When a company is growing as quickly as 3D Systems (DDD 6.25%), in an industry with tremendous promise, it can be difficult to gauge the importance of earnings. Do you ignore profit while the company builds sales? And if the quality of those earnings is difficult to assess because of recent acquisitions, should you just focus on the company's valuation versus its peers?
The short answer is that earnings always count, and even in situations where the herd is snapping up shares largely for future potential, understanding a corporation's current profit or loss can arm you with the confidence to either to jump in or pass on the opportunity. Moreover, it can illuminate which aspects of earnings will be important in the future.
A considerable GAAP
Like many other companies, 3D Systems includes non-GAAP earnings and metrics in its earnings releases and SEC filings. GAAP is an acronym for "generally accepted accounting principles," and publicly traded companies are required to file their financial statements under these guidelines, which seek to ensure that the economic reality of a company is reflected across its financial statements. Corporations are allowed to provide alternative numbers alongside GAAP earnings. According to its most recent SEC filing, 3D Systems asserts that it uses non-GAAP earnings to help investors better understand the impact that numerous acquisitions have had on the company's results.
In the first six months of 2013, 3D Systems' non-GAAP, or "adjusted," earnings were roughly 2.5 times greater than GAAP earnings ($0.40 per share and $0.16 per share, respectively). This is an increase over 2012, when non-GAAP earnings were 1.75 times higher than GAAP earnings in the first six months.
How does management arrive at these adjusted numbers? The most prominent item the company strips out on a consistent basis is amortization of intangibles. In the first half of 2013, adding back amortization improved earnings by nearly 40%.management understandably wants to remove amortization to arrive at what it believes to be a more representative portrayal of earnings. After all, it's a non-cash number -- a way to assign expense to intangible items. Does the expensing of items like patents and licenses really have any bearing on the day-to-day operations of the company?
In 3D Systems' case, amortization has everything to do with earnings, and you should read management's non-GAAP presentations, but not rely on them as the primary view of results. The reason stems from the path the company has taken to grow. If you follow 3D Systems, you're probably aware that it's a serial acquirer of other companies. After sleepily plodding along for most of the 2000s, it began buying up smaller 3-D companies in 2010, and since then, it's been in a royal hurry to acquire revenue and stay ahead of rivals such as Stratasys (SSYS 3.54%). Since 2010, the company has generated $125.3 million in operating cash, yet it has raised almost $590 million through stock and debt issuances, and it's used up $381.7 million of that cash to fund acquisitions.
As a result, goodwill and other intangibles are now the largest assets 3D Systems owns. The following table and chart give us a sense of the proportion of these assets to tangible assets:
| Balance Sheet Category | Size in Dollars |
|---|---|
| Goodwill and Intangible Assets | $437,567 |
| Cash and Equivalents | $349,255 |
| Accounts Receivable, Net | $111,459 |
| Inventories | $49,771 |
| Equipment, Net | $36,466 |
| All Other | $19,847 |
| Total | $1,004,365 |
Source: company SEC filings. All dollar figures in thousands.
Here's a case in point: In its SEC filings, 3D Systems discloses that it has spent $89.6 million cumulatively on the acquisition of customer lists. Accounting for the portion that has already been amortized, that's still $77.6 million, or nearly 8% of the entire asset base, that's been attributed to customer acquisition. As a shareholder, you want to follow the amortization of this asset, and you want to see net income on the books even after the amortization is taken into account. In this way you'll be comfortable that 3D Systems is using its customer lists in an efficient and profitable manner. In a global sense, because of the amortization of intangibles, 3D Systems has a much higher cost of sales (both operational and general/administrative) than one might realize from just looking at non-GAAP earnings.
Goodwill: not amortized, but significant
Goodwill presents a slightly different situation. In financial reporting, goodwill is a balance sheet account. When a corporation acquires another company for more than book value, it records the excess in this account. Companies are no longer required to amortize goodwill; rather, they test goodwill each year for "impairment." Expense is recognized only if management determines that the value of the goodwill has declined.
For 3D Systems, which has grown primarily through acquisition and has a proportionately large goodwill account, reviewing GAAP earnings can help an investor discern whether the company is generating reasonable income from the acquired assets. While there is no recurring amortization bar as with intangible assets, prolonged GAAP losses are a potential flag that a company has overpaid for its acquisitions.
Earnings going forward
So far, 3D Systems has credibly delivered earnings on a GAAP basis: It's shown a profit in each of the past three fiscal years since beginning its acquisition spree. Going forward, look for differences between unadjusted net income and non-GAAP earnings to decrease over time, as organic revenues replace acquired revenues, and net intangible assets decrease because of amortization. Increasing GAAP income will be a decent indicator of 3D Systems' progress. But decreasing GAAP income in the future will serve as a cautionary flag -- a reason to peel back the onion when reading through the company's quarterly earnings, and reach comfort (or not) with the stock price, given the company's typically high valuation.
