Before selecting a stock, there are a number of things that you need to consider in order to ensure that you are buying the stock of a high-quality company whose shares are poised to grow in value over time. Some of these concerns include what the company does, its competitive advantages, valuation, dividend payouts and sustainability, and earnings consistency.
Another important thing that you need to consider is the financial condition of the company in question. You want to know if the company is able to continue paying its bills, and how much debt it carries. The balance sheet is one of the most effective tools that you can use to evaluate a company's financial condition. In this article, I will discuss the balance sheet of 3D Systems (DDD) in order to get some clues as to how well this company is doing.
I will go through the balance sheet, reviewing the most important items, in order to assess the financial condition of 3D Systems. The information that I am using for this article comes from the company's website here.
Note that this article is not a comprehensive review as to whether 3D Systems should be bought or sold, but rather, just an important piece of the puzzle when doing the proper due diligence.
This article might be a bit too basic for some and too long-winded for others, but I hope that some of you can derive benefit from it.
3D Systems is a provider of three-dimensional printers, print materials, computer-aided design services, reverse engineering, inspection software tools, and on-demand custom parts services for printing on everything from plastics to ceramics to edible sugar. The company was founded in 1986.
Over the last 9 months, products have accounted for 68% of the company's sales, while services were responsible for the other 32% of sales. 3D Systems got 55% of its sales over the last 9 months from the U.S., while getting 26% from Europe, and 18% from the Asia-Pacific region.
Cash and Cash Equivalents
The first line in the Assets column of the balance sheet is for the amount of cash and cash equivalents that the company has in its possession. Generally speaking, the more cash the better, as a company with a lot of cash can invest more in acquisitions, repurchase stock, pay down debt, and pay out dividends. Some people also value stocks according to their cash positions. Some of the larger and more mature companies tend not to carry a lot of cash on their balance sheets, as they might be more inclined to buy back stock with it, or pay out dividends.
As of Sept. 30, 2013, 3D Systems had $345M in cash and short-term investments, which can be easily converted into cash. Over the last 12 months, the company has generated $46M in free cash flow. They have not paid any dividends, and have been net issuers of common stock thus far, preferring to reinvest their profits back into the business.
Receivables constitute money that is owed to a company for products or services that have already been provided. Of course, the risk with having a lot of receivables is that some of your customers might end up not paying. For this reason, you usually like to see net receivables making up a relatively small percentage of the company's sales.
3D Systems had a total of $114M in net receivables on its balance sheet, which represents 24.7% of its trailing 12-month sales of $461M. For fiscal 2012, 22.6% of its sales were booked as receivables, while that percentage was at 22.3% for fiscal 2011. Receivables accounted for 22.4% of company sales in 2010.
While these percentages are considerably high in absolute terms, they are very consistent, which shows that they probably have more to do with the nature of the industry in which the company operates. I don't see any reason to press the panic button in this regard right now.
With manufacturing and service companies like 3D Systems, I like to keep an eye on inventory levels. I usually like to see inventory levels stable or slightly rising from one year to the next. If I see inventory levels rising, then I want to see revenues rising as well, to indicate higher demand for the company's products. I don't like to see rapidly fluctuating inventory levels that are indicative of boom and bust cycles. In some instances, if inventory ramps up without increases in volumes or revenues, then it may indicate that some of the company's products are going obsolete.
As of Sept. 30, 2013, 3D Systems had $66.1M worth of inventory, which amounts to 14.3% of the company's sales over the last 12 months. At the end of fiscal 2012, this level was at 11.8% of sales, while at the end of fiscal 2011, it was at 11.0% of sales. This shows that the company's inventory levels are steady relative to the revenues. I don't see anything here that would indicate boom and bust cycles or the possibility of a large number of their products going obsolete. So, I see nothing to worry about here at this time.
Another factor that I like to look at is the current ratio. This helps to provide an idea as to whether or not the company can meet its short-term financial obligations in the event of a disruption of its operations. To calculate this ratio, you need the amount of current assets and the amount of current liabilities. Current assets are the assets of a company that are either cash or assets that can be converted into cash within the fiscal year. In addition to cash and short-term investments, some of these assets include inventory, accounts receivable, and prepaid expenses. Current liabilities are expenses that the company will have to pay within the fiscal year. These might include short-term debt and long-term debt that is maturing within the year, as well as accounts payable (money owed to suppliers and others in the normal course of business). Once you have these two figures, simply divide the amount of current assets by the amount of current liabilities to get your current ratio.
If a company's operations are disrupted due to a labor strike or a natural disaster, then the current assets will need to be used to pay for the current liabilities until the company's operations can get going again. For this reason, you generally like to see a current ratio of at least 1.0, although some like to see it as high as 1.5.
The current ratio of 3D Systems is 5.20, which is outstanding.
Property, Plant and Equipment
Every company, regardless of the industry in which it operates, requires a certain amount of capital expenditures. Land has to be bought, factories have to be built, machinery has to be purchased, and so on. However, less may be more when it comes to outlays for property, plant and equipment, as companies that constantly have to upgrade and change their facilities to keep up with competition may be at a bit of a disadvantage.
