Stratasys Ltd. (SSYS 3.81%) announced solid first-quarter 2014 results on Friday before the market opened. The 3-D printer maker's revenue for the quarter jumped 54% to $151.2 million, handily beating analysts' expectations of $143.3 million. This included strong organic growth of 33%, plus the contribution from MakerBot, which it acquired it 2013. Adjusted earnings per share of $0.40, while down 7.5% from the year-ago period, hit the consensus on the bull's-eye. On a GAAP-basis, EPS improved to $0.08 from -$0.40. So, yes, investors, Stratasys has now returned to profitability on a GAAP basis for the first time following its 2012 megamerger with Objet.

Highly valued, high-growth stocks like Stratasys have fallen out of favor in 2014. So it's no surprise that the market sent shares tumbling about 10%, though shares partially recouped their losses to close the trading day down 4.7% at $89.90. One likely reason for the sell-off was that Stratasys merely reaffirmed its previous 2014 guidance, while many investors were undoubtedly hoping for a bump up. A similar scenario recently played out when prime competitor 3D Systems announced its Q1 earnings. Expecting a guidance raise after just one quarter seems unrealistic, so I don't think investors should view this as a negative.  

Shares of Stratasys are down 33% in 2014, though they're still 8.2% in the green for the one-year period.

Moving beyond the headliner numbers and market reaction, here's what investors should know.

Revenue growth continues to roll nicely along
Stratasys sells 3-D printers and print materials (or "consumables") and provides services, which include on-demand 3-D printing services and maintenance contracts for its printers. Here are key revenue stats for the quarter:

  • Total revenue increased 54% to $151.2 million.
  • Product revenue increased 58% to $129.5 million.
  • Within products, hardware revenue grew 71%, while consumables revenue increased 36%.
  • Service revenue increased nearly 41% to $21.7 million.
  • Overall organic growth (excludes MakerBot's sales) was 33%, which tops 3D Systems' first-quarter organic growth of 28%.
  • Within products, hardware revenue grew 40% organically, while consumables revenue increased 29% organically.
  • MakerBot generated revenue of $20.6 million, a 79% increase over the revenue it generated as an independent company in Q1 2013.

Continued strong demand for the company's 3-D printers bodes well for future growth of print materials. Consumables are a key reason that both Stratasys and 3D Systems are powering up their efforts to capture as much market share as fast as possible. The more 3-D printers these companies install, the more reoccurring revenue from material sales they should receive, since most 3-D printers use proprietary materials. Consumables generate higher than companywide profit margins, so they boost earnings.

Here's a look at the revenue trend picture since Q1 2013:

Source: Stratasys.

Service revenue has been steadily increasing on a sequential basis. Product revenue for the first quarter was down from Q4 2013, though that's because the fourth quarter is historically a strong quarter. This end-of-year strength will likely further increases now that MakerBot, which heavily sells its desktop units to the consumer and "prosumer" markets, is in the fold. So there's no need for concern here. 

Gross margins up, profitability down, as Stratasys invests for future growth
Some key margin stats for the quarter:

  • Adjusted gross margin increased to a record 60.9%, from 59% in the prior year's period. This is especially notable since MakerBot continues to grow faster than Stratasys' overall business, and MakerBot's margins are lower than Stratasys' overall margins.
  • GAAP-gross margin jumped to 51.5%, up from 38.4%.

Overall gross margin has generally been trending up sequentially since Q1 2013. The service gross margin has been the driver here, as the product gross margin has been flat.

Source: Stratasys.

CEO David Reis stated: "The rapid adoption of our higher-margin products and services remained impressive during the first quarter, which helped drive strong organic revenue growth of 33% during the period and contributed to a significant increase in our gross margin over last year." The product part of Reis' statement isn't obvious from the preceding chart. While overall product gross margin has remained flat, it's important to keep in mind that Stratasys closed on MaketBot in the middle of Q3 2013, so MakerBot's lower-than-product-average margins have exerted downward pressure on Stratasys' product margin. So for the overall product margin to remain flat, it's obvious that there has been solid growth in the higher-margin products to offset the effect from MakerBot. 

