Now that the dust has settled around 3D Systems' (NYSE:DDD) disappointing second-quarter earnings, it's a great time for investors to dig into the report to determine if the long-term investment thesis remains intact. While 3D Systems' earnings highlighted a few areas of concern to watch going forward, investors should ultimately continue to have faith that the company is positioning itself to deliver on its long-term growth potential and will participate in the overall rise of 3D printing.
Breaking down the disappointment
For the quarter, 3D Systems grew revenue by 25% year over year to $151.5 million, which translated to $0.02 a share in unadjusted earnings, or $0.16 a share in adjusted earnings. Analysts were expecting 3D Systems to generate $162.3 million in revenue and take home $0.18 in adjusted earnings.
3D Systems' organic growth rate -- revenue growth that doesn't account for acquisitions within the last year -- plummeted to 10% from an impressive 30% the year before. This decline in organic growth could indicate that 3D Systems may be experiencing potential market share losses, execution issues, or isn't making the right kinds of acquisitions. However, it came to light during the conference call that the sharp decline in organic growth can be attributed to product shipment delays for its Cube 3 consumer 3D printer in order to improve the user experience, customers scheduling later deliveries for their polymer 3D printers, and demand for its metal 3D printers continuing to outstrip manufacturing capacity.
To substantiate this claim, management highlighted that the company reported a record order backlog of $31.9 million, underscoring that demand for its products remains strong and the underlying business fundamentals are intact. In other words, after accounting for a strong order backlog, a 10% organic growth rate doesn't appear as weak as the first glance suggests.
Adding to concerns, 3D Systems' gross profit margin compressed by 400 basis points year over year to 47.8%, dragged down by an unfavorable product mix, a one-time inventory writedown related to legacy product obsolescence, and a concentrated number of future product releases that carry high up-front manufacturing tooling costs in the short term. Going forward, management expects that gross margin will rebound as manufacturing costs are normalized, inventory writedowns disappear, and 3D printing materials' profit margins rebound.
It wasn't all bad
During the quarter, 3D Systems' design and manufacturing revenue rose 28% year over year, driven by a 126% increase in units sold, suggesting that its flagship products are being well received. Over the long term, a growing installed base of 3D printers should help 3D Systems drive a long-term stream of recurring revenue growth through the sale of highly profitable proprietary materials that are consumed as its 3D printers are used. Going forward, investors should acknowledge that material sales will likely become an increasingly important driver of 3D Systems' overall profitability as the company continues growing its installed base with faster and even more capable machines.
Meanwhile, 3D Systems' healthcare-related businesses continued to shine, reporting a 46% year-over-year increase in revenue, and has grown to represent more than 18% of the company's total revenue. With the company's solid growth and tremendous potential, 3D Systems investors should expect that it will continue building out its healthcare portfolio to better cater to the needs of personalized healthcare applications.
What's more, 3D Systems' services bureau, Quickparts, which allows customers to take advantage of 3D printing without needing the technical expertise, continued to build out its menu of service offerings, helping it drive more than 38% revenue growth year over year. From a strategic perspective, 3D-printing-related services gives 3D Systems an opportunity to showcase its portfolio to prospective customers, which may lead to future product sales.
Investing for the future
Like Amazon.com, 3D Systems is willing to sacrifice short-term earnings for its long-term best interest. In the second quarter, 3D Systems continued its aggressive pursuit of becoming The Everything 3D Printing Store by investing heavily in research and development, building out its sales channel, preparing upcoming products for launch, making new acquisitions, and forming strategic partnerships. Although this aggressive investment strategy isn't applauded by every investor, it demonstrates that management is more concerned with doing what it believes is best for the business in the long run, rather than meeting short-term expectations, which may have little to do with how the business is performing five years from now.
Taking a long-term view
As a long-term investor, it's a wise decision to focus more on how the underlying business is performing rather than how the stock reacted to its most recent quarterly earnings report. While 3D Systems' earnings numbers may have disappointed shortsighted investors, management continues to take a long-term view at the expense of short-term operating results. Ultimately, 3D Systems' commitment to R&D, strategic partnerships, future products, and acquisitions should it help drive long-term earnings growth in a meaningful manner for shareholders.
Considering how the 3D printing industry expected to generate $12.8 billion in revenue in 2018 -- more than quadrupling the $3.07 billion it generated in 2013 -- and how 3D Systems' management expects its operating leverage will be fully restored in 2016 -- prospective investors should have a time horizon of at least three years. In the meantime, be on the lookout for 3D Systems' organic growth rate and gross profit margin to rebound in coming quarters, which would indicate that management is delivering on its promise.
Steve Heller owns shares of 3D Systems and Amazon.com. The Motley Fool recommends and owns shares of 3D Systems and Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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