However, another way of looking at it is that large amounts of money invested in this area may present a large barrier-to-entry for competitors. Right now, 3D Systems has $41M worth of property, plant and equipment on its balance sheet. This figure is above the $34.4M that the company reported at the end of fiscal 2012, as well as the $29.6M that it reported at the end of fiscal 2011. Of these assets, 64% is in machinery and equipment, while 22% is in buildings and leasehold improvements. The rise in these figures over the last few years stems largely from 35 acquisitions that the company has made since the end of 2009.
Goodwill is the price paid for an acquisition that's in excess of the acquired company's book value. The problem with a lot of goodwill on the balance sheet is that if the acquisition doesn't produce the value that was originally expected, then some of that goodwill might come off of the balance sheet, which could in turn lead to the stock going downhill. Then again, acquisitions have to be judged on a case-by-case basis, as good companies are rarely purchased at or below book value.
3D Systems has $324M worth of goodwill on its most recent balance sheet, which is well above the $240M that was reported at the end of fiscal 2012, as well as the $108M that was reported at the end of fiscal 2011. In 2011, the company's goodwill nearly doubled from $59M at the end of 2010. These increases are due to the 35 acquisitions mentioned above, in which the company acquired businesses that were involved in numerous activities such as manufacturing 3D printers, rapid prototyping, and digitizing film for radiology, oncology, and dental applications.
Overall, goodwill accounts for 30.5% of the total assets of 3D Systems. Usually, I don't like to see goodwill account for more than 20% of a company's total assets for the reason that I discussed at the beginning of this section. Since 3D Systems is currently well above this threshold, this is an item of concern for me.
Intangible assets that are listed on the balance sheet include items such as licensed technology, patents, brand names, copyrights and trademarks that have been purchased from someone else. They are listed on the balance sheet at their fair market values. Internally developed intangible assets do not go on the balance sheet in order to keep companies from artificially inflating their net worth by slapping any old fantasy valuation onto its assets. Many intangible assets like patents have finite lives, over which their values are amortized. This amortization goes as annual subtractions from assets on the balance sheet and as charges to the income statement. If the company that you are researching has intangible assets, with finite lives, that represent a very large part of its total asset base, then you need to be aware that with time, those assets are going to go away, resulting in a reduction in net worth, which may result in a reduction in share price, unless those intangible assets are replaced with other assets.
3D Systems currently has $145M worth of intangible assets on its balance sheet. This is well above the $108M that it had at the end of 2012, as well as the $54M that the company reported at the end of fiscal 2011. These assets consist of customer relationships, patents, acquired technology, and non-compete agreements that were picked up by the company in its numerous acquisitions. Virtually all of these assets have finite lives, which will expire over the next 10 years.
These intangible assets account for 13.6% of the company's total assets. While seeing these assets disappear from the balance sheet is not a good thing when it comes to the company's net worth, the fact that it will be done over a ten-year period gives 3D Systems ample time to replace those assets or bolster its balance sheet in other ways.
Return on Assets
The return on assets is simply a measure of the efficiency in which management is using the company's assets. It tells you how much earnings management is generating for every dollar of assets at its disposal. For the most part, the higher, the better, although lower returns due to large asset totals can serve as effective barriers to entry for would-be competitors. The formula for calculating return on assets looks like this:
Return on Assets = (Net Income) / (Total Assets).
For 3D Systems, the return on assets would be $86.7M in core earnings (non-GAAP) over the last 12 months, divided by $1.06B in total assets. This gives a return on assets for the trailing twelve months of 8.18%, which is decent. I also calculated the company's returns on assets over fiscal years 2012, 2011 and 2010 for comparative purposes. This can be seen in the table below.
Table 1: Returns On Assets At 3D Systems
The numbers shown in the above table are decent returns on assets, and they show that management is doing a good job at making efficient use of what it has as its disposal. These returns have been consistently good over the last 2-3 years, although there hasn't been consistent growth in this figure. However, this is due to the company's asset base, which has grown faster than its earnings, which isn't always a bad thing. This is especially true when considering that the core earnings of 3D Systems have nearly quadrupled since 2010.
Short-Term Debt Versus Long-Term Debt
In general, you don't want to invest in a company that has a large amount of short-term debt when compared to the company's long-term debt. If the company in question has an exorbitant amount of debt due in the coming year, then there may be questions as to whether the company is prepared to handle it.
Right now, 3D Systems has just $184K in short-term debt. This figure is more than dwarfed by the company's free cash flow of $46M. Over the last three full fiscal years, the company has averaged free cash flow of $35M. With this kind of cash flow generation, $184K in maturing debt should not be a problem at all.
Long-term debt is debt that is due more than a year from now. An excessive amount of it can be crippling in some cases. For this reason, the less of it, the better. Companies that have sustainable competitive advantages in their fields usually don't need much debt in order to finance their operations. Their earnings are usually enough to take care of that. A company should generally be able to pay off its long-term debt with 3-4 years' worth of earnings.
Right now, 3D Systems carries just $18.6M of long-term debt, which is well below the $87.9M that the company reported just 9 months ago, at the end of 2012. It is also below the $139M that was reported at the end of 2011. This shows that the company has been doing a great job of paying down its long-term debt.
