3D Systems (NYSE:DDD) will report third-quarter earnings before the market opens on Monday. Wall Street expects the 3D printing company to report $167.7 million in revenue and $0.17 in adjusted earnings per share for the quarter, which works out to year-over-year growth of 23.6% on the top line, and a 34.6% year-over-year decline in EPS.
Rival Stratasys (NASDAQ:SSYS) got earnings season off to a poor start for 3D printing stocks earlier this week, as its disappointing fourth-quarter guidance has sparked fears of an industrywide slowdown. Can 3D Systems stand apart from Stratasys with stronger fourth-quarter expectations? Will it succumb to the same pressures as its peer? Investors will have a lot to look over in 3D Systems' report on Monday; but let's focus our attention on the most important metrics now.
Will 3D Systems' organic growth rate reaccelerate?
3D Systems has been famously acquisitive during the past few years. As a result, it's introduced a new metric into its quarterly earnings reports called organic growth, which reports only the increase in revenue that wasn't from recent acquisitions. Over time, all revenue becomes organic revenue as acquisitions are absorbed into the company; but the gap between overall growth and organic growth is perhaps the single best metric we have as investors for understanding 3D Systems' acquisitive strategy.
In the second quarter, organic growth fell to just 10% year over year, which is by far the lowest organic growth rate 3D Systems has reported since it began offering this metric in mid-2012. The company's overall revenue grew by 25.4%, which implies a sizable contribution from new businesses; but it was still the lowest quarterly revenue growth rate 3D Systems has reported in this decade:
In 3D Systems' second-quarter earnings call, CEO Avi Reichental blamed weak organic growth on a bloated order book, which was, in turn, blamed on demand exceeding the company's manufacturing capacity, as well as on decisions to delay the shipment of consumer 3D printers.
Still, if analyst expectations prove accurate -- 3D Systems only offers full-year guidance -- organic growth may look weak in the third quarter, as well. The bull case for 3D printing stocks depends on gangbuster growth rates, and multiple quarters of 10% or lower organic revenue growth would be a cause for concern. Company executives expect newly acquired businesses to account for less than 10% of total revenue in the second half of the year, so we're bound to get more clarity on this metric on Monday.
Can 3D Systems improve its (adjusted) bottom line?
Both 3D Systems and Stratasys have strayed rather far from GAAP earnings in their quarterly reports, as amortization costs eat into official profits. But unlike Stratasys, which has reported fairly strong adjusted EPS growth for most of the past two years, 3D Systems' adjusted earnings have actually been in decline for some time. If third-quarter expectations hold up, it will be the seventh time in the past eight quarters in which 3D Systems reports lower year-over-year adjusted EPS:
3D Systems has seen its margins -- adjusted and not -- fluctuate quite a bit in recent years. At the start of 2010, the company's net margin -- it didn't report adjusted figures then -- was just 6.4%. From there, it surged to 22.2% in the final quarter of 2012 before dropping a long way back, and its second-quarter adjusted net margin was just 11%, with GAAP net margins at a razor-thin 1.4%. Company executives have offered up a number of excuses in their quarterly earnings calls as to why margins keep dropping, and have been promising margin expansion for a while now to no avail:
2014 second quarter:
During the first half of the year our gross profit margin shouldered a number of factors. The impact of a concentrated number of new product launches ... the end of life for legacy products ... the incremental cost of bringing several manufacturing facilities online ... [A]fter conducting a careful and detailed analysis of the specific drivers, we concluded that our fundamentals are intact and our gross profit margins are poised to rebound and resume their extension trajectory.
2014 first quarter:
[I]t's clear that our anticipated gross profit margin expansion was delayed as a result of our compressed new product transition period and mix ... [but] as we place more printers faster we expect an overall gross profit margin expansion trend over the next few periods, driven by accelerated materials revenue growth as well as higher contributions from software sales and improving services gross profit margin.
2013 fourth quarter:
While it is clear at the moment our gross profit margin expansion is pressured by the substantial printer growth rate, we expect gross profit margin expansion to resume after the temporary margin compression from the heavy concentration of new products and our significant manufacturing expansion. Specifically, we expect continued gross profit margin expansion to be driven by accelerated materials revenue growth, higher contributions from software sales, and improving Quickparts gross profit margin.
2013 third quarter:
While it's clear that our gross profit margin expansion is suppressed by the substantial printers growth rate that is outpacing all of the revenue categories, it should be equally clear that we expect continued gross profit margin expansion in future periods to be driven by ongoing materials revenue growth, higher contributions from software sales, and improving Quickparts gross profit margin.
The nearly identical phrasing in the latter half of 2013 isn't a misprint -- it's clear that 3D Systems developed a script to explain why gross margins suffered sequential declines since the fourth quarter of 2013, and adjusted net margins were lower year over year in all four of the quoted quarters. The ideal result of greater scale in a growing industry should be improved pricing power, better cost controls, or a combination of both. 3D Systems hasn't shown investors either of these qualities yet, and investors should be very skeptical if management pulls out the same "we'll get it right next time, promise!" excuse that it's used for a year.
What will you be watching when 3D Systems reports on Monday?