charges as incidentals.

Another red flag is that profit growth is slowing down, resulting in stagnant profits per share as the share base is diluting, despite strong revenue growth. Worse, this revenue growth is mostly the result of an aggressive acquisition campaign. This resulted in a "goodwill" asset on the balance sheet more than doubling to over $240 million in the past year.

Another key concern is the continued discussion and issue of reliability of organic growth rates. Organic growth came in at 22.4% for the year of 2012, slowing down to 18.8% in the final quarter. As 3D continues to acquire re-sellers of its own printers, it artificially inflates organic sales growth by supplying its own printers to those acquired re-sellers. This practice has already resulted in a lot of furious discussions among commentators who wonder if 3D engages in "channel stuffing".

Finally, 3D-Systems has financed much of its recent growth by making acquisitions financed with its ever rising stock. As shares have corrected 25% in recent weeks, this important source of financing future growth might dry up, or dilute shareholdings even more. As I wrote in an earlier article, following the acquisition of Geomagic:

As such, acquisitions enable 3D Systems to report higher growth, which propels the share price even higher. The company uses this to issue more shares at elevated prices in order to make even more acquisitions. This makes the company's operating performance directly tied to the share price performance, as a setback in the share price automatically reduces the capability to acquire.

Another warning sign of a bubble is the recent public offering of smaller competitor ExOne (XONE), which went public a couple of weeks ago. In traditional fashion for high-demand public offerings, shares spiked up on the first trading day. From that point in time shares have also witnessed a serious correction.

The growth engine of 3D-Systems might have stopped as the share price has seen a serious correction in recent weeks. Widespread red flags and disappointing earnings per share growth has resulted in some doubts about the valuation.

At these levels I remain on the sidelines. Despite the prosperous long term growth prospects of the industry, the valuation is too high at the moment. Note that this does not automatically translate in a short thesis as the market can remain irrational longer than you can remain solvent.

I remain on the sidelines with a slightly bearish stance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: 3D Systems - Red Flags As Operating Performance Continues To Deteriorate

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