3D Systems: There Is No Need To Panic

Apr.30.14 | About: 3D Systems (DDD)


Strong growth in business segments and the organic growth numbers are in line with the industry growth rates.

The bottom-line has suffered due to the focus on achieving higher market share through increased marketing and sales expenses.

The outlook for the year remains intact and the growth in revenues will be higher in the latter parts of the year.

3D Systems (NYSE:DDD) reported its first quarter earnings yesterday, and despite beating the top-line estimates and meeting the bottom-line estimates, the stock lost more than 9% in the regular trading hours. It is surprising to see such a big fall in the stock price despite strong revenue growth numbers. However, the market works in mysterious ways and sometimes a stock is punished purely on the basis of false expectations. Usually, when a company meets or beats the consensus estimates, the stock price is positively impacted. However, in the case of 3D Systems, the difference between the reported numbers and the expectations of the investors was substantial - the investors were expecting the company to beat the consensus estimates by a large margin, which did not happen and the stock price took a tumble.

During the full year results conference call, the management of the company was clear in saying that the growth in the first two quarters will be in line with the expectations and the major portion of the revenues will come in the latter parts of the year. However, the investor expectations were still high despite the management giving hints that the earnings growth in the first two quarters will be on the slower side. Nonetheless, the growth in revenues has been extremely strong and almost all of the segments have shown solid progress.

Click to enlargeSource: 3D Systems First Quarter Presentation

Printers and other products continues to be the largest segment for the company and showed strong year-over-year growth of 53% -- print materials currently accounts for 27% of the total revenues, down from 28% a year ago - however, the growth in this segment also remained strong with year-over-year sales growth of 41%. Services segment is the third largest segment for the company and grew by 38% along with consumer segment, which grew by 150%. One of the most recent acquisitions for 3D Systems was in the healthcare segment (I explained the potential in this article) and this segment is one of the fastest growing segments in the 3-D printing sector - year-over-year growth for healthcare was also strong at 53%; however, I believe this segment will get stronger as the Medical Modeling acquisition gets integrated over the next few months.

It is hard to deny the growth for a company when the organic growth is close to 30% and the company has been beating the top-line estimates for the last 17 consecutive quarters. The organic growth of the company will remain intact as the metal printing business will be fully integrated by the third quarter and then the subsequent integration of acquisition in healthcare will continue to support organic growth. The demand in the metal printing segment is outstripping the production capacity and it will add to the revenues substantially as the company ramps up its production.

Click to enlarge Source: 3D Systems First Quarter Presentation

The growth in revenues is straightforward and does not need much explanation. However, the operating expenses structure of the company needs more focus. First of all, SG&A expenses have seen an increase of 65.4% on U.S. GAAP basis and over 47% under Non-GAAP basis - accounting treatment of certain items under these both systems is slightly different. The total increase in SG&A expenses was $19.2 million and this increase took it to 33% of total revenues from 29% a year ago. The biggest increase ($8.3 million) was due to the compensation expenses as the company increased its marketing and sales staff. Furthermore, in order to reach the new markets, the budget for marketing sales was increased.

Some acquisition costs and expenses along with R&D expenses of the acquired firm are expensed under U.S. GAAP - as a result, the total increase in the SG&A expense has been larger than the Non-GAAP numbers. One of the most important non-cash expenses is amortization expense - there was an increase of $5.4 million in amortization expense during the quarter - this expense is added back to the net income in order to calculate the operating cash flows. Furthermore, the increase of 165% in R&D has played a part in bringing down the EPS of the company. R&D is an extremely important expense for a company and this expense ensures the long-term competitive edge of the company.

The focus of the company has been to grow its top-line by expanding into different geographic regions and segments. 3D systems wants to have the largest market share and enhance its margins later by selling larger volumes and bigger market share than its competitors. The cash position of the company has been unchanged during the last year ($306 million) despite increased SG&A and R&D expenses. At the moment, the company is operating at a lower operating leverage, meaning each new sale is adding less to the gross margin of the company. A company operating at a high operating leverage means each new sale adds more to the margins. This means that 3D systems has high variable costs and lower fixed costs; as a result, as the production is increasing its variable costs are increasing resulting in lower addition to the gross margin. The management expects the operating leverage to come back by the end of 2015. It means that for the next 12-18 months, the addition to the gross margin will be low.

So, what can we take away from going through the revenues as well as the expenses of the company?

  1. Revenue growth remains strong with organic growth close to 30%, and the latter parts of the year will result in even higher revenue growth.
  2. Earnings of the company will remain under slight pressure due to the focus on increasing market share by spending heavily on the sales and marketing efforts.
  3. Outlook for the year is intact and the company is confident in meeting its targets for the full year.
  4. Recent movements in the healthcare segment (Medical Modeling) and the expansion in South American markets (Robtec Acquisition) will support the company policy of segmental and geographic expansion.

Bottom Line

The 3-D printing sector has been under pressure recently as the major players have been focusing on expanding the market share by spending more on sales and marketing. As a result, the earnings of these businesses have suffered. However, the strategy to grow the business in the short term to ensure the long-term growth is commendable, in my opinion. Markets usually look at the numbers and the reaction was a bit hasty in yesterday's post-earnings trading. In my opinion, the long-term growth story of the company is intact and the stock will make a strong recovery. Most of the analysts have price targets between $60-100 for 3D Systems, and I agree with these valuations as I believe the strong expected growth in the sector will support the growth in the fundamentals of the businesses operating in this sector.

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. This article is for educational purposes only and it should not be taken as an investment recommendation. Investors are urged to do their own due diligence before making any investment decision.