Over the last three full fiscal years, 3D Systems has averaged $43.8M in core earnings, which is more than double the company's long-term debt. This means that the company could pay off its long-term debt with an amount that is less than six months worth of profit. With the company's cash position, earnings power, and free cash flow generation, this long-term debt shouldn't be an issue.
The debt-to-equity ratio, as normally calculated, is simply the total liabilities divided by the amount of shareholder equity. The lower this number, the better. Companies with sustainable competitive advantages can finance most of their operations with their earnings power rather than by debt, giving many of them a lower debt-to-equity ratio. I usually like to see companies with this ratio below 1.0, although some raise the bar (or lower the bar if you're playing limbo) with a maximum of 0.8. Let's see how 3D Systems stacks up here.
Debt-To-Equity Ratio = Total Liabilities / Shareholder Equity
For 3D Systems, the debt-to-equity ratio is calculated by dividing its total liabilities of $162M by its shareholder equity of $898M. This yields a debt-to-equity ratio of 0.18.
This tells us that 3D Systems is in excellent shape with regard to its debt and equity positions.
The table below shows how debt-to-equity ratio has changed over the last few years.
Table 2: Debt-To-Equity Ratios Of 3D Systems
From this table, we can see that the debt of 3D Systems is very manageable when compared to its equity position. On top of that, the debt-to-equity ratio has declined a lot over the last couple of years. This is great to see when assessing a company's financial condition.
Return On Equity
Like the return on assets, the return on equity helps to give you an idea as to how efficient management is with the assets that it has at its disposal. It is calculated by using this formula.
Return On Equity = Net Income / Shareholder Equity
Generally speaking, the higher this figure, the better. However, it can be misleading, as management can juice this figure by taking on lots of debt, reducing the equity. This is why the return on equity should be used in conjunction with other metrics when determining whether a stock makes a good investment. Also, it should be mentioned that some companies are so profitable that they don't need to retain their earnings, so they buy back stock, reducing the equity, making the return on equity higher than it really should be. Some of these companies even have negative equity on account of buybacks. However, 3D Systems is not one of these companies.
So, the return on equity for 3D Systems is as follows:
$86.7M / $898M = 9.65%
This appears to be a decent return on equity, although nothing to write home about at first glance. In the table below, you can see how the return on equity has fared over the past three years.
Table 3: Returns On Equity At 3D Systems
At first glance, the returns on equity do not look good, due to the downward trend that we see Table 3. However, this is due to the fact that the company's equity position has increased nearly sevenfold since the end of 2010, as the company has paid down debt and effectively managed its other assets. The equity of 3D Systems has increased sevenfold, while the earnings have increased fourfold. This explains the declining returns on equity, which aren't as bad as they appear.
Retained earnings are earnings that management chooses to reinvest into the company as opposed to paying it out to shareholders through dividends or buybacks. It is simply calculated as:
Retained Earnings = Net Income - Dividend Payments - Stock Buybacks
On the balance sheet, retained earnings is an accumulated number, as it adds up the retained earnings from every year. Growth in this area means that the net worth of the company is growing. You generally want to see a strong growth rate in this area, especially if you're dealing with a growth stock that doesn't pay much in dividends or buybacks. More mature companies, however, tend to have lower growth rates in this area, as they are more likely to pay out higher dividends.
Right now, 3D Systems has a retained earnings figure of $49.3M. Below, you can see how the retained earnings have fared at 3D Systems at the ends of each of the last four fiscal years.
Table 4: Retained Earnings At 3D Systems
While the current retained earnings figure of 3D Systems is not impressive, it is miles better than the deficits that the company was posting until the end of last year. In fact, the company has been profitable every year now since 2008, and the profits have been steadily growing, as can be seen by the declining retained earnings deficit that has turned into a growing surplus.
After reviewing the most recent balance sheet, it can be concluded that there are a lot of things to like about the financial condition of 3D Systems. For starters, 3D Systems has an extremely good current ratio, which shows that the company has more than enough current assets on hand in order to meet its short-term obligations in the event that its operations encounter an unlikely disruption. 3D Systems has solid returns on assets and equity, showing that management is making efficient use of the assets at its disposal. The company's short and long-term debt are all but negligible, as its earnings dwarf those figures. 3D Systems has a very low debt-to-equity ratio, which has been declining over the last couple of years. Retained earnings growth has also been very good, as the company is now able to reinvest some money back into its business.
The biggest concern that I have with the financial condition of 3D Systems is its large amount of goodwill, which accounts for just over 30% of the company's total assets. The company has made 35 acquisitions since the end of 2009, for a total of over $400M. If some of these acquisitions don't pan out like management originally thought, then that could have a detrimental effect on the balance sheet, as some of that goodwill might disappear.
While this is not a comprehensive review as to whether 3D Systems should be bought or sold, I think that the company is in very good financial condition at this time.
More information on how I analyze financial statements can be found at my website here. It's a website that I created in order to help people make more intelligent financial decisions.
Thanks for reading, and I look forward to your comments.