Reis expounded on this topic during the conference call, saying that advanced prototyping and final parts manufacturing applications are driving the demand for the higher-margin printers. More specifically, the company is experiencing strong demand for its PolyJet and Fortus lines, as well as its new Objet500 Connex3 Color Multi-Material 3-D Printer. He attributed the increasing service margin to two primary factors: increased customer uptake of maintenance and service contracts, because of the increase in sales of higher-end printers; and greater efficiency in its on-demand 3-D printing service business. 

The increase in adjusted gross margins didn't make it down to the operating and profit margins levels, causing Stratasys' EPS to fall 7.5% from the year-ago period. Decreased profitability, however, was expected because of the company's growth strategy of sacrificing short-term profits for spending on activities aimed at fueling long-term growth and capturing market share. Stratasys ratcheted up its sales and marketing spending in the quarter, which resulted in increased operating expenses, and a lower operating margin. 

Source: Stratasys; SGA = selling, general, and administrative.

Key business highlights
Among the quarter's key business highlights, Stratasys:

  • Announced agreements to buy Solid Concepts and Harvest Technologies, which both provide on-demand 3-D printing services.
  • Experienced strong demand for the Objet500 Connex3 Color Multi-Material 3-D Printer, the world's first 3-D printer that can print in multiple colors and materials.
  • Began shipping the MakerBot Replicator, and announced the availability of the MakerBot Replicator Mini Compact and MakerBot Replicator Z18 for preorder, with shipping expected before the end Q2. 
  • Closed the acquisition of select assets of Interfacial Solutions, designed to strengthen materials R&D.
  • Completed the global alignment of the company's operations and R&D that resulted from the Stratasys-Objet merger.

Solid Concepts is the largest independent 3-D printing services operation in North America, while Harvest Technologies has expertise in advanced parts production and materials. Both deals are slated to close early in the third quarter and are expected to be accretive to Stratasys' non-GAAP earnings within one year of closing.

The Objet500 Connex 3 printer was introduced in Q4 2013 and should open up many new opportunities in advanced prototyping. The three Replicator 3-D printers were also introduced in the previous quarter and have also experienced strong early demand. 

Guidance for 2014 reiterated
Stratasys reiterated its previous guidance, though Reis stated on the call that the company would reconsider its guidance once the acquisitions of Solid Concepts and Harvest Technologies have closed. 

The company reaffirmed that it expects adjusted EPS for 2014 in the range of $2.15-$2.25, GAAP EPS between $0.20 and $0.38, and revenue of $660 million-$680 million. Going into earnings, the consensus estimates were for adjusted EPS of $2.21 on revenue of $674.8 million. So analysts are expecting both revenue and earnings to be a bit higher than the midpoints of Stratasys' guidance. Further, Stratasys reiterated that it expects organic sales, which exclude MakerBot sales, to grow at least 25%; MakerBot is expected to grow at a higher rate.

The 2014 guidance at the midpoint implies revenue growth of 37.7% and adjusted EPS growth of 19.6%.

Foolish final thoughts
Stratasys turned in a solid earnings report, and there doesn't appear reason for long-term investors to not stay the course. The 3-D printing sector is projected to grow more than 20% annually through 2021, and Stratasys remains one of the top players in this fast-growing space.

An increasing gross margin and strong organic growth both bode well for the future. However, investors need to monitor gross margins going forward as the acquisitions of the two service bureaus could exert downward pressure on margins. Stratasys is surely playing a long-term game and undoubtedly believes it will be able to more than offset any near-term downward margin pressure because of the increased service offerings by growing sales of its higher-margin segments over the long term.

A positive for investors is that Stratasys' digestion of the Objet merger is essentially completed, which means investors should be able to get a clearer picture of how the combined entity is performing going forward.