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3D Systems: Has The Printer Jammed?

November 12, 2012by: Douglas W. House | about:DDD, includes:SSYS

Disclosure:

I have no positions in any stocks mentioned, and no plans to initiate any positions within the next72 hours.

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What is not to like about 3D printing and additive manufacturing? Prototypes can go from CAD to print in lesstime than it takes to drive my kids to school. Once in production, manufacturers canchange productspecifications literally on the fly. Retooling or setup costs? Forget ’em. Mass customization is truly at hand. Theflexibility and nimbleness that this technology offers producers is truly profound. The

Economist

calls it"transformative." It represents a new paradigm in manufacturing.I agree with this assessment of 3D printing’s potential. My bullish opinion has onlygotten stronger since I wroteanarticle on the subject back in March, 2011. It is truly a game changer.The advantages are so great that rapid market adoption is as certain as higher taxesin Obama’s second term.Wohlers Associates, a leading consulting firm in the industry, states that the annual growth rate is approaching30%. Every article I read says the same thing. The 3D printing tsunami is going to overwhelm all alternativemethods for low-to-medium production volumes. I suspect that printer makers will have to work overtime tokeep up with demand. Anyone who has at least a cursory knowledge of 3D printing knows that Stratasys (SSYS) and 3D Systems(DDD) are leaders in the field. The latter firm’s performance over the past several years has beenextraordinary.Sales are growing at ~50%, earnings ~75%, common shares have skyrocketed from a low of $1.88 in March,2009, to a high of $46.92 on November 9. Mutual fund ownership has increased from 162 to 238 over the lastfour quarters. Consensus FY12 earnings growth is projected to be 68% and FY13’s 29%.On October 25, DDDannouncedrecord results and increased its FY12 guidance.In the IBD database, DDD sports a stellar EPS rating of 98, a composite rating of 99(highest possible), an "A"timeliness rating, an "A" institutional sponsorship rating and a "B" accumulation/distribution rating (net buying).DDD’s industry group is also a leader, sporting a 98 rating. Its group, Machinery - MaterialsHandling/Automation currently ranks 4th out of 197 groups. My heart is racing as I type this.You can imagine how dismayed I was when, on October 23, I read Gray Wolf Research’sarticle asserting thatDDD’s extraordinary growth rate is not extraordinary at all. Wolf claims that management overstates itsnumbers by employing dodgy accounting vis-à-vis its numerous acquisitions. Sounds serious.This is Wolf Research’s first contribution to SA. It literally dropped a bomb in themiddle of a scrum of backslapping and high five’s. Who do these guys think they are? They must have cantaloupe-size brass ballsto publish a negative article just as the celebration reaches a fever pitch. Since Ialways pay close attention tonegative articles, though, I decided to investigate.I reviewed DDD’s most recent10-Q. I noticed that the company purchased Z Corp and Vidar Corporation inJanuary of this year. Z Corp, based in Burlington, MA, manufactures 3D printers thatprint in various colors.

3D Systems: Has The Printer Jammed? - Seeking Alphahttp://seekingalpha.com/article/999501-3d-systems-has-the-printer-jammed1 of 1011/15/2012 9:23 PM

Vidar, based in Herndon, VA, manufactures analog-to-digital film scanners for the healthcare industry. They areentirely separate businesses. DDD, however, combines the two companies in its reporting.Itdoes not disclosemuch and what little is there has to be massaged a bit to clarify a couple of scant revenue numbers. Why isthis?The only reason I can surmise is that management is hiding something. Obfuscation isan irresistible sirensong for me so I decided to look closely at what DDD is doing. What did I find?Gray Wolf Research is right.

Acquisition Analysis

3D Systems’ serial acquisition behavior began in 2009. Its financial performance hasramped up in perfectlockstep with its "grow-by-acquisition" behavior. It is a hockey stick. Here are DDD’s operating results for themost recent thirteen fiscal years:

(click to enlarge)

Now here are the growth rates:This spreadsheet tells the story is stark detail. DDD’s average annual revenue grew only 3% in itspre-acquisition period (FY00 - FY08). Also notable is that COGS and operating expenses grew faster thanrevenues and gross profit hardly grew at all. If these trends continued, well...


The "stimulating" effect of its acquisitions becomes apparent when the calculation period includes all thecompleted FY’s (00 - 11). Now revenue growth averages 7% (almost in line with GP growth) and operatingincome growth expands to ~10%. Including FY12 (annualized) further improves the numbers.When we focus on the acquisition period, however, we see the true steepness of the hockey stick. Using FY08as the base year (the acquisitions began FY09) and calculating the growth rates through FY11, averageannual revenue jumps up to ~18%, GP to ~25% and operating income to a healthy 319%. If we include FY12(annualized), the numbers leap again. Now revenue growth explodes up to ~34%, GP to ~45% and operatingincome to an eye-popping ~690%.I have heard of acquisition synergies before, but this is truly extraordinary. How can a low growth company,only a few years removed from near-bankruptcy, now outperform 99% of all publicly traded companies? Is the3D printing market growing exponentially? Bullish organic growth rarely explains a turnaround this dramatic.DDD’s acquisitions must be jet-fueled. Let’s take a closer look. Here is a summary of its acquisitions:

(click to enlarge)

When DDD buys a company, it immediately incorporates the acquisition’s revenues intoits own. This is howthe CFO, Damon Gregoire, explained it in DDD’s Q3earnings call:"

Specifically, we count newly acquired business revenue from the date of acquisition until its12-month anniversary as acquired revenue. From its 12-month anniversary forward, we add theactual total first year revenue to our total base and count only the incremental revenue growthgoing forward on our total base as organic revenue."

What he is saying is that DDD excludes the acquired firm’s revenues prior to the acquisition date. The acquiredrevenue "grows" from zero on the date it is bought. The Z Corp/Vidar acquisition exemplifies the impact of thisscheme.DDD purchased both firms in early January of this year. It made this disclosure on p19 of its most recent 10-Q(bold type mine)

: Revenue for Z Corp and Vidar for the thirdquarter of 2012 was $13.3 million and, after taking into account the integration and severance costs, the operating loss for Z Corp and Vidar was $2.2 million.

Onp25, it discloses

: For the first nine months of 2012, Z Corp and Vidar

contributed $40.2 million of revenue

.For the first nine months of 2011, Z Corp and Vidar had revenue of $40.8 million

. The business is flat. Growthis zero. DDD, though, added $40.2M to its 2012 revenue number and counted it as "growth".This overstates DDD’s true growth rate. Through Q3, it posted total revenues of $251.1M representing yoygrowth of 56%. If the Z Corp/Vidar revenues are backed out, then the total revenues are $210.9M. Thisreduces the yoy growth rate to 31%. This single acquisition accounts for a whopping 25% of DDD’s statedrevenue growth (56 - 31).
